Youku Emerging a Goliath in China Internet

NEW YORK (TheStreet) -- After the all-stock merger between Youku (YOKU) and Tudou (TUDO) a couple of weeks ago, Youku's stock has receded from the $32 levels it hit the day of the deal announcement.

The stock is now back down at the $24 level -- and actually less than where it traded before the deal was publicized.

That seems a bargain considering that Youku's in a much stronger position today than it was then. (Tudou is still trading at $32, which is more than double where it traded before the merger.)

Consider these important facts:

China's Internet population just reach 513 million last year according to the government-run China Internet Network Information Center (CNNIC)

56 million Chinese used the Internet for the first time in 2011

60% of China's population remains offline at the moment

That means that all Chinese Internet sites are poised to benefit from increased Internet penetration over the next couple of years.

However, Youku is in a unique position among Chinese Internet stocks.

Youku was the second-largest video Web site in the world after YouTube with 4.6 billion videos viewed in October. This represented 2.3% of all videos viewed worldwide that month according to ComScore.

Tudou is the No. 2 video site in China.

By combining with Tudou, Youku now has a dominant position in the Chinese online video space, although some of the bigger portals like Baidu (BIDU), Sohu (SOHU) and Sina (SINA) could always spend a lot of money to beef up their presence.

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For the last four months, Youku and Tudou had been engaged in a bitter legal battle over IP rights. They'd also been forced to bid for rights to different types of online content to increase traffic to their sites.

The fight for content was not unlike what we saw in the world of satellite radio a few years ago with XM and Sirius (SIRI). Both had paid up handsomely for sports content rights and for on-air talent like Howard Stern, Oprah and Martha Stewart.

Once the companies merged, however, the hunger for paying up for content went away. The two sides had already locked up a lot of the best content already. And, of course, by merging, they'd taken the No. 2 bidder out of the market for all future content.

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