Youku Inc (NYSE: YOKU) and Tudou Holdings Ltd (NASDAQ: TUDO), the operators of China's two largest video website, said they will merge via a stock swap deal estimated to be valued at $1.04 billion.

Youku will own a 71.5% stake in the new entity, Youku Tudou Inc, and Tudou, which will get delisted, the remaining 28.5% after the deal that is expected to be finalized by the end of the third quarter. The deal is pending approval from the boards of both firms.

Since late last year, the two firms have been involved in a spate of lawsuits in which they sued each other over copyright issues.

Competition to buy rights to video content and to attract advertisers have exerted great financial pressure on them and hence caused operating losses, market watchers argue. Tudou posted ¥511.2 million in the red for 2011; Youku's loss was better, at ¥172.1 million.

Tedious propaganda TV programs have prompted Chinese viewers to go online. At present there are over 10 video hosting sites in China serving some 400 million viewers. This already vast population is projected to reach 445 million by the end of this year. Revenue from China's online videos surged 135% to ¥1.7 billion last year, with Youku and Tudou capturing a 21.8% and 13.7% share respectively, figures from Analysys International showed.

Analysts believe that the merger, as a result of Youku and Tudou struggling for cash to get rid of losses, will give the new company more leverage in negotiating with advertisers and reducing licensing expenses, and that the merger of these two market leaders marks a beginning of further consolidation in China's online video industry.

Interestingly, the new company will probably be shortened to Youdou, sounding similar to YouTube.

$1 = ¥6.33

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