Focus on Consolidation Deals in China

 | Mar 13, 2012 | 10:30 AM EDT
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After yesterday's news that China's Youku (YOKU) and Tudou (TUDO) would merge, many of the other Chinese Internet names got a boost. The thinking seems to be: If Tudou can get bought, why not another smaller Chinese company?

But let's take a step back and look at what happened in the merger between the two online video companies. Both Tudou and Youku have been losing money for some time, spending enormous amounts on acquiring new content and paying for bandwidth costs. Each had raised so much capital and spent it that they had few other competitors in the space. Even though Baidu (BIDU) has an offering and the other larger Chinese portals, such as Sohu (SOHU), have video sites as well, these two pure-play online video sites have a clear market-share lead.

By merging, the two companies dramatically reduce their costs for content acquisition going forward, and they can reduce their sales-force costs as well. They will also have a powerful market-share lead, even if the bigger portals decide to spend a lot of money trying to catch up -- which is probably unlikely.

Other Chinese names including RenRen (RENN), Dangdang (DANG), the Chinese portals, and even Baidu, are all in different boats than Tudou.

There are a number of group buying sites in China that are dramatically losing money and could benefit from consolidating. Yet, none of them have been able to go public yet because the public market investors have been too skeptical, so there is no way to play this.

RenRen could be an acquisition target in the future, but, unlike Tudou, it was able to raise a billion dollars from its IPO, which gives it much more freedom. RenRen's management might want to continue to experiment with new lines of business until they feel they need to accept some acquisition offer from someone else. Assuming it can keep up or even grow its user base, RenRen could be attractive to a company such as Tencent.

Similar to Tudou, Dangdang raised far less capital than Youku and its management would love to sell to a larger company. Yet, two of the larger potential acquirers, Taobao and 360Buy, are currently private names, which makes them unlikely to want to pull the trigger. If they saw a competitor running low on cash -- and they're already in strong market-share positions -- why not just stand back and watch?

One of the first e-commerce companies to go public about 18 months ago was Mecox Lane (MCOX), which is an online clothing retailer that caters mostly to young professional women. The company has seen its share price decimated since the IPO and has been trying to grow their sales. It still has a decent amount of cash $80 million on its balance sheet from their IPO. However, it would love to sell and Sina (SINA) is already one of its investors. I expect it will get bought this year.

Other places to watch in China for consolidation would be the bigger portals, including NetEase (NTES) and Sohu, and the gaming sector, such as Giant (GA), Perfect World (PWRD) and others.

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