Video Shuffle Continues With Sohu, Xunlei

by: Doug Young

This year's shake-up of the online video space is taking yet another turn, with word that Sohu (NASDAQ:SOHU), one of China's top 3 services, has agreed to buy rival Xunlei's service called Kankan. If true, this development would be quite exciting, as it would mark the rise of a third major player in the space that is undergoing a major consolidation. Youku Tudou (NYSE:YOKU) remains the industry leader after its formation last year with the merger of China's 2 largest video sites. Baidu's (NASDAQ:BIDU) iQiyi is emerging as a strong number 2 after its acquisition of PPS in May for $370 million. Sohu previously operated China's second largest video sharing service, and a purchase of Xunlei Kankan would comfortably bolster its place as one of China's top 3 sites.

Of course I would be remiss if I didn't mention that all deals involving Sohu are usually painful affairs due to the difficult nature of company founder and CEO Charles Zhang. While the latest reports indicate a deal is imminent and may have even been signed, I won't believe anything until we see an official announcement from Sohu. Regular readers will recall that Sohu was at the center of a nonstop stream of tie-up rumors earlier this year, including one report that said it was on the verge of buying PPTV, another major online video site. (previous post)

But in the end, only one of those deals actually came to fruition when Sohu said last month it would sell 36.5 percent of its Sogou search engine to Internet giant Tencent (OTCPK:TCEHY) for $448 million. (previous post) I have to credit Zhang for making a relatively smart decision to partner with Tencent in that case, since an alternate partnership with Qihoo 360 (NYSE:QIHU) that was also in discussion would have paired him with Qihoo's even more difficult chief Zhou Hongyi.

All that said, this latest potential tie-up looks like a good fit for Sohu if it's really happening and Zhang can close the deal. Let's take a closer look at the reports, which say Sohu and Xunlei have reached a "capital partnership" agreement, which would presumably see Sohu buy most or all of Xunlei Kankan. (English article; Chinese article) The source of all the chatter is a blog post by a well known industry insider, meaning it could easily just be a rumor.

Xunlei and PPTV have emerged over the last few months as the 2 major remaining independent video sites without deep-pocketed backers, meaning both are probably under pressure to find a cash-rich partner to help continue funding their operations. PPTV is clearly looking for a buyer, as the company has appeared in numerous reports throughout the year about talks with various companies. The latest of those saw media report a month ago that it was close to a deal to be bought by e-commerce and retail giant Suning (Shenzhen: 002024). (previous post)

Xunlei was once considering an IPO to raise cash, but ran into headwinds when investor sentiment tanked towards Chinese tech firms 2 years ago. The company later tried to relaunch the IPO, but reportedly ran into difficulties again due to the presence of rampant piracy on some of its sites. It made Xunlei Kankan into a separate unit that was relatively free of those problems, and was reportedly considering an IPO for that.

I suspect that IPO plan didn't go far since Kankan is probably still losing money. That's important because investors have shown a strong preference for profitable companies during the recent thaw in sentiment. At the end of the day, I would quite like this Sohu-Xunlei deal if it happens, as it would create a strong new player with the necessary cash resources to compete in the market. But due to Zhang's difficult nature, the deal may stand only a 50-50 chance of actually closing.

Bottom line: Sohu's plan to purchase Xunlei Kankan looks like a smart move, but stands only a 50-50 chance of closing due to the difficult nature of Sohu CEO Charles Zhang.

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