Will Investment Ever Stop Flowing Into Chinese Video Sites?

  • Posted by
  • on February 25th, 2010

As I mentioned in my last post, over the last several months money has continued to pour into Chinese online video sites. Baidu (UPDATED with official announcement) raised $ 50m from Providence Equity partners for Qiyi.com, a Hulu clone. Shanda-controlled Hurray bought Ku6 for $ 40m+, a distressed price in relation to the $ 30m+ that investors had put into Ku6. Youku raised $ 40m, all from existing investors Maverick Capital, Chengwei and others, bringing their total raise to date to $ 110m. The “National Team”, led by CCTV and its new subsidiary CNTV.cn is pouring an undisclosed but not insignificant amount of capital into its online video efforts.

Now I am hearing that Tudou, which last raised $ 57m in April 2008, bringing their total raise to date to $ 80m+, is raising another round, this time reportedly $ 40m at a $ 200m pre-money valuation. If the rumors are to be believed, Tudou lost money on about 100m RMB net revenue (after rebates) in 2009. A $ 200m+ valuation is “aggressive”. Tudou’s PR person refused to comment, but if you are interested I think the CEO and other management may be available for meetings in the US in early March. Tudou has a great brand and I believe is a reasonably strong second place player to Youku. But the amount of capital raised is mind numbing, and could fund so many other good, innovative Chinese startups.

When you add in sites like 56.com, PPstream, PPlive, 6rooms etc., you are looking at something close to $ 500m in investment in China online video sites, and that is not counting what the portals Sina, Sohu, Netease and Tencent have invested. So far, the only exit on that $ 500m I know of is Ku6′s distressed sale to Hurray, a transaction that was probably quite painful to most of Ku6′s investors and option holders.

No question the audience is there; tens of millions of Chinese watch video online. The advertising dollars are still primarily spent on TV, but they are beginning to shift to the Internet. However, you have many aggressive salespeople with good stories competing for relatively small change, all while their sites burn cash. The big ones like Youku and Tudou are burning less, but they are still not profitable. And the online video model does not appear to have much leverage in it, especially given the rapid Chinese content cost increases in addition to the still huge bandwidth fees.

China’s online video industry is in desperate need of consolidation, with maybe 2-3 private companies left standing to compete with the “National Team” players like CCTV and Shanghai Media Group. Youku is in the lead and has a strong management team and supportive investors. They seem like they could be a consolidator with the obvious target someone like Tudou. But with the combined capital the two firms have raised–close to $ 200m and counting–and the difficulty of determining relative valuations and roles, I am not sure what is logical will actually happen.

Even if it did, the exit path for these private companies is very unclear. The online video industry is big enough now that foreign firms are not allowed to buy into it, which kills the early pitch some of these firms had that Google or Microsoft would buy one of them to get into China. Chinese Internet firms do not have strong track record of M&A, and when they have bought they have done so at distressed prices.

A huge public firm like Tencent could easily afford Youku or Tudou (Note to Pony Ma, the market has gifted you an amazing currency in the form of your stock at a $ 35+ Billion valuation. You should use it.), but they don’t seem to have it in their DNA. Perhaps that will change as management grows into its valuation, but I would not want to bet on it. The technology is not difficult, and the Chinese portals touch most of the video users anyway, so these guys all seem to think they can build it themselves, much cheaper, while waiting for the advertising market to grow into the online video sector.

The only really profitable exit for these guys would be an IPO, and that is what firms like Youku are now betting on, but to get to that scale they are going to have to start taking significant advertising dollars out of the mouths of state-owned behemoths like CCTV. That is going to be very difficult, as CCTV is an immensely profitable and powerful entity that will not give up material revenue without a nasty fight. And given to whom CCTV reports–the Ministry of Publicity, and given the money and “interests” involved, any real threat to CCTV will likely be met with regulatory blockades as well as commercial competition. A private firm, especially a foreign VC-backed firm, will not win against CCTV.

I am not surprised that the reports of Tudou’s fundraising have them going to the US. Chinese investors seem allergic to new investments online video now. I know investors and management at several of the companies mentioned above, and the local Chinese investors have a much gloomier outlook for their online video portfolio companies than do the foreign investors.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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