Last week, Chinese streaming media provider Youku (YOKU: Charts, News, Offers), hailed as the Youtube of China, launched its IPO to massive bullish interest, with its shares surging 161% by the end of the week in three trading days, the strongest Chinese IPO since 2005′s Baidu (BIDU: Charts, News, Offers) offering. While American investors, eager to escape the domestic doldrums of U.S. stocks, are keen to invest in hot IPOs in the second largest global economy, is the hype surrounding Youku justified, or will overly eager investors be left holding the bag in a delayed version of the American dot com bubble?
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While Youku’s business model initially sounds lucrative, providing online streaming video to the world’s fastest growing Internet consumer base, there are realistic concerns about monetizing the business model and keeping bandwidth costs down. These are the same challenges that have kept Youtube from being a profitable investment for Google for four years. There is little technical information about this stock, as the company has yet to post a profit, and the price now is purely dictated by investors whom have yet to settle on Youku’s fair value. The IPO shares, originally priced between $9-$12 USD per ADS, were in such high demand that underwriters boosted the offering price to $12.80 at the last minute. This put the company’s value at $1.3 billion USD, but by the end of the week, the company’s market cap had climbed to $4.4 billion. These are mighty high expectations for a company that has yet to make a single dollar in profits.
Youku’s “Chinese Youtube” nickname has been its hot selling point; but just how does it stack up against its American counterpart? Youtube was sold to Google in 2006 for $1.65 billion, when it served 73 million visitors. In contrast, Youku currently serves 264 million users per month. Similarly to Youtube, the company has been reporting losses, albeit consistently smaller in proportion to revenue. In 2008, Youku posted a net loss of $30.7 million with a negative cash flow of $25.6 million, and in 2009 the company posted a net loss of $27.4 million with a negative cash flow of $20.4 million.
Two thirds of its operating costs comes from bandwidth, and as its user base grows, the necessity for expensive high bandwidth servers increases as well, and its margins will inevitably shrink. The company also has additional expenditures in hiring additional sales representatives to bring in ad revenue from prospective sponsors. In the first nine months of 2010, the company’s revenue increased from $15 million to $35.3 million over the last year. However, this was offset by an increased loss of $25.1 million, significantly higher that its $20.5 million loss last year, which the company attributes to additional sales and marketing expenses.
Youku has stated that the proceeds from its IPO will be used to invest in higher bandwidth capacity, licensed video content, an increased focus on courting advertisers and possibly a subscription-based premium service. From the highly optimistic results of its IPO, the company may just have enough cash to pull its plans off, if management is disciplined enough. Youku claims a 40% share in Chinese streaming videos, with its closest competitor at a distant 23%. Just like Youtube, more views do not necessarily equal more ad revenue, and Youku only has a 14% market share of online-video ad spending in the country. In addition, the company’s risk factors are listed in a 38-page long prospectus that cites risks from Chinese agencies and government intervention.
Looking forward, Youku has several immediate hurdles in its path. Firstly, its business model of online video is an easily replicated one, as copycat sites can flourish quickly and easily given enough bandwidth. Secondly, government censorship and sparse licensing agreements may severely limit the amount of available content on the site. Lastly, if well-equipped and well-financed 800-pound gorilla Baidu launches its own video site, it could quickly make Youku irrelevant. In December 2008, Youku had to temporarily block Baidu and Google (GOOG: Charts, News, Offers) video searches from accessing its site due to an inability to keep up with the increased traffic. Then, there are the lingering fears of China’s attempts to raise interest rates to reduce the chance of a bubble bursting, which some economists forecasts as the next economic crisis. Youku may have promise, but prudent investors should consider all these factors before chasing this hot IPO into a bull trap.
Other News About YOKU
Youku.com, China’s largest online video company, has posted 161% gains for it’s US IPO
Youku makes headlines with its incredible post-IPO gain.
Youku’s IPO: Could This Love Story Break Investors’ Hearts?
A more pessimistic view of this hot IPO.
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Leo Sun is long-time market follower and finance writer. He regularly contributes to the Stock of the Day analysis.
