China's largest online video company, Youku Inc, yesterday inked an agreement to merge with its immediate domestic rival, Tudou Holdings, through an all-share deal that is valued at more than $1 billion. The transaction will combine two companies that jointly account for one-third of China's online advertising market, yet it remains to be seen how dominant the new group will be.
The merger comes as a surprise since the two US-listed companies, which are referred to as China's equivalent of YouTube, have until recently been bitter competitors. Sources say the deal was agreed following several rounds of negotiations over the past few weeks, which underlines both parties' urge to fortify their foothold in China's vast, yet competitive, market.
The combined company will be named Youku Tudou and will have a total equity market value of $4.2 billion. Following the takeover, Tudou’s current shareholders will own a 28.5% stake in the combined group, resulting in an acquisition value of about $1.2 billion.
They will receive 1.595 new American depositary shares (ADS) issued by Youku for every existing Tudou ADS, which values Tudou at $39.89 per share – a 159% premium to Friday's closing price of $15.39.
“The companies made this arrangement after assessing each other's contribution to the new group, including their online traffic and advertising revenue,” said one source. The merger will “help them to reduce costs. Much of their content is duplicated, so they can upload twice as many ads with the same content,” he said.
The new company will also have a leading market share across a number of important metrics, including unique visitors, click views, time spent and advertising revenue. However, both companies are still loss-making.
The significant premium to the latest close gives Tudou’s shareholders a chance to realise a decent return on their investments. The company listed on Nasdaq in August last year after raising $174 million from an initial public offering that was priced at $29 per ADS. The share price fell 11.9% on the first day and has never returned to the IPO price.
Tudou was initially planning to launch the IPO at the end of 2010, around the same time as Youku went public. However, the divorce of its founding CEO, Gary Wang, prompted questions about the ownership of the company that needed to be cleared up first. The delay meant that Tudou lacked the funds to compete with Youku on an even basis in the first six months last year and its market share suffered as a result. So, it came as no surprise that Tudou wanted to go ahead with the listing as soon as the ownership question was resolved. Unfortunately that meant it came to market the week after S&P’s downgrade of the US and at a time of heightened investor concerns about the accounting accuracy at Chinese companies.
Youku, on the other hand, had a very strong debut following its $233 million IPO. The stock surged 161% on the first day of trading in December 2010 and gained 425% in the first four months amid optimism about internet stocks, but then started to trend lower. Last Friday it closed at $25.01, which was well below its highs but still almost double the IPO price of $12.80.
After the merger news yesterday, Tudou jumped 156.5% to $39.48, while Youku gained 27.4% to $31.85 – its highest close since early August.
Victor Koo, chairman and CEO of Youku, will become chief executive of the new company, while Tudou's CEO, Gary Wang, will join the new entity's board of directors.
Morgan Stanley acted as lead financial adviser to Tudou on the deal and Credit Suisse was a co-financial adviser. Goldman Sachs, Allen & Company and China Renaissance are financial advisers to Youku. The deal is subject to regulatory approval in both the US and China.
The merger comes as observers are still digesting reports about the fierce fight between the two companies, which have been accusing each other of stealing content. At the end of last year, Tudou (which means potato in Chinese) said it would file a lawsuit against Youku for stealing a Taiwanese television show. Tudou has demanded Rmb150million ($23 million) in compensation.
The dispute escalated early this year when Youku accused Tudou of stealing its programmes. Youku sought a court order requiring Tudou to apologise for its alleged unfair competition practices and pay compensation of Rmb4.8 million. A Beijing district court has accepted the case.
However, unlike the many happy-ending films that the two operators are uploading to their websites, the merger doesn't guarantee the enlarged company will live happily ever after. Competition in China's internet market is growing increasingly stronger. Internet giants like Baidu, Shanda and Sohu all have similar products through which they compete for China’s more than 450 million internet users and paid content is still a foreign concept.
Moreover, the Chinese government, in a cultural tightening campaign, has told TV broadcasters to minimise “excessive entertainment” programming that may poison the thoughts and behaviour of people. The government has also told broadcasters what may air at prime time periods in order to create a “harmonious society”.
The government will no doubt be wary of online video companies and make sure that the combined YouTube-clone doesn’t get too big for its boots.
