Youku-Tudou price pop not only about synergies

By Wei Gu
March 14, 2012

By Wei Gu

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

Investors are hooked on Internet video portal Youku’s plan to merge with smaller rival Tudou. The companies’ combined market capitalisation swelled by $1.5 billion after the unveiled merger. Cost savings of $50 million to $60 million a year only partly explain it. Other factors may include a squeeze on short sellers, a re-rating of the sector, and hopes that an enlarged Youku could itself be a bid target.

Synergies offer some justification for the 45 percent increase in the combined companies’ value. Youku and Tudou could cut costs by sharing some content, and using their search functions to link to each other’s sites. Youku sees annual cost savings of up to $60 million, compared to their total content costs of $140 million in 2011. Those could be worth up to $600 million in present-value terms.

There may be revenue synergies too, but it is hard to see where these will come from. While the two companies will merge their ownership structure, the two user-facing sites will remain separate.

What of the remaining $900 million increase? A short squeeze may have played a part. Short-sellers have targeted U.S.-listed Chinese companies after scandals like the deep accounting irregularities at forestry company Sino-Forest. Concerns over unusual, cross-border holding company structures also weigh on the sector. The surge in the companies’ shares will have left some short-sellers scrambling to cover their positions as the shares surged.

Then there is the hope of more deal activity. An enlarged Youku-Tudou could itself be a target. It would be a relatively small potato, with just 3 percent of China’s online advertising market. Their current combined market cap of $4.8 billion is a 10th of that of diversified Internet player Tencent, which is pushing aggressively in the online video market. Youku’s combined knowhow in online video technology and content may be attractive to those deep-pocketed diversified players.

A second deal won’t happen in a hurry, since any new buyers will need to get Youku’s founder and chief executive Victor Koo on-side. But with the pure-plays throwing off cash, that needn’t be out of the question. If Youku-Tudou kicks off a wave of merger activity, its new high valuation might be justified.

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