Selling Pressure Ahead for Dangdang and Youku as IPO Lock-Up Periods End

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Includes: DANG, YOKU
by: The Skeptical Investor

May has been a tough month for Dangdang (NYSE:DANG) and Youku (NYSE:YOKU). Both stocks have fallen significantly since the beginning of the month. Though sky high valuation was at the root of the decline (Dangdang still has a P/E ratio of over 1000, while Youku has no P/E because it is not yet profitable and even its boosters do not expect it to break even until a year or two from now), the immediate trigger to the avalanche was probably the less than stellar IPO of Renren (NYSE:RENN).

Renren went public on May 5, at an offer price of $14. There was a smaller than expected pop on the first day, but only 5 trading days later, the stock had fallen to $13, below the IPO price. Institutional investors typically promise to hold on to their IPO shares in exchange for getting IPO shares at the offer price. They expect a pop after the IPO for holding on to their shares.

Renren’s rapid fall must have sapped the confidence of the many institutional investors who expected it to rocket up the charts like Youku and, to a lesser extent, Dangdang, earlier this year. After all, wasn’t it promoted as the Facebook of China? Many of these same funds also invested heavily in Youku and Dangdang.

With Renren’s fall, Youku’s shares dropped precipitously from $60 to $43. Youku had already announced a secondary offering when it released its Q1 results earlier. It was a bad time for a secondary offering, but better now than after the stock price goes even lower. Youku and its venture capital investors managed to sell 12 million more shares on May 20 at $48.18 per share. But the stock price quickly dropped below $43 a few days later, raising further doubts among institutional investors who bought in the secondary offering.

More troubles are still ahead, however, as the 180-day lockup for pre-IPO shareholders expires in early June. The market for stocks, like any other market, is subject to the laws of supply and demand. A large number of shares suddenly coming on the market will put tremendous pressure of the price of the stocks.

Dangdang’s post-IPO lockup period will end on June 6, and Youku’s will end on June 6. Millions of shares owned by pre-IPO shareholders will become available for sale after the expiration.

For Dangdang, the number of shares released from lockup on June 6 will be an equivalent of 58 million shares of ADSs (compared to the current float of 19 million ADSs).

For Youku, the number of share available for sale on June 6 will be 19.6 million shares of ADSs (compared to the current float of 30 million shares of ADSs). Two pre-IPO institutional investors in Youku, Brookside and Sutter Hill, agreed to an additional 3-month lock-up in exchange for selling 3.8 million ADSs in the secondary offering on May 20. Maverick and Farallon, each owning about 10% of Youku’s shares, did not join the secondary offering and did not agree to the additional lockup. They will be able to sell the nearly 20 million Youku shares they own after June 6.

Of particular note, Maverick had $142 million invested in Longtop Financial Technologies (NYSE:LFT) , which has been accused by its auditor Deloitte of fraud and is currently halted. Tiger Global, which owns about 17% of Dangdang, had $94 million invested in Longtop (see here).

After the Longtop debacle, they are likely to be extremely skittish about Chinese stocks and eager to rush for the exit when the lock-up ends.

Dangdang Lock-Up Release

Total Common

ADSs or equivalent

Shares To Be Released from Lock-Up on June 6

Directors and Officers

175,567,390

35,113,478

Tiger Global Funds

69,350,000

13,870,000

DCM Funds

25,321,400

5,064,280

IDG Funds

19,778,570

3,955,714

Others

3,607,450

721,490

subtotal

290,017,360

58,003,472

Public Float Before June 6

97,750,000

19,550,000

total

391,374,810

78,274,962

Youku Lock-Up Release

Total Common

ADSs or equivalent

Shares Subject to Lock-Up Until Aug 18

Directors and Officers

708,036,612

39,335,367

Brookside Capital

228,382,288

12,687,905

Sutter Hill Funds

165,734,998

9,207,500

Others

41,981,088

2,332,283

subtotal

61,230,772

Shares To Be Released from Lock-Up on June 6

Maverick Funds

181,965,920

10,109,218

Farallon Funds

172,018,194

9,556,566

subtotal

19,665,784

Public Float Before June 6

544,047,390

30,224,855

total

2,042,166,490

113,453,694

Note: Each DANG ADS consists of 5 common shares. Each YOKU ADS consists of 18 common shares.

Sources: Dangdang IPO Prospectus, Youku Secondary Offering Prospectus

Operational Concerns in Q2

Beside the upcoming massive increase in the supply of shares for sale, Dangdang and Youku also face operational headwinds. Their Q2 results, to be released in August, are likely to be much worse than expected.

Price war between Dangdang and 360buy.com

Dangdang has been engaged in a vicious price war with 360buy.com, which received $1.5 billion in venture financing earlier this year. 360buy is the largest online electronics retailer in China. It expanded into selling books and other merchandise late last year, right before Dangdang’s IPO.

Due to competition from 360buy (and not to forget Amazon.cn, Amazon's (NASDAQ:AMZN) China subsidairy), Dangdang first held a two-day “buy 200 yuan, get 100 yuan store credit” sale in the middle of March (see here). 360buy quickly matched the offer. Interestingly, the rebate credits were to be given to customers 30 days after the sale, in Q2, for the sales in Q1.

Dangdang started another “buy 200 yuan, get 100 yuan credit” sale on April 16 initially for books, and then expanded to other merchandise on May 17. According to reports, Dangdang has given more than 60 million yuan in rebates in just one month for books alone (see here). Accounted properly, these rebates should either reduce current sales revenue or require a reserve against future sales. It will be interesting to see how Dangdang accounts for them. Either way, the price war does not bode well.

Dangdang has been so unnerved by 360buy that Li Guoqing, Dangdang’s CEO, “joked” at a national Internet commerce conference in Beijing on May 21 that if 360buy is able to raise $3 billion to compete against Dangdang, then Dangdang would surrender (see here).

Content and HD Bandwidth Costs Rising for Youku

Things are not looking any better at Youku. Instead of being Youtube or Netflix of China, it is finding itself competing against well-financed rivals like Baidu’s Qiyi and Sohu, as well as Tudou, which is slated to go public in the US soon, and Tencent, the 600-pound gorilla of the Chinese Internet, which is starting a video service of its own.

Content licensing costs have doubled or tripled every year with all the video sites vying to license the latest movies and TV shows.

Bandwidth cost is another concern. Baidu Qiyi and Sohu have long offered HD videos and have been taking market share away from Youku (see here). HD video requires much more bandwidth and is likely to at least double bandwidth costs compared to lower resolution videos. Youku held off on making HD the default for its video for as long as it could. But with competitors taking market share away, Youku made HD the default on its site starting in Q2 (see here - pdf).

The increase in bandwidth costs for HD will be known when Q2 results are released in August, after the June 6 lockup ends.

Disclosure: I am short DANG, YOKU.