Youku Tudou (YOKU) CEO Victor Koo on Q2 2014 Results - Earnings Call Transcript

Aug.20.14 | About: Youku Tudou (YOKU)

Youku Tudou Inc. (NYSE:YOKU)

Q2 2014 Results Earnings Conference Call

August 19, 2014; 09:00 p.m. ET

Executives

Victor Koo - Chairman & Chief Executive Officer

Dele Liu - Board Director & President

Michael Xu - Chief Financial Officer & Senior Vice-President

Ryan Cheung - Corporate Finance Director

Analysts

Eddie Leung – Merrill Lynch

Alicia Yap - Barclays Capital

Dick Wei - Credit Suisse

Jiong Shao - Macquarie

Philip Wang - Morgan Stanley

Alex Yao - JP Morgan

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Q2, 2014 Youku Tudou Inc. Earnings Conference Call.

At this time all participants are in a listen-mode. There will be a presentation followed by a question-and-answer session (Operator Instructions). I must advise you that this conference is being recorded today, Wednesday the 20th of August 2014.

I'll now like to hand the conference over to your speaker today, Mr. Ryan Cheung, the Corporate Finance Director. Thank you. Please go ahead.

Ryan Cheung

Thank you operator and welcome to our second quarter 2014 earnings conference call.

First of all, I would like to introduce our management team on this call. They are Chairman and CEO, Victor Koo; our Board Director and President, Dele Liu, and Michael Xu, our Chief Financial Officer and Senior Vice President.

Regarding today's agenda, Victor will begin with a strategic outlook of Youku Tudou and an overview of the performance in Q2 of this year. Dele will cover our business operations and content strategy and Michael will discuss second quarter financials, after which we will take your questions.

As a reminder, the financial results and a webcast of this conference call are available at the Investor Relations sections of the Youku Tudou website. A replay of the call will be available on our website in a few hours.

I'll refer you to our Safe Harbor statement in our earnings press release, which applies to this call, as we will make forward-looking statements. Finally, please note that unless otherwise stated, all figures mentioned during this conference call are in RMB.

At this time, I will turn the call over to our Chairman and CEO, Victor Koo. Please proceed.

Victor Koo

Thank you, Ryan. Good morning and good evening everyone. Thank you for joining us. I am happy to inform you that there are exciting new developments at Youku Tudou, which are generating the momentum necessary to capitalize on new market opportunities.

Today, technological changes are creating new markets for all Internet companies and Youku Tudou is in a strategic position to capture growing opportunities in the Chinese media and entertainment sector. Furthermore, changes are accelerating as markets are converging, as boundaries between the online and offline worlds are disappearing.

We believe that 2013 and 2014 will be seen as the period when the Chinese Internet entered into the multi-screen age that is driving these changes. This new era has significantly broadened Youku Tudou’s market scope and our business model has dramatically expanded.

As such, we are in the process of enhancing our product offering, strengthening our core competencies and diversifying our business operations. Our fundamental approach is to make long-term investments in order to build a multi-screen media and entertainment ecosystem.

We believe that the online video space, along with the entire Internet space in China is going through a period of inflection. There has been three inflection points over the last 20 years of Chinese Internet. During 1997-1998, period we saw the birth of the first generation of consumer Internet companies in China, as fixed line Internet grew. In 2005 and 2006 a new wave of innovation was driven by the acceleration of both the broadband penetration across China.

Recently in 2013-2014 due to the rise of mobile Internet and Internet enabled devices, multi screen Internet has become increasingly screen. There were new and expanded market opportunities after each inflection point, with each one bigger than the last.

In this historical context, the online video landscape in China has changed fundamentally in the past year. Back in 2005-2006 when Tudou and Youku were founded, we saw the inflection point with the opportunity to build the leading PC based video website. Our pro-active investment during that window has allowed us to reach a point where we now penetrate over 80% of the PC Internet population in China.

In 2013 and 2014, although the multi-screen era is still in the nascent stage, we have entered into another growth and investment period as we have moved into a multi-screen video content distribution and creation platform.

The latest CNNIC report shows that the mobile Internet population in China has already surpassed the PC Internet population, with video representing one of the most used applications on mobile Internet. With the rapid growth of Internet users in China bringing online video into a new paradigm, the market scale we first envisioned as an online video website back in 2006 has grown significantly.

Concurrently the penetration of Internet enabled devices across China is also changing the habits of Chinese people in regards to how they consume content and they are now demanding more diverse genres of content, not only traditional TV dramas and variety shows. All of these transformations represent tremendous opportunities, but at the same time our product content and business model must adapt to the new landscape.

Ahead of this trend, Youku Tudou anticipated these changes and made early investments in multi-screen product and original content offerings. Because of this, we have been successful in evolving from a PC web based service to now a multi-screen platform, as traffic of our mobile app has reached over 60% of our growing traffic and is the number one Chinese media related app in the world.

We also predicted the shift in content consumption of our users and understand the importance of building up our own content brand and IP’s. As a result Youku and Tudou launched initiatives in original content starting in 2009, to diversify the genres and variety available in our content library, contributing close to 10% of our traffic generated from original and product generated content, up from less than 5% around the end of last year.

The convergence of online and offline media and entertainment is presenting us with new opportunities as web based video extends to movie and Internet enabled TV screens, while Chinese content consumption behaviors change. Today Youku Tudou has become an essential part of the media value chain and no longer just a PC based content distribution website. This also means that our scope of opportunities in online video has broadened to include for example, movie marketing and joint production and the development of ancillary revenue streams through our original content IPs.

In regard to these new opportunities, Youku Tudou is now well positioned and recognized as a multi-screen media distribution platform. Going forward we also want to be known as a content IP creation and fan based ecosystem.

Since our inception Youku Tudou as the leader in the multi-screen video space has helped transform how video and entertainment related content is distributed and marketed. Going forward we will work with our online and offline partners to continue to change how content is created and monetized, by directly connecting with the ever-growing multi-screen user base and consumer economy.

As we look to capitalize on these opportunities, we are scaling our investment, leveraging the company’s strengthened strategic and financial resources to build an immersive media platform, that integrates online and offline entertainment capabilities. To this end, the three major growth initiatives in online video are: one, multi-screen product development; two, content ecosystem; and three, diversified revenue streams.

In each case we believe the long term opportunities are substantial, but timing and decisive investment is necessary to unlock this growth potential. Our pursuit of such opportunities will be undertaken via a combination of organic growth, strategic partnerships, equity investments and all acquisitions.

Our multi-screen development efforts in the second quarter reflected the reality that Internet is increasingly moving towards mobile and thus our leadership and investment in mobile will continue to capture more market share.

In our second quarter we continue to innovate in order to create a better experience for our multi-screen users. First, our homepage was revamped to enable users to log in now, to receive personalized content by applying our data mining capabilities based on a broad range of user behavioral data. Furthermore, the Youku and Tudou iOS mobile apps have been upgraded with our in-house developed video players.

While our new version of our PC client based software was launched to enhance the overall user experience. Our partnership with Huawei, CIBN and Unity was recently announced in order to enhance our home entertainment offerings.

In regards to traffic monetization, as a result of our continued investment in content technology and brand, we have been able to create strong momentum in our traffic growth this quarter. I’m pleased to report that Youku Tudou’s multi-screen strategy is materializing and now covers more than 500 million monthly and 140 million daily unique visitors. Today Youku alone has over 600 million daily video views across different screens, with more than 60% of this total coming from mobile.

Recently released iResearch data shows Youku Tudou holding the leading position in the three key mobile traffic matrices, with Youku’s monthly user time spent, daily unique and monthly visits for mobile, beating out the second closest competitor by wide margin. In July Youku’s PC and mobile and Tudou’s mobile average daily video views increased by 27%, 30% and 60% respectively as compared to April.

On the monetization front it has been a year since we launched our multi-screen advertising product and started monetization on the mobile front. Multi-screen monetization has progressed very well, growing from 3% in Q3, 2013, to over 30% today, with more behavioral advertising initiatives to be launched in the near term. The healthy mobile video monetization ramp is a testament to online video, as a proven business model with vast potential.

Now let’s turn to our original content strategy. I would like to emphasize that our diverse and comprehensive mix of content offering is critical to elevate our media value and expand our presence across China. We are scaling our investment to launch our original content 2.0 strategy, which includes six major themes; namely Big Data, Expanded Scale, Increased Investment, Premier Partners, Big Screen and Major Impact.

Regarding Big Data, we are now leveraging the scale of our user base and analyzing behaviors such as viewership, search, comment, interaction, subscription and video uploads, to customize our original content to fit the taste of the Chinese Internet audience, which is vastly different from China’s TV audience due to differences in user demographics. This has enabled us to increase our success rate and has already provided valuable information to our content team and partners.

As for Expanded Scale, we already have the largest originals portfolio among our peers in China, with more than 50 different shows to-date. In addition we have the most successful case examples across different genres and multiple seasons, including for example On The Road, Miss Puff, Hip Hop Office Quartets among others.

Going forward, we are expanding the scope of our portfolio, the contents of which would be accessible through different channels from Internet to movie screens, and will cover an even wider range of genres such as variety shows, music, live performances and reality shows.

Our increased investment in our visual content is fueled by our high and improving success rate. Our budget for originals this year is RMB300 million and we expect the scale will continue to grow.

Regarding premium partners, Youku and Tudou are cooperating with top tier production teams to improve the quality of our original shows. For instant, Youku’s Searching For Divas is co-produce with the production team of the number one variety show in Korea, SBS Running Man. While Tudou’s reality TV show Guest House is co-produced with SBS and SM Entertainment and features Super Junior, one of Korea’s top bands.

On big screen, as our investment in originals and cooperation with top tier production houses increases, the quality of our original shows has become attractive to media channels such as TV and movie theatres. For example, On The Road was aired during a prime time evening slot on China’s Central Television flagship channel, CCTV-1. Another show (Foreign Language) Surprise was also aired on Hunan TV, the most popular provincial satellite station that’s watched nationwide.

Finally, in regard to major impact. With more and more of our originals available in different distribution platforms, the media influence of Youku Tudou is increasing correspondingly. For instance, we developed a music video Xiao Pingguo with Little Apple, which has become a music and dance phenomenon in China, similar to Gnangnam style in Korea and around the world.

This song and music video was launched in May and it went viral on social media instantly with more than 5 million video views the same day. As we are dominant in UGC with a highly engaged user community, more than 3,500 different versions of the music videos were uploaded on to our platform, which when combined with our original generated over 500 million video views on Youku Tudou and topped every major music chart in China with more than 500 million plays across online music channels.

In summary, our content creation capabilities are growing rapidly, which complements our already dominant multi-screen content distribution platform. These core competencies enhance each other in product offering, user experience and revenue generation, as Youku Tudou is best positioned to develop the leading multi-screen media and entertainment eco-system in China.

With that, I will turn the call over to Dele, who will continue to discuss our business operations and content strategy.

Dele Liu

Thank you, Victor. We made solid progress in Q2 on diversifying our revenue streams. Despite our large user base, our monetization ratio is very low. It is important for us to increase our ARPU from our branded clients, as well as grow our consumer business. I like our competitors, which are spending rationally on license contents to subsidize their revenue grows. We are investing aggressively to transform our advertising platform into a unique marketing solution for brand advertisers in China.

Youku Tudou continues to be the preferred platform for brand advertisers to increase their large-scale brand awareness and generate the highest ROI among our competitors in online video space.

To illustrate, in the last quarter we gained 110 new clients as compared to 81 new clients in Q1, 2014. Notable clients include Timber Land, Helen Keller, Earth Groove (ph), (inaudible) etcetera.

Our recently launched demand-side platform has increased the effective CPM rates by 100% and the related sales process is now automated. Despite this however, challenges remain as our brand advertising monetization model is still in the period of transition due to mobile and we are reorganizing our sales team this quarter, in order to address market growth for domestic clients.

General feedback from our advertising partners on our multi-screen advertising product is positive. With that said, however, we are also aware of the concerns from our advertising partners that online video industry cannot identify the uniqueness of the users across different screens and thus effective frequency control cannot be measured.

In response to this, the strategic partnership with Alibaba has empowered us to leverage later from its app network and I am pleased to inform you that we have made solid progress, which shall be announced later this quarter.

Firstly, we have completed cookie mapping with Alibaba’s Big Data. With this initiative, even in the event that our user stops logging to either Youku or Tudou platform, our app system is able to duplicate overlapping users from different screens. This unique value proposition revolutionalize the way multi-screen app solutions are being delivered, by significantly reducing advertising wastage, and in return will increase brand advertisers ROI as it places budget onto our app distribution platform, increases our CPM bargaining power over the long term and enhances demand from existing and new brand advertisers to allocate budget to us.

Cookie mobile mapping has also established a solid pace for the further exchange of data and will search to bring in more targeted advertiser solutions across multiple screens for advertising partners. In this likes we will start to roll out app solutions for our existing clients, with more targeting features to explore new advertisers from sectors such as auto, financial services and high end luxury products, which have user demographics that are niche in nature.

We will also start to tailor unique app solutions for our existing clients, with more targeted features to increase their ARPU. These new advertising products will be introduced to the market by the end of Q3. Along with the data exchange process, more and more innovative and unique app products will be launched, and we are confident that our client base will continue to diversify and grow.

Regarding diversified revenue in our consumer business, we are implementing several initiatives to develop our consumer business further. We have seen encouraging results in the last quarter with subscription revenue growing by 379% year-on-year and 55% quarter-on-quarter. Our investments in product development and content and further collaboration with Alibaba’s payments ecosystem will continue to improve the traffic conversion rate to grow our subscriber base.

Furthermore, in addition to our subscription businesses, we recently rebranded our live Interactive Entertainment Platform to Li & Fung’s to connect fans directly with their favorite celebrities, musicians and web personalities. One example of Li & Fung’s success was the season final of our Internet reality show, Searching Divas, (inaudible) a program which features contestants who compete against each other to secure performance contracts, what’s broadcasted live online with the winner garnering more than six million votes.

Now on recent developments in content, as we head into the third quarter, we continue to improve our overall content offerings, including in professionally syndicated content, user generated content, partner generating content and original content. With a strength and balance sheet, our bucket for content syndication as well as that for content production will increase aggressively.

Our target is to maintain a level equal to 30% to 40% market share of all the high engaging professional syndicated content in China. Moreover, we are further transforming Youku Tudou into a platform based business model, by building an ecosystem for content creators to share revenue with us, enabling the company to eventually disrupt the traditional content creation model.

In the area of professional syndicated content, we continue to offer our audience an extensive selection of domestic and overseas premium content syndicated from China, Korea, Hong Kong, Taiwan, U.S., Europe and Japan. Furthermore, we have expanded our exclusive agreement with TVB for another three years from 2015 to 2018, a pack which will cover all TVB new dramas and its entire library.

In career, we have expanded our scope of corporation with SBS and CJ entertainment to cover more titles and more genres.

To illustrate just one example of how our own content distribution capabilities surpasses that of our competitors, who again keep up one of the non-exclusive domestic TV serial drama, generated close to 700 million videos viewed, more than 170 (inaudible) comments and broke the 100 million videos viewed mark within just four days.

As to the regions of our most popular drama, two of the top five TV dramas in terms of average videos viewed per app sold are re-connected from Hong Kong and Korea, with the two generating more than 300 million and 400 million videos viewed respectively. Such results are evidence that the scale of our platform is benefiting our content partners by enabling them to reach out to a larger audience through online video.

Our efforts to produce original content are going ahead full stream. We have assembled 15 production teams, which are working on different types of content, with incentives that are compatible to those of TV stations, including key variety shows, TV dramas, talk shows and animation among others. We announced the release of more than 20 new programs and drama series produced by our in-house production unit.

During the second quarter the company announced that 17 original dramas, covering a wide range of genres will be broadcasted on a weekly basis starting from Q2 of this year through Q1, 2015.

To provide just one highlight (inaudible) season two debuted in July 1 and has already begun to build on its season one audience. In consideration of the on-demand nature of Youku Tudou, we feel that as we promote season two there will significant long tail traffic from season one. Season two opened with more than 85 million videos viewed in three days and the entire series already generated more than 1 billion videos viewed in total.

In June we premiered Searching For Divas, (inaudible) which immediately became a social media phenomenon as it broke 100 million videos viewed within six episodes. Other shows such as On the Road, (inaudible), all consistently rank among the top variety shows on our platform.

We recently announced corporation between Tudou and KBS from Korea to co-produce music shows specifically tailored for the Chinese Internet audience to include interactive features. As Victor has previous mentioned, another reality show called Guest House co-produced with SBS and SM, will be featured on Tudou in September with fans selected from our platforms to participate in the show.

In the second quarter another web series Midnight Taxi co-produced with Japanese entertainment company Amuse premiered on Tudou and was subsequently broadcasted on the satellite TV network, thus demonstrating Tudou’s brand image and character in front on the main stream audience. For the long term we believe that the value of our self developed content IP will grow as it will drive additional traffic and create incremental revenue steams, as we develop more seasons of already popular shows and try new series.

Turning to PGC and UGC, on top of our leading UGC ecosystem, our early investment in PGC is beginning to pay off and ecosystem is starting to take shape. To-date we have entered into more than 200 exclusive content partnerships, which have resulted in the creation of more than 7,000 episodes of content. Domestic partners include (inaudible) while overseas partners include (inaudible) with whom we have recently announced the strategic partnership. To-date more that 7 billion videos viewed have been generated since the launch of this revenue sharing program.

Youku Tudou is moving ahead with its joint movie production and promotion efforts. Our online influence has developed into a powerful pre-cinema, in-cinema and post-cinema marketing solutions for future films, particularly with younger generations who get their entertainment on the Internet. Levered in our Big Data and movie promotion capabilities, movies have been co-produced. We have co-produced and achieved impressive results at the Chinese box office.

For example, we have produced a feature film Old Boys: The Way of the Dragon, which was spaced on a 43 minutes microfilm, which became a hit, over 80 millions views in 2010 and its China’s first microfilm to big screen movie. As Victor mentioned, we promoted its title theme song Xiao Pingguo in the pre-cinema release to create a social media hype and to give our audience something to look forward to when the featured film premiered. The result was that the box office return for Old Boys broke RMB100 million within four days.

In July three domestic movies we co-produced, including (Foreign Language) over RMB1 million in total box officer returns. We marketed and co-produced eight movies to-date this year, which in total brought in over RMB1.9 billion at the box office, representing 40% of the box office for domestic movies.

We are also online marketing partners for highly successful international movies in China such as Transformers 4 and Captain America 2. These results demonstrate how Youku Tudou consistently elevates the marketing efforts of Chinese film markers.

With that, I would like to pass the floor to Michael, our CFO, to go over second quarter financial results with you.

Michael Xu

Thank you, Dele. Hello everyone and thank you all for joining our conference call today and I will walk you through our financial highlights for the quarter. The amounts mentioned here are in RMB unless otherwise noted.

For the second quarter our net revenues were RMB959 million, a 27% increase year-on-year and meeting the guidance previously announced by the company. We generated revenue from mobile value-added services through partnership agreements with third party mobile network operators and shared the fees collected by the mobile network operators for such services.

During the second quarter 2014 we have not finished the service agreement renewal processes with one of our major mobile network operators and as a result, we deferred recognition of such revenues, about RMB40 million through the completion of service agreement renewal processes.

Advertising net revenues were RMB916 million, meeting the guidance previously announced by the company. Bandwidth costs were RMB214 million, representing 22% of net revenues, compared to 22% in the same period in 2013. The growth of the bandwidth cost is currently attributable to growth in traffic.

Non-GAAP content costs were RMB403 million, representing 42% of net revenues, compared to 38% in the same period in 2013. The growth in content cost is primarily attributable to more investments in in-house production and amortization from syndicated content.

Non-GAAP gross profit was RMB224 million, a 10% increase year-on-year due to strong operating leverage. Non-GAAP sales and marketing expenses were RMB186 million, as compared to RMB150 million in the same period in 2013. This increase was primarily due to higher commission expenses paid to our sales force, in line with our revenue growth.

Non-GAAP product development expenses were RMB79 million as compared to RMB55 million in the same period of 2013. This increase was primarily due to higher personnel related expenses for our product development in mobile, search, social, paid and live broadcasting services.

Non-GAAP G&A expenses were RMB48 million, a decrease of 13% year-on-year due to better AR collection. Non-GAAP net loss was RMB76 million as compared to RMB45 million in the same period 2013.

Turning to cash flow items, as of June 30, 2014 cash, cash equivalents, restricted cash and short-term investment totaled RMB7.2 billion. Our acquisition of the intangible assets was RMB246 million. Looking ahead to third quarter 2014, we expect net revenue roughly between RMB1.1 billion and RMB1.13 billion; implying approximately 27% to 32% year-on-year growth, with advertising net revenue contributing between RMB965 million and RMB1.01 billion implying approximately a 30% to 36% year-on-year increase.

Now, I will turn to floor to the Q&A session.

Question-and-Answer Session

Operator

Ladies and gentlemen, we will now begin the question-and-answer section. (Operator Instructions). Your first question comes from the line of Eddie Leung from Merrill Lynch. Please ask your question.

Eddie Leung – Merrill Lynch

Good morning. Thank you for taking my questions. You have talked quite a lot about your sales production content. Just wondering if you could give us an update on the user generated content side. Any update on percentage of traffic or revenues from UGC would be great and any plans to expand your leadership in that area? Thanks.

Victor Koo

Thank you for the question. UGC has always been the historical forte of Youku Tudou and that this is an area that we have continued to lead and invest in. You’re right to say that this call, we focus a lot more time on original content, but that’s not discounting all the efforts we still continue to push on the UGC front. Whether it is the recent successful Tudou video festival, plus all the Pike (ph) and UN efforts of Youku, plus the G Ke G Pai which is the revenue sharing program that was instituted, which Dele pointed out in his earnings script.

We’ve actually seen very good traction in terms of both, traffic as well as revenue momentum on the UGC side as well that we’ve mentioned in previous calls.

Eddie Leung – Merrill Lynch

Got it. Thank you.

Operator

Your next question comes from the line of Alicia Yap from Barclays. Please ask your questions.

Alicia Yap - Barclays Capital

Hi. Good morning Victor, Dele, Michael and Ryan. Thanks for taking my questions. My question is related to Alibaba investment and corporation. So can management share with us what has been done so far in terms of integrating the Youku product offering to the Alibaba user database and the cloud system?

I understand – I think Dele mentioned earlier that we have completed the cookie mapping, but I also wanted to know what is the next phases of the integration, and in relation to that, what can we expect for Youku in the couple of quarters. Will there be any new advertising format or new groups of advertisers that we can attract and how will that impact and benefit our revenue growth and margins? And if you could also share how Alibaba's sees the video business in their overall ecosystem, that will be great. Thank you.

Victor Koo

Thank you. We’ve put together different task teams to focus on different aspects of the strategic operation. I think the last script mentioned about some of the progress on the Big Data and advertising side, where in the initial period the corporation was really focused in terms of the back end operations to make sure the cookies mapping, as well as the Big Data capabilities match. And then you will see more and more of these products being launched by the end of this quarter and then in Q4, which will help us both in user as well as the monetization side.

As we move later in this year, you will also see a progress on the corporation, on the commerce as well as the payment said, especially as related to our original content. And then this area, we’ll mention some progress on the membership and subscription side as it ties in with the payment ecosystem with Alibaba, as well as the original content side, how it works with the Taobao, TMall, as well as the ecosystem of the SMEs on the Alibaba commerce ecosystem. So those will also come to bear as we make more announcements in this and next quarter.

Alicia Yap - Barclays Capital

Yes, thank you. And can I just follow up – how do you see Ali being the overall video business in their ecosystem.

Victor Koo

Well, I think the partnership with Alibaba is very healthy and positive and the one area that we are also working on together where we coincide is really the OTT side, including the set-top box and so forth, and this is an area that we are working hand-in-hand in terms of the home entertainment products.

Alicia Yap - Barclays Capital

I see. Okay and my last question is on – I think Dele mentioned just now. I wanted to get more clarification about the 30% to 40% market share target that we aim for on the syndicate professional content, and I think Dele also mentioned a little bit about the revenue share, that will be a disruptive business model. So can you elaborate a little bit more on that? I probability did not hear it correctly. Thank you.

Michael Xu

Thanks. The overall content strategy is to offer a very comprehensive content repository to our users. Professional syndicated content is one of the major categories that users are focused on and that’s also where its most comparative vis-à-vis our peers. And our strategy has been to maintain reasonable and fair share, which we think is about 30%, 40% around the market. We are not going to buy everything, no, which is not extremely value created. So we are keeping our 30% to 40% share to maintain, to continue to lead on the professional syndicated content.

So on the partner generated content and revenue sharing model, its something that we have been working on for the last few years. Just like YouTube, we have a partner program to incubate and cultivate high quality UGC and upgrade them to more and more professional, even to future film, you have seen from the case of Old Boys.

And the traffic has been increasing pretty solidly and revenue share and buyback over time, with the democratization of the content creation, you will see that, in the future hopefully we will build an ecosystem to disrupt the traditional way of the content creation in China.

Victor Koo

On the strategic basis the way we think about how this ecosystem works is, first of all you have the widest reach platform and two original content was developed, successful case examples in all the different genres where we continue to delete and then as Dele pointed out, in recent years, building a revenue sharing ecosystem with the successful case examples, we are seeing very positive signs where these partner content already created their own successful examples distributed, marketed and on our platforms.

So you will increasingly see now just a real content that Youku produces that are successful, online and offline. You are going to see increasingly more PGC programs that are successfully, online and off line.

Alicia Yap - Barclays Capital

I see, great. Thank you so much.

Operator

The next question comes from the line of Dick Wei from Credit Suisse. Please ask your question.

Dick Wei – Credit Suisse

Yes, hi thanks you for taking my question and thanks for the strategic update for the company. I just wanted to follow on the platform strategy. How should we think about that Youku maybe in like two or three years time, maybe the content among some channels like UGC and PGC or in-house produced content. How should I think about that and what does it mean to the margins for the company. Thank you.

Victor Koo

Thank you, Dick. I think as Dele pointed out, I think our fair share strategy on the syndicated content is consistently our strategy. So the primary focus in terms of growth and investment, still on the web based content ecosystem, whether it is a video content UGC or PGC, including joint production online plus offline.

And this is an area where we see tremendous amount of potential, where on one hand with leading brand advertising monetization capability and because we have full control of the content brands and IP, the potential for revenue monetized on the consumer revenue side, which was started from the movie side now extend to the live broadcast and games and other consumer areas.

You will increasingly see more and more successful examples, which our partners are increasingly excited about, because they are seeing not just revenue sharing from the advertising side, but also from a consumer and non-advertising side, and that’s how our complete ecosystem will prosper and scale in terms of network impact.

Dick Wei – Credit Suisse

Got it. And just a quick follow-up on the advertising market; maybe any comments on the trend that you are seeing maybe for the second half of the year. Thanks.

Victor Koo

The question is about pricing. I think the most important transition right now on the advertising side; one, PC to mobile and our strategy is the multi screen strategy as we move from PC to mobile is to have a cross stream price, which we mentioned I think in the previous two earnings call and we have seen an increase in percentage of mobile Internet revenue, which will continue, especially with the new solutions we are tying with Alibaba’s Big Data capabilities and cross stream de-duplication that Dele mentioned.

The other transition is really broadening our client base from international and interactive clients to domestic advertisers, which are dominant with satellite television stations and we are seeing increased interest in this area. And again, this is where content marketing solutions are and original content becomes very important, because when the domestic clients are looking for one broad reach very similar to other clients, but at the same time, capabilities and the ability to be able to do sponsorships and product placements in original and partner-generated content.

Dick Wei – Credit Suisse

Okay, great. Thanks a lot Victor.

Operator

Your next question comes from the line of Jiong Shao from Macquarie. Please ask your question.

Jiong Shao - Macquarie

Good morning. Thank you for taking my questions; I have two. The first question is about your revenue growth. Its great you guys are doing a lot on the content side and on multi screen, on new products, etcetera. The advertising revenue growth rate now is below 30%. Will you be able to elaborate a bit on what are the key problems or challenges behind this sort of a similar challenging revenue growth environment for Youku Tudou.

Victor Koo

I think we mentioned really the reorganization of our sales force, where we basically brought in domestic TV team. In the past most of our clients are on the international and interactive side and the background of our team comes from Internet as well as foreign agencies.

As we are trying to broaden and diversify into more and more domestic clients, which contribute a large proportion of the satellite television advertising revenue, which we see great potential.

We’ve brought in a television based advertising team in the end of the first quarter and we’re going through this integration in Q2 and Q3 and during this period is where – during a restructuring period, because our accounts are reallocated and new client relationships are passed over. This is really a transition period for us and you will see increased growth after this transition and integration period.

Dele Liu

This is Dele Liu. Moving into Q3, we are accelerating our revenue growth as you can see from our guidance and some earlier results are gradually increasing. We are also working closely with Alibaba to tap into their SMEs and other solutions to build a larger advertiser base and hopefully we will see results going forward.

Victor Koo

Also as Dele mentioned, the targeting new features that will be launched at the end of the quarter, which will also help us with interactive clients as we see more and more auto and financial services and high end product really leveraging the mobile screens.

Jiong Shao - Macquarie

Okay, thanks for the color. That’s very helpful. My second question is on the subscription, as you highlight that as a key initiative for the company and I think for Youku Tudou and for some of your peers, all sort of driving towards the subscription base, the business model, which may eventually end up to be in a huge market for the whole industry. Could you talk about the number of subscribers you now have? What are the key things your kind of pushing and nudging your users towards being a subscriber?

Michael Xu

Okay, this is Michael. I will take this question. So at the moment we have roughly 400,000 paying subscribers. I think the key initiative from our side is on two fronts. One is to increase the conversion rate. Basically, based on all estimates, if we have done a good job and have streamlined the registration of payment processes, it is not that difficult to increase the conversion rate by four times, that’s one thing.

And the other thing is to increase the retention rate of our existing paying subscriber base. The key to increase the retention rate is to have better quality cut-ins and to broaden the customer offering. We are very confident with the collaboration with Alibaba, as well as with other companies. We can streamline the registration and payment process, so that we increase conversion rate and also with the increased incremental investment in the (Technical Difficulty)

Jiong Shao - Macquarie

Hello.

Michael

Can you hear me?

Jiong Shao - Macquarie

Yes. Sorry, you broke up for like 15 seconds. Sorry Michael.

Michael

Okay. So a long answer short, we’re going to increase conversion rates of the traffic and work by the streamlining of registration of payment processes, that’s one thing. And the other thing is to increase the retention rates of the existing subscriber base, to often broaden – to broadening our content offering. So I think that’s in essence my answer to your question and finally, there is roughly 400,000 subscribers on Youku.

Jiong Shao - Macquarie

Okay, great. Thank you very much Michael.

Dele Liu

One good news. This is Dele here. One good news coming from this side is that the Chinese government is implementing a more rigorous anti-piracy campaign and that will certainly help the people to pay.

Jiong Shao - Macquarie

Right. Thanks Dele.

Operator

Your next question comes from the line of Philip Wang from Morgan Stanley. Please ask your question.

Philip Wang - Morgan Stanley

Hi, good morning. Thanks for taking my question. Could you please update us with the customer mix for this quarter and then also, could you also share with us any particular sector you are seeing a weaker outlook in coming quarters. Thank you.

Victor Koo

So the custom mix has been pretty stable. Roughly 55% to 60% are coming from FMCG. Of that 55% to 60% FMCG clients, roughly 80% are coming from international and also the rest of major verticals are also in a finance, which accounts for 15%, IT probably 10% and the rest are from different industries.

Philip Wang - Morgan Stanley

Could you comment on any particular category that you’re seeing a relatively weaker outlook in the coming quarter?

Victor Koo

I don’t think any particular industry is under weak outlook. I know recently the Chinese government required that a major SOE to significantly reduce their marketing and promotion expense. However we don’t have much exposure to SOE, to State Owned Enterprise, so we are kind of immune from this.

Philip Wang - Morgan Stanley

Thank you.

Operator

Your last question comes from the line of Alex Yao from JP Morgan. Please ask your question.

Alex Yao - JP Morgan

Hi, good morning everyone and thank you very much for taking my question. Just a few very quick follow up questions on the previous Alibaba Corporation and partnership. Firstly, does the partnership mean you guys will essentially be feeding traffic from your website to the Taobao SSP (ph) and then to TANX and then eventually to the advertisers who are majority the Taobao merchants and TANX.

And then secondly, does it mean going forward you will sell an increasing amount of the inventory to brand advertisers who buy inventory on TANX. And thirdly, if Alibaba helps you guys identify the user profile, user behavior, what will you guys give to Alibaba in return. Thank you. I’ll stop here.

Michael Xu

I think probably the market – this is Michael again. I think the market probably has some kind of wrong assumptions to what can be done between us and Alibaba.

First of all, the corporation between we and Alibaba is not only about long term inventory monetization, which is only a very small portion of our collaboration. The major collaboration at the moment are two areas. One is to provide true cross solutions for our grant advertisers by reducing the inventory, using their budget wastage. I think the Dele has elaborated very clear. And a second area or key initiative, second key initiative is to provide more targeted advertising solution to our brand advertiser.

To give you one example, suppose you are one of a cosmetic makers and you want to provide high-end lipstick for women aged from 25 to 35, living in the urban area with a certain level of income. At the moment no other video operator can provide this kind of target ads and everything. All this profile has to be based on estimate. However through the collaboration with Alibaba, actually we can very accurately deliver this kind of advertising solution. It is very much revolutionary.

So again, the perception about selling redundant inventory, long tail inventory to help out and to monetize this kind of long term inventory is a very small portion of the collaboration. It is a very much wrong perception by the people.

Victor Koo

Yes, just to clarify, Youku Tudou continues to run its independent ad delivery system, independent of TANX.

Alex Yao - JP Morgan

So if Alibaba helps you guys to improve the targeting capability level, what will you guys give to them in return?

Dele Liu

This is Dele here. There is a lot of things being discussed around how to link comp and consumption and eCommerce together. This is a huge potential as perceived by both sides and there is a lot of things that probably we’re not today able to describe clearly.

Victor Koo

There’s also initiatives in terms of data that we’re polling to make sure that we can get insights from it that actually shared by both parties.

Michael Xu

Yes, to gives you a very specific example of what we’re going to offer to Alibaba in return. At the moment we’re working on a channel called the (inaudible). On this channel, Alibaba’s power sellers are going to generate a lot of video short clips and load it onto Tudou, and in this process with our Youku site we have a lot of user generated content that didn’t produce and on Alibaba’s site, we can direct those traffic, as well as the merchant, the sales intention to Taobao. So I think that’s a very much neutrally beneficial collaboration. It is not only one sided.

Dele Liu

And also, Taobao merchandisers can also be empowered into video capabilities to demonstrate their goods and previously its all about the pictures that now when Youku Tudou CDN and video solutions, there is a lot more choice that’s for those merchandisers.

Victor Koo

Also, the ancillary products of our original content programs have also opened up stalls in Tmall, which is also a win-win.

Alex Yao - JP Morgan

Got it. That’s very helpful. Thank you very much.

Victor Koo

Thank you all for joining us on this call. Feel free to call us if you have any questions. Good-bye.

Michael Xu

Thank you.

Dele Liu

Thank you.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.

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