Article / 20 March 2015 at 5:39 GMT

Content cost control key for online video firm Youku Tudou

China Watcher / Shanghai
China
  • Alibaba-backed Youku Tudou beat Q4 revenue consensus, but missed on earnings
  • The firm's content costs have been rising – an industry-wide issue
  • Original programming and partner & user generated content can help it curb costs

By Neil Flynn


Online video platform Youku Tudou reported its fourth quarter earnings last night, with revenues of 1.28 billion yuan, beating analysts’ consensus of 1.2 bn yuan, but earnings of -1.18 RMB per ADS was below the consensus of -1.00 yuan per ADS.

Revenues showed a 14.3% sequential growth and 40.3% annual growth, with advertising revenues of 1.1bn yuan growing 37% annually and consumer revenues growing 649% annually.

Net Revenue Growth



















Source: Youku Tudou Investor Relations  

However, content costs continued to grow, and now account for 46.6% of total revenues. Revenue guidance for the first quarter looks promising, with net revenues expected to be between 1.01 bn yuan and 1.03 bn yuan, which is above the 996.5 m yuan consensus. Advertising revenues are expected to be between 870 m yuan and 890 m yuan.


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Partner and user generated online video content, as well as its original programming, is cheaper than foreign shows, and offers Youku product placement opportunities. Photo: iStock
 

Original content focus can curb costs

Over the past few years, the cost of television and film content has grown exponentially, as the industry becomes more competitive and more willing to spend on quality content. It has been a growing problem for video platforms, because unless they have a wealthy backer, it’s more and more difficult to compete.

Sohu has been a leader in the market, and in the fourth quarter offered over 70% of the top 30 TV dramas. However, the online video business continues to post an operating loss that is growing, and I expect that Sohu will see its market share decline as it is priced out of the market.

Youku Tudou, on the other hand, has the benefit of being backed by Alibaba, so it is able to compete in the market better than Sohu. The problem with growing syndicated content costs is that overall content costs as a proportion of net revenues has been growing throughout 2014. This is an issue that Youku has to address because rising content costs are simply unsustainable, particularly if the firm wants to maintain its market leading status.


Cost Of Revenues



















Source: Youku Tudou Investor Relations  

Youku Tudou has been seeing strong returns on investment from both its partner generated content (PGC) and user generated content (UGC), as well as its original generated content (OGC). Dramas from Hong Kong and Korea have also seen strong ROI, because they are relatively difficult to view in China, and the popularity of Korean content over the past few years has seen significant growth.

However, the problem for the industry is the syndicated content, which has seen exponential growth in price over the past few years. China’s online video firms are investing in producing their own content, in order to reduce content costs, and we will see this strategy further pursued in 2015 from Youku Tudou.

An important aspect of monetisation from PGC, UGC and OGC is that Youku can control product placements, such as making sure that characters in a particular drama all drink a certain brand of soft drink. This is important because not only are these types of content cheaper for the firm, but the return on investment can be increased. For syndicated content from China and overseas, Youku can’t increase the monetisation of the content in this way.

Net Revenues & Content Costs




















Source: Youku Tudou Investor Relations

We are currently seeing that content costs are growing at a similar rate to net revenues. However, with the firm continuing to post losses, further monetisation of the user base is required as well as a reduction in content costs as a percentage of net revenues.

I do expect to see a decrease in content cost contribution during 2015, particularly after it has recently enjoyed the success of the music and related video content for Little Apple and the viral pollution documentary Under The Dome. The firm has also seen good progress in mobile games and live broadcasts, which despite being relatively new, should be pursued more by the firm in 2015.

Movie content with Heyi Pictures

Youku Tudou has been producing its own films through its Heyi Pictures subsidiary, as the value of intellectual properties grows in the industry. Heyi Pictures has had a lot of success in China since its launch in the second half of 2014. The firm has co produced 11 films with total box office receipts of 3.3 bn yuan, with three of these films being in the top 10 films in China during 2014.

Launching a movie business is a strong move by Youku Tudou, because it has had success in marketing films in China. To date it has marketed 88 movies, with total box office proceeds of 28bn yuan, which represents 42% of China’s overall box office receipts over the past three years. By producing its own film content and partner-generated content, it will be able to boost revenues through intellectual properties, as opposed to marketing third party content, which has a relatively lower ROI.

SEC and non-cash revenue recognition

The firm announced that after conducting a routine review, the SEC has some queries about accounting treatment on previous financial statements. Advertising arrangements generally contain multiple deliverables and the revenue is recognised at the time of the delivery of the final deliverable. The SEC queried the appropriateness of this method of deferred revenue, but the firm has stated that it believes that it is appropriate and conservative.

There are also queries about the valuation of non-monetary transaction values for the exchange of broadcasting rights of video content. The firm has been recording these transactions at carrying value, which is nil, but the SEC believes that these should be recorded at fair value. The value of these transactions has not been significant historically, but the adoption of fair value would see a change in the barter exchange line on the balance sheet, and a change in the amortisation expense line. Therefore any changes would be non-cash. The third query was regarding the treatment of licensed content, and should the firm agree with the SEC, then the way that licensed content is recorded on the balance sheet would be changed.

These queries won’t result in significant changes to historical financial statements, but I expect that investors will be slightly concerned about the SEC queries. The firm has stated that it has used the same accounting methods since its IPO, which the SEC checked prior to the IPO, but the query will likely cast a shadow on the earnings release.

Falling margins need to be addressed

The fourth quarter saw a decline in profit margins, due to higher content costs and sales and marketing costs. The industry is highly competitive, and the rising costs of content is pricing many smaller players out of the market. Whilst this makes it difficult for the firm to post a profit at the current time, it has been making good progress on its user base.

The second half of the year saw stronger revenue growth, which was driven by PGC and OGC, and this should continue in 2015. Advertising revenues saw strong annual growth of 37%, and the firm now has 538 advertising clients, including 113 that were new in the fourth quarter. It is also expanding the type of advertising customers that it has, so that as the range of content grows, advertising can be more targeted to the users’ preferences.

Consumer revenues, which are derived from subscriptions and pay-per-view, grew 649% annually and 67% sequentially, and the firm now has over 1m subscription users. In terms of the firm’s mobile platform, mobile contributed over 35% to overall advertising revenues in the quarter, compared to 10% at the start of the year. This should be another driver for the firm in 2015, as it has seen its lead in mobile video grow.


Youku Profit Margins

Source: Youku Tudou Investor Relations  

Youku Tudou has also been exploring new strategies to boost revenues, including hardware. It has introduced a new set-top box, which allows users to access their content library through their television. It has also been working with smartphone and tablet manufacturers in order to have the Youku and Tudou apps embedded into the default software of the device, which should help to grow the user base.

Despite having 100m unique monthly users, the average revenue per user (ARPU) is actually rather low, and increased monetisation of its large user base needs to be pursued in order to drive the company towards profitability. Management has discussed that it will work with Alibaba in order to improve the firm’s ecommerce and advertising technology, and we should see this during 2015.

– Edited by Robert Ryan

Neil Flynn is a portfolio manager at Alcuin Asset Management. Follow Neil or post your comment below to engage with Saxo Bank's social trading platform

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