SHANGHAI (Reuters) - Baidu Inc, China's largest search engine, has agreed with top music studios to distribute licensed songs through its mp3 search service, ending a legal dispute over accusations the company encouraged piracy.
Baidu signed the deal with One-Stop China, a joint venture by Universal Music, Warner Music and Sony Music, for its catalogues and new releases that can be streamed or downloaded from Baidu's servers. Baidu also launched, Ting, a social music platform.
The deal is significant for the recording industry that has seen little profit in China where piracy is endemic and pirated movie DVDs and music recordings are sold for under a dollar.
Music companies gained just $64 million from China in 2010, according to the International Federation of the Phonographic Industry (IFPI), versus $4.2 billion from the U.S. market.
Music studios have long accused Baidu of aiding piracy via its mp3 search that provides links for users to download pirated music. Earlier this year, the U.S. Trade Representative's office named Baidu as a notorious market for piracy.
"It's an important step forward for Baidu now to be working with three of the major companies on a licensed model in China," said Frances Moore, IFPI's chief executive.
"This looks promising for the development of a legitimate digital music business in a market that has for years been largely dominated by piracy," Moore said.
The move by Baidu to legitimize its music search is part of a broader trend in the Chinese Internet space, where online media firms such as Youku, Tudou and Ku6 Media vie for the right to buy and stream legitimate content.
"This deal is really about Baidu evolving its business," said Michael Clendenin, managing director of RedTech Advisors.
Analysts said Baidu's shares could see a short-term boost on the news, but cautioned against projecting too much importance on it at this early stage.
The Nasdaq-listed company's shares have more than tripled in value since Google's partial withdrawal from China in early January 2010. Baidu's shares gained 3 percent to close at $152.56 on Nasdaq on Tuesday.
Under the terms of the deal, Baidu will compensate music owners on a per-play and per-download basis for all tracks delivered through its mp3 search and Ting platform.
The licensed music will be supported via advertising and the music studios will receive a minimum revenue guarantee against the songs streamed or downloaded.
If the advertising revenue exceeds that amount, a revenue split will kick in. If it doesn't, Baidu will still make the payout, said Baidu spokesman Kaiser Kuo.
For the music companies, the deal offers a chance to boost their relatively low revenues from China.
Universal Music estimates sales in China "have the potential to double" over the two-year Baidu deal, a company spokesman said. He declined to provide current sales in the country.
Lachie Rutherford, a director of One-Stop China and president of Warner Music Asia, said "China obviously has the largest population in the world and 450 million people are online, so the scale of the possibility is self-evident."
Baidu is in the process of uploading the music catalogues onto its servers but the firm will not conduct a clean-up of the mp3 search site, meaning links leading to illegal music will remain for now.
Kuo said in the long term, Ting will be Baidu's only music offering which the firm aims to monetize by providing value-added services.
Currently, a search for popular music titles on Baidu's mp3 search brings up a mix of legal and illegal download links.
Baidu said the agreement with One-Stop China was accompanied by an agreement endorsed by the Beijing High People's Court that ended outstanding litigation between all parties involved in the deal.
The U.S. Trade Representative's office welcomed the deal. "USTR hopes that today's announcement signals a new willingness by Baidu, and the larger Chinese internet marketplace of which it is a part, to reject piracy and promote the growth of legitimate online commerce," a spokeswoman said.
Analysts said although the deal is incrementally positive, it could see Baidu paying more for content and the firm may not be able to generate revenue from Ting in the near term.
"I think there will be a higher cost involved and I'm not very sure they can generate the revenue," said Wallace Cheung, a Hong Kong-based analyst with Credit Suisse.
China is the world's biggest Internet market by users with 485 million netizens. Searching for music is one of the top activities for Chinese online users. There were 381 million online music users by the end of June, according to government data.
Earlier in the year, Baidu signed an agreement with the Music Copyright Society of China (MCSC) to pay fees to MCSC for every song downloaded using Ting. Baidu already has an agreement with EMI Group through the one with MCSC.
Baidu also recently removed hundreds of thousands of infringing links from its Baidu Library product after a group of Chinese authors accused the search engine of not respecting copyright laws.
China's search market grew 62 percent in the second quarter to 4.3 billion yuan, with Baidu capturing 75.9 percent of the market.
Reporting by Melanie Lee in Shanghai and Lisa Richwine in Los Angeles; Editing by Ken Wills, Vinu Pilakkot and Tim Dobbyn