Jiaodaokou Road, enroute to Gehua Dasha
No sign of the Olympics here
China video sites have been taking in a lot of cash lately, over US $100 million total in the past few months. The digerati have been understandably cynical: the State Administration for Radio, Film, and Television (SARFT) and the Ministry of Industry and Information Technology (MIIT) have done little publicly to hearten investors in the sector. Regulations passed last year make it seem at first glance that the sector is closed to all but state-owned broadcasters, while not documenting an alleged promise that current web video sites would be “grandfathered.”
More ominously, a recent list of licensed broadcasters was issued, but Youku, Tudou, 56.com, and YouTube were conspicuously absent, and 56.com has found itself shut down, with no word as to why or when (if ever) it will return. When you put all of that against what is arguably the most conservative media regulatory environment in a decade, you can start to understand the cynics.
I have to admit, my first reaction was something like “I wonder what they were putting in the bottled water at the negotiating table.”
Who knows what?
But there are indications that the investments – while certainly not on the “low risk” side of the portfolio – are not as ill-conceived as they might appear. (Disclosure – I have zero interest in any of these sites, and have no client relationships with them or their investors.)
First, my informal poll of the media people in the capital suggests that Youku and Tudou will get licenses at some point in the not-too-distant future. Chances are pretty long against it happening before the Olympics or even before the annual Party meetings in the fall, but I’d say it is in the offing.
Second is what I call my “wiser fool theory.” We who have lived a long time in China have a tendency to believe that anyone who has less experience in China than we do is more likely to be taken to the cleaners on a given deal. Annoyingly, we’re usually right. But not always.
One of the things that keeps China so interesting for both investors and business people is that unlike more transparent societies, information flows unevenly here. I’d say it is possible – if not likely – that the investors who just put their cash into Youku have information that is germane to the regulatory situation that is not public. They may have received what they feel is adequate assurance that a license is forthcoming.
At this point, you are probably remembering Samuel Goldwyn‘s legendary line that “an oral contract isn’t worth the paper it’s written on.” You would be right to do so. Assurances from policymakers – however high in government – about future events are only good if the situation does not change in the interim. But a senior official in a position to know – or even decide – may well have helped (unofficially, of course) to assuage investor concerns. I would be floored if this was not the case.
There are also probably some other mitigating factors, such as agreements with local broadcasters, that give Youku additional regulatory air-cover.
The point is this: I’m willing to grant the investors the benefit of the doubt because they see the little picture more clearly. I only hope they’re seeing what they think they are.
Contrarians at the gate
Third, the subjective value of Youku as a company is probably pretty low right now. This is the ideal time to invest, when Youku needs cash and the hardware to manage its growing traffic, when there is no license, and when a similar site has been forcibly shut.
I find it fascinating that no mention is made in Schwankert’s coverage or the press release about what the VCs are getting in return. I’d bet Maverick Capital, Brookside, Sutter Hill Ventures, Farallon Capital, Chengwei Ventures, and Western Technology Investment all cut a pretty fair deal for themselves.
Playing the long game
So I figure licenses are coming, and the investors got in at a good time. None of that eases the uncertainty around the sector in the longer term, however.
This remains a profoundly sensitive environment for media – especially foreign-invested media – and the Internet is no exception. Among all types of Internet sites, the government is most cautious with online video: giving the people the power to broadcast makes conservative officials (who are used to total state control over the communication of information) feel like they’re getting a wedgie.
No matter how much care Youku, Tudou, Ku6 and others take with what gets posted, a cold northern wind – a “crackdown” in response to a political crisis of some sort – could spell an instant change of fortune.
There is also the implicit competition problem. Broadcasters are state owned, these sites are not. Some very desirable viewers with money to spend are spending more time watching Internet stuff and less watching TV, and few broadcasters have demonstrated much skill in creating compelling online video offerings of their own.
At some point, broadcasters are going to begin howling about these sites that are showing video, are not state owned, and who are taking away their most prosperous viewers (and their advertising revenues.)
Either a change in the political environment or broadcasters falling into dire straits might be enough to foment a change in policy. But if both happened at the same time – and if that situation coincided with one or more of the sites running a video or two that stepped beyond the pale – you would wind up with a perfect storm that would see the government “re-examining the structure of the industry.”
None of this means that the VCs made a bad investment. I am certain they do not think everything to be smooth sailing after getting past the license problem. After all, we have not even discussed the problem of actually turning all of those unique visitors into ordinary cash.
What it does mean is that they – and we – should expect there to be problems in the future. What will determine the ultimate fate of the companies is how well they (and their investors) prepare themselves for and respond to The Perfect Storm when it finally does come.