MILLBURN, N.J. (IPOfinancial) -- The IPO market continues to be inundated with Chinese offerings, as the compelling long-term growth trends within the country have created an interesting value proposition for U.S. investors. But not all of the offerings out of China have been embraced by Wall Street. Moreover, strong fundamentals don’t necessarily translate into a success story.

What have worked are consumer-driven stocks, such as education and retail stocks -- including e-commerce providers -- as well as hi-tech-related issues.

This leads us to Youku.com (YOKU), a leading Internet television company in China with a 40% market share of total user time spent viewing online videos in China during the second quarter. From an industry perspective, the components driving growth and expansion in China are very different from those stimulating U.S. or European markets, because the video media market is highly regulated and fragmented regarding both production and distribution.

  • Youku.com (YOKU)
  • Lead Underwriter: Goldman Sachs
  • 15,367,500 American Depository Shares
  • Current Price Range: $9-$11
  • Dealsize to the midrange: $153.68 million
  • Sector: Internet Content, Info/News
  • Week Due: Dec. 6

 

There are two key points to keep in mind when examining this industry. First, there are more than 2,000 television and movie production companies in China, and there is a significant imbalance in the number of content producers compared with the number of traditional distribution channels. Moreover, the majority of video content produced in China is never distributed through traditional channels, and fewer than half of the 12,000 television episodes produced each year make their way to the public.

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    The emergence of Internet television has created a new distribution channel for programming. This is where Youku fills a significant void. Since the company’s inception back in 2005, it has compiled an extensive video library that contains more than 2,200 movie titles, 1,250 TV serial drama titles and more than 231,000 hours of other professionally produced content.

    Efforts to diversify Youku's revenue sources by expanding its wireless and Web-based subscription services should lead to additional financial improvements, with overall demand expected to be facilitated by a rise in disposable incomes and broader proliferation of broadband users. Furthermore, China is the largest Internet market in the world in terms of the number of users and has the world’s largest number of mobile subscribers, making it clear that the pool of potential users will continue to expand moving forward.

    As noted above, Youku's market share in this space is roughly 40%, with its next closest competitor, Tudou, at 23% and Sohu (SOHU) at 9%. Strategies such as infrastructure investments, increases in HD content, user experience improvement, expansion of overall content offerings and diversification of revenue sources are expected to lead to an additional increase in its user base, which totaled over 203 million monthly unique visitors from homes and offices for the month of September and roughly 61 million unique visitors from Internet cafes during August. However, while industry trends present a compelling story, the financial results of the company are less than stellar.

    Currently the company derives substantially all of its revenue from online advertising services, and while the online advertising market in China is growing faster than the overall advertising market, the lack of a more diversified revenue stream is cause for concern. Furthermore, while revenues have grown significantly over the past several years, they haven’t been able to counterbalance expenses. Bandwidth and content costs totaled $29.365 million for the nine months ending September 2010, or roughly 83% of revenues for the period.

    Moreover, these are charges that will continue to expand as the company looks to improve broadband speeds, extend its user base and add to its available content offerings. From a financial perspective, Youku is not even close to breaking even, and while this is a notable blemish when evaluating the short-term prospects of the company, an expanded outlook presents a much different picture, as long-term growth is supported by both a solid business model, as well as bullish industry, including a rapid expansion in wireless and broadband users.

    IPOfinancial.com in Millburn, N.J., is the oldest equity new issues research firm on the Street, with 20 years of experience. IPOfinancial projects the opening premiums of IPOs and secondaries before they price. Its research packages are available to individual investors and institutions alike.