Win-Win in Youku-Tudou Merger

 | Mar 12, 2012 | 11:30 AM EDT
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Today's announcement that Youku (YOKU) and Tudou (TUDO) will merge is a long-term positive for the stock of the combined company.

The market sees this and has bid up the shares of YOKU by 24%.

Why is this such good news?

The biggest knock against either of these companies is that it's too expensive to buy the content while waiting for the subscriber advertising revenue and premium subscriber numbers to come in to support the business.

Yet, now each other's No. 1 competitor has disappeared. There won't be the same pressure to bid up the price of content. Both companies have already locked up a lot of content already as well.

What's more, both will share the cost of advertising across the unified platform.  It's likely they'll be able to reduce costs by having a single, best-of-the-best salesforce.

Despite the perception that Tudou had been a weak sister next to Youku in the last year, the service is still very strong, popular and has been growing.  The combination of these two companies brings together a powerful force in Chinese online video. Think of it like Netflix (NFLX) merging with its No. 2 competitor or HBO merging with Showtime back in the mid-1980s.

Maybe the best analogy for what is happening today is the recent merger of Sirius (SIRI) and XM Radio a few years back.  Both were beating their brains out spending wildly on content costs for high-priced talent while trying to build up their subscriber base.

When the merger was finally approved, there wasn't much time before the combined company ran into the teeth of the 2008 crash with a high amount of debt.  Its near-death experience masked the strength of the combined businesses that has only showed itself as the company has come back since 2009.

Mel Karmazin was on Jim Cramer's "Mad Money" last week touting the strength of the company and how the cash flow keeps growing.

Sirius is built primarily on a subscriber base, which is inherently more stable than advertising. It will be a long time before Youku can say the same.

Youku is still vulnerable in the short term if the market grows impatient with it if the ad revenue fails to materialize. But the market is likely to be patient, as this morning's reaction shows. The market sees that this could be the premium online video delivery mechanism satisfying China's population for some time.

The new HBO of China just got born this morning.



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