BofA Merrill Lynch publishes research report today

The following is the full report:

In the release of the third quarter financial, Youku potato New accounting policy stipulates that the procurement costs of professional production content in the first year of playback will be amortized 92%, higher than the previous 70%. This means that Youku potatoes will face higher costs in the short term, but this is good for future profit margins. It also gives Youku potatoes a better chance of achieving a break-even in the short term and boosting market sentiment. However, we also believe that this adjustment reflects a shorter generation capacity for professional production, or a smaller "long tail effect", since accounting policies typically require that the amortization of content costs be consistent with the continuation of advertising revenue.

We believe that these two factors bring about a relatively balanced risk-return ratio. Over the past 6 months, Youku's shares have risen 20% per cent, close to our target share price, so we downgraded the stock to "neutral". We anticipate that Youku will achieve a break-even in the fourth quarter, supporting market sentiment and its leadership, and maintaining long-term growth in the use of advertising budgets to shift from television to online video. We also think that the "run the market" rating is unreasonable.

Taking into account the higher cost upfront, we lowered the net profit margin of Youku 2013 and 2014 from 13% to 20%, and down from 4% to 3%, while the 2015 and 2016 net profit margins were raised from 18% to 22%, and from 23% to 29%. We also lowered the annual composite growth rate of 2013 to 2016 from 46% to 39% to reflect the "long tail effect" of smaller ad revenue from professional content. As a result, we have cut the earnings per share of Youku for 2014 to 45%, and will increase the earnings per share for 2015 and 2016 by 2% and 7% respectively. According to the DCF valuation method, our target price for Youku is slightly reduced to $28.5 trillion. And given the recent surge in Youku's share price, it means the future is shrinking.

Youku potato is still China's most comprehensive video content platform, if you can successfully promote advertisers to quickly accept mobile advertising, then there is still a greater room for growth. Currently, mobile advertising accounts for less than 10% of the total revenue of Youku. However, piracy of mobile apps still affects the commercialization of major video sites. In addition, market competition will bring downside risks. Youku's revenue is far ahead of rivals, but the flow gap with rivals is not too big. Even the budget-rich advertisers still choose the market's top-ranked Youku, but their competitors will grow more likely than the company in the coming year.