In an effort to wade even deeper into the waters of digital content, Alibaba Group Holding (BABA) is offering to buy the portion of Youku Tudou (YOKU) it doesn’t already own — the remaining 82% of the company — at a price that implies Youku is worth $5.1 billion.
While only time will tell if the deal is one that will breathe new life into a struggling BABA stock and simultaneously bring some much-needed stability and growth to the erratic performance of Alibaba as a company, Wall Street is mostly optimistic about the pairing even if it seems a little mismatched on the surface.
Alibaba Aims to Acquire Youku Tudou
Youku Tudou is often referred to as the YouTube of China because … well, that’s what it is. But, it’s a description that doesn’t quite do the company justice.
Yes, Youku Tudou serves up a platform on which amateurs can upload their own videos, but its venue also delivers television programming in the same vein as U.S. consumers’ consumption of cable television. (YouTube also offers full-length television programming, but none of it is new, nor is any of it explicitly created for YouTube.) To that end, it wouldn’t be off-base — in some regards — to compare Youku Tudou to Hulu as well.
But is that unfamiliar territory to Alibaba, which has built a name and reputation for itself as the Amazon.com (AMZN) of China?
It’s true that Alibaba’s online shopping site TMall is designed to sell physical goods, but current or would-be owners of BABA stock should know online video isn’t exactly uncharted waters for Alibaba CEO Jack Ma.
Yes, Alibaba Group currently owns an 18% stake in Youku Tudou, but that minority stake is only part of the story. Alibaba dove deeper into online video waters last month when it opened TMall Box Office for Chinese consumers … the nation’s first equivalent to subscription-based Netflix (NFLX).
It’s still not a wide enough net, though, so Ma is looking to span the gap between the online shopping site and the subscription-required TMall Box Office site with a free-to-use, ad-driven site. Youku Tudou fills that gap, which is why Alibaba is offering $26.60 per share of YOKU that it doesn’t already own. Subtracting the cash Youku has on the books and factoring in the fact Alibaba already owns nearly one-fifth of the acquisition target, the deal that will cost Alibaba about $3.6 billion actually values Youku Tudou at $5.1 billion.
The Upside for Owners of BABA Stock
In the same sense that Google … whoops, Alphabet (GOOGL, GOOG), as well as Apple (AAPL), own their own mediums and also have a stake in the messages those mediums deliver (iTunes, YouTube, Google Play, etc.), this acquisition gives Alibaba Group a means to leverage another user base, cross-selling its offers and sharing expenses rather than enriching the owners of other venues.
To that end, the long-term upside of this pairing clearly has bullish implications for BABA stock.
The flipside: It won’t take long for BABA stock investors to recognize that in addition to the frothy price Alibaba is paying for YOKU (about 4.9 times the company’s trailing revenue), Youku Tudou is also losing money. Last quarter, YOKU lost $55 million on revenue of $260 million. For the past four quarters, the online-video site has lost $217 million on $816 million in revenue.
Those numbers alone can be daunting, but shouldn’t necessarily be discouraging.
As was noted, leverage is the key. Youku draws more than 500 million people to its portal every month. Many of them are apt to already be TMall shoppers, but it’s likely most of them have yet to sign up for the relatively new TMall Box Office service. The fact that they’re at an online video site already prequalifies them as at least marginally interested in digital programming, so they’re a natural target market for TMall’s Box Office.
Only a small portion of them would need to sign up for the service, which costs about $6 per month, for Alibaba to see a solid-enough return on the investment.
And it’s not just the marketing of TMall’s Box Office offer to Youku users on the table. Cross-marketing works in more than one direction, and in this case, each revenue-bearing enterprise can directly and indirectly support the other two.
While it would be premature to call it a game-changer for BABA stock, it’s a solid step forward toward reaching the size and scale needed to be a middleman in the digital world.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
