China online video: Big fish, small fish

China's online video industry is going through a consolidation phase. "It's more of an efficiency play now," says J.P. Gan, managing partner at Qiming Venture Partners, as the bigger players compete for content and more users.

Last year the two leading online video sites, Youku and Tudou, merged to beat increasing costs for internet bandwidth, content and mobile video services. In May this year search engine Baidu agreed to pay $370 million for PPStream, which has raised capital from Qiming, Ceyuan Ventures and Vision Knight Capital.

Baidu will combine PPS' online video business with its existing online television and movie portal iQiyi. While iQiyi is web-based, PPS uses a cloud system better suited to mobile penetration.

David Wei, chairman at Vision Knight, says web-based sites are easier to promote but there is no stickiness because users can find videos via a search engine. Mobile apps, on the other hand, enjoy higher customer loyalty as users do not hop from video player to another as much.

It is in the latter area that VCs are most active - even though many are now looking to exit online video rather than make fresh investments.

"There is still a lot of potential innovation both in technology as well as in business models related to video," says Qiming's Gan. He adds that video aggregation and sharing apps similar to Vine and Snapchat are two mobile trends his firm is interested in.

Moving to mobile

According to iResearch, Youku Tudou had over 14 million unique users per day in June to iQiyi's 7.9 million and PPS' 6 million. Most online video companies rely on advertising for revenues and in the last 12 months, mobile ad revenue has more than quadrupled, according to David Yuan, partner and head of Redpoint China. It stood at RMB5.52 billion ($906 million) in 2012.

Yuan expects mobile ad revenue to grow from the current a low single-digit percentage of overall digital advertising spend in China - estimated to be RMB75.31 billion in 2012 - to at least 20% in the next three years.

For this reason Redpoint has targeted advertising technology companies, including big data specialist Miaozhen Systems and mobile in-app ad network Domob. It is part of a broader investment thesis based on mobile services outperforming online offerings in the long term.

"Looking at the existing online desktop video space, it is clear that content cost is increasingly going to be a heavier burden for online video operators and content providers," says Yuan.

Online video companies in China have yet to turn profitable, as the costs of acquiring content, marketing and bandwidth eat up revenues. Youku and PPS have spent more than RMB200 million to secure the web broadcast rights to a single show. Sohu's video service spent more than RMB30 million on the web broadcast rights to 30 episodes of "Ups and Downs," a serial drama. A single episode cost RMB1 million but could be bought for RMB10,000 three years before.

So Redpoint chose to focus on user-generated content with an investment in advertising-supported video app developer Yixia. The start-up makes Miaopai, a Vine-like app that allows users to shoot 10 second video clips and share them on the Sina Weibo microblog.

"Social type apps are probably the only area within video where there is opportunity for VC," says Michael Clendenin, founder and managing director of consultancy RedTech Advisors.

Swimming with sharks

But investors will have to compete with big online video players such who already have scale and can create something on mobile that is more UGC generated. Last year Youku launched a news-oriented app called Youku Paike to let users submit reports about events across the country. Tencent, meanwhile, has developed a video app called WeShow to complement the likes of Tencent Weibo and social networking site QZone.

"Unless the start-ups build a sufficient user base in a short period of time, they are not going to be able to withstand the copycats that come in and start doing the same thing," Clendenin continues. "Another way of doing it is to get a strategic investment from one of the mainstream players and that will help to protect them."

Yixia has used the second strategy. Sina and the start-up have a co-branded app called Sina Paike, and in September Sina led a $25 million Series B round in Yixia, alongside existing investors Redpoint and Morningside Technologies. "The collaboration with Sina Weibo has helped Yixia grow. It has a strong distribution channel and its content can be distributed across the Sina user population," says Yuan.

While a potential problem with VC investment in smaller apps is that VCs may invest and get it off the ground, and a strategic will come in and copy it instead of buying it, Yuan is more upbeat on the strategics' role.

"These are large platforms, each with more than 300 million active users and market caps of over $10 billion so they have war chests," he says. "We now have more exit opportunities since we are not only dependant on IPOs but also have acquisition opportunities by these large platforms."

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• Topics
• Technology
• Venture
• Greater China
• Exits
• Early-stage
• China
• TMT
• Venture
• Exit
• Qiming Venture Partners
• Vision Knight Capital