YUKO - In a crowded place

Backgrounder on China Online Video portals:  

Chinese video-sharing market, started with +200 copycats of Youtube. By 2010 many closed shops due to cash burn and I expect this consolidation to be complete by end 2011. Similar to Youtube, china video portals rely on advertisement revenue. However instead of user-generated content, chinese viewers use these portals to consume traditional, commercial media content like soaps and movies. The success of Netflix.com has established subscription model as a monetization method and I believe, the winner would emerge from this direction. NFLX partnership related news flow could thus be a significant catalyst. 

86.4% of China internet users watch video online, which is close to 340 million. As per i-research, total effective browsing time in Q1 2011 was 3.64 billion hours, up 22.1% from the previous quarter. The online video market in China is estimated to grow 12 folds from $210million in 2010 to $2.5billion by 2013. In Q1 2011, three online video portals, Youku(YOKU), Tudou and Qiyi(61% owned by BIDU), combined represent over 70% market share by effective browsing time. Other upcoming players are Sohu(SOHU) and KUTV of Shanda group. It is to be noted that, the effective browsing time of Qiyi.com more than doubled from 250 million hours in Q4 2010 to 560 million hours in Q1 2011.  

  

YOKU

YOKU is a listed pure play video portals and has a Hulu like advertisement model. Number of unique visitors and time spent at site are important variables for this model. It served 231 million unique visitors in March 2011, a 10% increase qoq. According to Google Planner, in terms of unique visitors, YOKU ranked in the top five in China and top 15 worldwide in each month of 1Q2011, an improvement from last year’s 7th and 19th respectively.

  

YOKU recently launched a Prepaid Channel. It is a very small percentage of revenue and covers movies and educational videos for subscribers similar to NFLX business model. Keeping content timely and plentiful through content supply agreements with various video/TV show producers, distributers and copyright owners is a significant variable in this business model.  At end 2010 YOKU had copyright licenses for 2,200 movies, 1,250 TV shows and 194 videos clips. Due to competition among video websites, licensed content costs are high and expected to remain above 22% of revenue for 2011. However, 2011 will also prove to be the year of consolidation for video portals and then content costs should stabilize. As copyright restrictions grow tighter and the costs of purchasing TV rights increase, video sites such as Tudou and Youku have all begun to produce their own online shows, in a move that may vertically integrate content providers and distributors.

Another boost for online video would be Smart TV for internet video, online shopping, playing games, reading news, social chat etc. Smart TV like Smartphone, will be driven by software application and platforms for service/content providers. In China, Skyworth, Hisense, TCL and Lenovo have released their first Smart TV products this year and the trend would grow further in 2012. It is estimated that by 2015, 32.4 million Smart TVs will beat traditional TVs with 54% market share. Thus delivery platforms e.g. android and iOS applications (widgets) for tablets, set top box and game console applications, will be crucial to assess success of the subscription model. Youku estimates that such widgets have been pre-installed on approximately 14.5 million Internet enabled mobile phones with over 3.8 million iPhone users and over 600,000 iPad users, making both the number one online video application in the Chinese iTunes store. TCL has just released its first Window 7 based Smart TV in early May, with partnership with Youku, PPS etc internet companies.

For video portals bandwidth and content acquisition costs are the major cost factor. Bandwidth costs represented 44% of net revenues in 1Q2011. The business has inherent operating leverage due to semi-variable nature of bandwidth costs and fixed nature of content costs.

Catalysts:  Monetization news flow (advertisement or subscription), Leadership position in market share, Revenue growth is the key feature to tamper the high P/S.

Valuation:  YOKU has lofty valuations from every angle at its current $32. PE is not applicable due to its early growth phase. P/S is the only relevant measure and it stands at 50x. For such a multiple to sustain, YOKU must register yoy growth of +100% in revenue for at least next 2 years. Each quarter of 2011 should exhibit +150% in order to reduce this multiple to around 30 by year end.

Considering the competitive winds, these are stretched valuation and targets. I expect the stock price to continue move towards $20 - 25.