Remember Youku?

 | Apr 10, 2013 | 3:58 PM EDT
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Do you remember Youku (YOKU)? It was an IPO darling in late 2010 when it debuted alongside Dangdang (DANG). Both stocks took off. For a time in 2011, Youku reached $62 a share. And then both sank like a stone.

Dangdang is down more than 88% from its IPO price. Youku is doing a little better but not much. It's "only" down 55% from its IPO price. Youku recently perked up above $17. But that's still miles from its all-time high of $62. Yet after seeing Youku tread water for the last 18 months or so, I believe it's worth watching. I recently went long the stock.

You may recall from the IPO that this company was billed as the "YouTube of China." That's probably true. It's certainly the biggest online video site in China. However, unlike YouTube, most of Youku's content is "professional" online content and much less is user-generated content. So, maybe a better description of Youku is that it's two-thirds Hulu and one-third YouTube. But you get the drift.

Isn't this an expensive model –especially without the deep pockets of Google (GOOG) behind you? Yes. Running this business requires lots of servers that cost money. And, despite the fact that Youku has a nascent business charging Chinese users a few yen to download certain premium content like Hollywood movies, the vast majority of Youku's business comes from selling ads at the beginning, middle and end of their content.

As a result, Youku has always run at a loss. Many think that its market capitalization is way too high given the losses. At the moment, investors say the company is worth a little less than $3 billion. However, like Amazon (AMZN) and lots of other companies, most investors are willing to give Youku the benefit of the doubt based on its market leadership in China in a space that most expect will become increasingly popular.

Youku's losses have been narrowing of late. Also, unlike the U.S., no pay-TV stations exist. Imagine if all you could watch was ABC, CBS and NBC on rabbit ears and then, all of a sudden, you had access to HBO Go. That's basically what's going on right now in China -- and Youku is the equivalent of HBO Go.

Also, at the time of Youku's IPO, the  company was actually the No. 2 player behind Tudou. But the Tudou CEO was going through a divorce, which held up its IPO. Tudou's market share started to crumble and, last year, Youku bought Tudou (except they called it a "merger" in the press release to save face).

On news of that deal, Youku's shares surged to close to $30, but they've since sunk. Initially, investors got excited at the idea of selling more content with lower costs. But "integration costs" of bringing together the combined sales forces and back-end parts of the business cause the stock to sink again. 

Youku's first-quarter results missed Wall Street expectations and the stock dropped. However, the shares may have finally bottomed a few days ago in the $16 area. CEO Victor Koo implied on the last earnings call that integration issues would be behind Youku by the middle of this year. Given that, I've made a bet that the stock is finally ready to start breaking out of a trading range in the teens. Keep watching.

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