Can This Company Profit as the "YouTube of China"?

After the Hong Kong Televsion Broadcast Limited deal on Tuesday, fellow Fool Rick Munarriz made compelling points for Youku Tudou (NYSE: YOKU  ) to become the "Netflix of China" with a subscription-based model.

However, I’m not so sure the online video giant should abandon its YouTube-ish roots. It would put Youku Tudou in more direct competition with such online video giants as Baidu’s (NASDAQ: BIDU  ) iQiyi and Sohu (NASDAQ: SOHU  ) TV, both of which have carved out strengths in distributing professional content.

Looking at long-term demographic trends in China, Youku Tudou’s continued focus on user-generated videos -- similar to Google's Youtube -- may best lead the way for long-term profits and shareholder returns.

Why competition could crush Youku Tudou’s hopes
Youku Tudou displayed serious hopes to become a purveyor of all kinds of online video with its Hong Kong TVB deal. Not only will it receive 2,500 hours of exclusive content per year (including current and past TV shows), but the deal also opens the way for co-producing original content.  

Given the company’s position in the online video market, it’s not hard to see why Youku Tudou made the deal and thinks it can make the transition.

Video Site

Hours Watched

Parent Company

1. Youku.com

698M

Youku

2. iQiyi.com

569M

Baidu

3. V.QQ.com

474M

Tencent

4. TV.Sohu.com

406M

Sohu

5. Tudou.com

291M

Youku

Source: We Are Social. For Aug. 2012. Tencent is not a U.S.-listed stock.

Youku Tudou outpaces the competition in number of hours watched. Youku.com alone attracted 129 million more hours watched than its nearest competitor, iQiyi.com. And once you combine Youku.com and Tudou.com together (the companies merged in 2012), you’ll see that they trounce the competition.

So while Youku Tudou has the lead, it believes that it can continue to dictate its position in the market, whether that be a purely user-generated video website or something more.

However, I think that the company is underplaying the first-mover advantage that its competitors have already carved out in their online video niches.

Baidu acquired iQiyi.com last year because of its leadership in providing full-length movies and TV shows. In the latest earnings release, Baidu announced that it will continue to step up its "investments and [increase] sales and marketing efforts to ensure [iQiyi] captures the huge opportunities ahead." iQiyi.com is the No. 2 most watched video site for a reason, and could be for some time. 

Meanwhile, TV.Sohu.com has the variety show and, especially, the American TV audience in China locked down. Specifically, Sohu’s American TV views jumped 136% from the third to the fourth quarter -- thanks in part to popular shows such as "Breaking Bad" and "Modern Family." And given that American TV viewers are often of higher educational and wealthier backgrounds, it’s likely that Sohu will continue to dig out its niche to draw in higher-end advertisers. 

So, in a sense, Youku Tudou has few places to go. Of course, it shouldn’t give in without a fight, but with iQiyi’s lead in domestic, professional content and Sohu TV’s strength in variety and American shows, Youku Tudou may have to concede hopes to become a subscription service of premium content like Netflix.

That’s no matter because Chinese trends still favor Youku Tudou.

3 demographic reasons to favor Youku Tudou
First, Youku.com is No. 1 in terms of hours watched because of its focus on providing short, user-generated videos, which is what really appeals to Chinese online viewers. Moreover, Tudou.com is also a user-generated video website, so altogether the company is the 800-pound gorilla of China’s online video market.

Second, Chinese netizens love social, and Youku Tudou best caters toward sharing. Based on a McKinsey April 2012 report, 91% of China’s netizens use social media and 88% of them are active users. (For comparison, only 67% of U.S. netizens use social media.) Though these trends may mostly refer to social media sites such as Sina Weibo, the statistics are important because it shows that the Chinese like to share. Because Youku Tudou is primarily a user-generated video website, you can find similar online activity seen between Google’s video bloggers on YouTube.  

Third, the number of netizens will no doubt grow. As of January, only about 42% of China had desktop access to the Internet. That’s only 564 million people of the country’s 1.3 billion population. Back in Sept. 2012, Youku Tudou reported 475 million unique visitors a month, or about 84% of China’s online citizens. So, like China, Youku Tudou has plenty of room to grow. 

Youku is probably a good long-term buy
I’m sure there’s a reason Youku Tudou could beat out Baidu’s iQiyi or Sohu TV and become the "Netflix of China," but its core business is appealing enough.

As the Chinese continue to come online in droves, they’ll want to share more of their lives and connect via short, self-made videos. Currently, Youku.com and Tudou.com have been, are, and will continue to be the best places to share videos.

With an increasing audience, Youku Tudou should have no problem earning millions, perhaps billions, in the future as the "YouTube of China."


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