I don’t like stating the obvious, except when it seems many if not most are seemingly oblivious to it. Such, I believe, is the case with the stock price of Youku.com (YOKU). As I shared last week, I believe the firm is grossly over-valued even when assuming amazing revenue growth and margin expansion over the next decade. We’re talking 70% average revenue growth for the next 10 years. Off the top of my head, I’m not sure any firm of this size has achieved a decade-long run that impressive in the history of the corporation!
This should be obvious, but firms can only grow so much, so fast. YOKU makes substantially all of its money from online advertising, which means its revenue growth is bounded by two factors: the growth rate of the Chinese internet advertising market, and its share of said market. The very-same “independent” research firm YOKU cites in its regulatory filings – iResearch – says the market only (yes, only) grew 54% last year, yet YOKU’s revenues grow three times as fast (152%)!
The only way for this to happen (and continue to happen) is for the market to grow faster than estimated, the sub-market in which YOKU operates – online video advertising – grew (and will continue to grow) faster than the broader internet advertising market as a whole, and/or YOKU made (and will continue to make) HUGE market share gains last year. (YOKU could also expand into new markets, but for our purposes, we’ll assume the company invests most of its capital in the internet video space.) Of course there is another way – falsifying revenue – but as I have done in my financial analysis, I’m working on the (very possibly unrealistic) assumption that YOKU’s financials are fraud-free.
In order to rationalize YOKU’s current (at the time of my analysis last week, around $42/share) price, not only did YOKU’s revenue growth rate have to significantly outpace that of the industry rate, but going forward, it will have to continue to do so for years to come! Even if Victor Koo is the most brilliant CEO the World has ever seen, he is still (using our no fraud assumption) faces real-world constraints in how fast he can grow the company.
If we take a deeper look at the industry and YOKU’s position within it, I think it will become even more crystal clear that YOKU’s share price – driven largely by unrealistic revenue growth assumptions – is grossly over-valued.
China Online Video Advertising Market
YOKU quotes an iResearch report (presumably a newer version of this one, which I’ve yet to read given our budget of approximately $0) which estimates the following growth rates in the internet video advertising market:
According again to the iResearch estimates in Toudu’s filings, “according to a survey on 17 major advertisers’ online advertising spending in China, total online video advertising spending is set to grow” at a CAGR of 65.3% from 2010-2013, with the growth rate declining from 85% in 2011 to 52% by 2013. The numbers quotes in YOKU’s more recent prospectus (from which the screenshot is taken) filed last month, the CAGR is 66.3% 2011-2013, and the rate is set to decline from 74% in 2010 to 66% in 2013. Again, assuming the numbers in YOKU’s filing are more updated/recent than in Toudu’s, you should notice how the 2010 rate was significantly adjusted down from 107% to only 74%, while estimates for 2011, 2012, and 2013 were adjusted from 86%, 59%, 52% to 65%, 68%, and 66%, respectively.
As I haven’t read the report I can only guess as to why these numbers were changed, but considering the nearly-identical CAGR (only a 1.6% difference) between the presumably newer and older numbers, it looks alot like the 2011, 2012, and 2013 estimates were fudged to solve for a similar CAGR. If that is even remotely close to what happened, don’t be surprised if/when these estimates are revised-down over the next three years, that is, prudent investors would be well-served to assume the actual growth rates will be at least slightly lower than the iResearch’s estimates.
YOKU says it had a 21% share of the China online video advertising spending in 2010, while Tudou says as of 9/30/2010 it had approximately 18% share (stated 71.7mm users/2010 estimated 394mm online video users). Other competitors like 56.com claim to have approximately 8-14% share (imputed) depending on whose numbers you believe (if any). Various news sources have suggested that larger, more entrenched and established companies like Sohu and Bidu (Qiyi.com) have been successful in gaining market share with their own online video efforts, and plan to invest even more in them going forward. Considering the intense competitive landscape, I would be quite surprised if YOKU was able to make any material gains in market share absent some sort of significant shock like the PRC government going after a competitor, a transformative acquisition (using the company’s over-priced shares as currency) or something along those lines.
The aggressive revenue growth assumptions I used in my analysis give YOKU ~27% of the estimated Chinese online video advertising revenues by 2013. While its not impossible that YOKU becomes THE de facto destination for online video in China and/or the market grows even faster than forecasts, I find it EXTREMELY improbable that either happen, especially as soon as implied by YOKU’s recent stock price.
UPDATE: a friendly comment below brings our attention to a newer report on online video in China not available in English from what I can tell. Here is the iResearch 4-19-2011 translation