Youku Tudou Has a Lot to Prove Tomorrow

Youku reports tomorrow, and it will be pretty on the top but ugly on the bottom.

May 21, 2014 at 4:05PM

Online video in China has always seemed like a slam dunk. The world's most populous nation is flocking to the Internet and doing so largely on mobile devices that are ripe for passing the time streaming clips. Popularity has never been the sticking point. The real question is if the growing viewership can be monetized profitably, and that's where Youku Tudou (NYSE:YOKU) steps in.

Youku reports quarterly results tomorrow night. There's no doubting that revenue will grow at a heady pace. Analysts see revenue climbing 38%, perched near the high end of the dot-com darling's earlier guidance that calls for $109.1 million to $115.5 million on the top line. Despite the seemingly scalable nature of the model -- and strength in drumming up advertising to the point where it's accounting for nearly 90% of Youku's revenue -- Wall Street sees it losing as much money as it did a year earlier.

Analysts once believed that this would be the year that Youku finally turns the corner of profitability, but that target has been pushed out to 2015.

Youku and Tudou joined forces two summers ago. The combination made it China's biggest player in online video. Investors cheered the merger, feeling that it wouldn't take long before the synergies kick in to create a profit-generating beast. It hasn't happened. Ad rates still aren't high enough. Bandwidth costs and licensing rights still aren't cheap enough.

Despite the crummy margins, the wild streaming video market attracted China's leading search engine into the fold. Baidu (NASDAQ:BIDU) moved to combine its majority stake in iQiyi with an outright purchase of in a $370 million transaction

It's now open to debate as to whether Youku or Baidu is the top dog in China. A report earlier this year out of Chinese traffic tracker iResearch would put Baidu in the lead -- drawing 94 million active users in March to Youku's 83.5 million unique users -- but that doesn't dive deep enough on engagement and the actual generation of revenue where Youku would seem to have the upper and more experienced hand.

Baidu is paying the price for following Youku into this growing yet low-margin niche. The search giant's profitability isn't growing as quickly as its top line, and clearly it's Baidu's push into online video and mobile apps that's eating away at net margins. However, if we believe at the end of the day that it's all incremental -- and that it's no accident that the world's largest search engine happens to own YouTube -- then it's hard to fault Baidu and Youku trying to take advantage of consolidation in this still fragmented market.

It would be great if Youku offered up a timeline for eventual profitability tomorrow, but for now investors will have to settle for raw top-line growth.

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Rick Munarriz has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Baidu. 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.

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