Throw This Stock Away

The house rules are simple in this weekly column.

  • I bash a stock that I think is heading lower.
  • I offset the sting by recommending three stocks as portfolio replacements.

Who gets tossed out this week? Come on down, Youku.com (NYSE: YOKU  ) .

Almost done with the tenth chapter
Shares of China's fast-growing video-streaming website soared 30% yesterday, after Youku officially launched a pay-per-view platform.

Partnering with Time Warner (NYSE: TWX  ) to offer 400 to 450 movies over the next three years is good news, but was it worth a better-than-$860-million pop in Youku's market cap given the company's more than 105 million outstanding ADS equivalents?

Spoiler alert: No!

For starters, Youku Premium has been in beta for months. The test has included Time Warner titles. Some will argue that Time Warner's move validates the model, but I remain skeptical.

Is China ready to pay for piecemeal streams when it's been a hard sell domestically? Outside of the success of Netflix (Nasdaq: NFLX  ) -- a completely different model given its cheap smorgasbord value proposition -- dot-com darlings and upstarts alike have struggled in getting folks to belly up to the virtual box office and shell out real money for premium streams.

Youku claims that it has sold 200,000 streams since Youku Premium went into beta eight months ago. This may seem encouraging, but how much are folks paying during this promotional period? Will it ever be enough to move the needle in what is now a $3.8 billion company?

Youku is growing fast. Revenue soared 163% in its latest quarter but only up to $19.5 million. The company is targeting a top-line spurt of 125% to 135% in the current quarter. The problem is that between content licensing fees, bandwidth costs, and corporate overhead, Youku is losing a lot of money. Some analysts believe that Youku will post a small profit next year, while others are holding out until 2013. Either way, Youku may never be the high-margin producer that typifies the handful of elite Chinese Internet stocks.

Youku isn't the YouTube or Hulu of China. It's the leader, but this is still a crowded niche with Youku competing against Todou, PPLive, and even the smallish Ku6 (Nasdaq: KUTV  ) for eyeballs.

Shares of Youku have come down sharply since peaking at nearly $70 two months ago, but the stock is still too expensive for a company that has yet to turn the corner or prove that it can generate great sums of revenue.

Good news
As I do every week, I don't talk down a stock unless I have three alternatives that I believe will outperform the company getting the heave-ho. Let's go over the three fill-ins.

  • Google (Nasdaq: GOOG  ) : YouTube has been offering piecemeal digital rentals since early last year, and it's been a hard sell. The difference here is that YouTube's parent Google is very profitable. The world's leading search engine is also pretty cheap, fetching just 15 times this year's projected earnings and less than 13 times next year's target. It's not growing nearly as quickly as Youku, naturally, but the downside protection is there.
  • Sohu.com (Nasdaq: SOHU  ) : If you don't think that successful Chinese dot-coms can be had for Google-esque multiples, check again. Sohu -- which also happens to run a popular video-streaming site through its portal -- is also trading for 15 times this year's estimates profits and 13 times next year's mark.
  • IMAX (Nasdaq: IMAX  ) : It remains to be seen if folks are willing to pay up for streams in China, but they certainly have no problem paying a premium for an enhanced cinematic experience. China has quickly become IMAX's largest market outside of the United States, and the world's most populous nation is showing no signs of slowing. Investors looking for a more China-centric play on cinema may want to consider IMAX is an attractive investment here, especially now as a misunderstood international company.

I'm sorry, Youku. The fundamentals just don't justify the lofty share price right now. Youku Premium isn't a platform: It's a valuation call!

The Motley Fool owns shares of Google. Motley Fool newsletter services have recommended buying shares of Netflix, Google, Sohu.com, and IMAX, as well as buying puts in Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Longtime Fool contributor Rick Munarriz doesn't mind taking out the garbage every so often. He does not own any of the stocks in this story, except for Netflix. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.


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