Alibaba Group Holding Ltd (BABA), Youku Tudou Inc (ADR) (YOKU): Why Are These Two Stocks Surging?

Shares of Alibaba Group Holding Ltd (NYSE:BABA) and Youku Tudou Inc (ADR) (NYSE:YOKU) are trending today after Alibaba made a non-binding proposal to acquire all outstanding shares of Youku Tudou it doesn’t own. Youku Tudou shares are up 22.5% and Alibaba is up 1.5% in pre-market trading. Let’s take a closer look at the deal and analyze what the smart money thinks of both companies.

In the eyes of most traders, hedge funds are assumed to be underperforming, old investment tools of the past. While there are more than 8,000 funds in operation, we look at the aristocrats of this group, around 730 funds. Contrary to popular belief Insider Monkey’s research revealed that hedge funds lagged in recent years because of their short positions as well as the huge fees that they charge. Hedge funds managed to outperform the market on the long side of their portfolios. In fact, the 15 most popular small-cap stocks among hedge funds returned 102% since the end of August 2012 and beat the S&P 500 ETF (SPY) by 53 percentage points (see more details here).

Alibaba Group Holding Ltd (NYSE:BABA) is offering to acquire Youku Tudou Inc (ADR) (NYSE:YOKU) for $26.60 per American Depository Share (ADS) in an all-cash transaction. Given that it already owns 18.3% of Youku, the deal will cost Alibaba an additional $4.2 billion. Alibaba doesn’t need external financing for the deal, as it has over $17 billion in cash and short term investments on its balance sheet as of June 30.

“Digital entertainment is core to Alibaba’s strategy of promoting consumption of virtual goods and services. The proposed transaction would expand the existing partnership between Alibaba and Youku, and would combine Alibaba’s unparalleled data-driven platforms in e-commerce, media and advertising with Youku’s market-leading digital video franchise to significantly accelerate Youku’s growth. Youku’s large user base, especially in mobile, and its popular platforms with high user engagement would form one of the key pillars of Alibaba’s digital entertainment strategy,” Alibaba said in a statement

As we mentioned earlier, Alibaba is similar to Alphabet Inc (NASDAQ:GOOGL) in many ways. Both companies have wide moats and are natural monopolies. Both use their cash flow to acquire potential growth. Alibaba’s purchase of Youku is just an another logical step in Alibaba Group Holding Ltd (NYSE:BABA)’s growth strategy. Since e-commerce growth is slowing as the Chinese economy slows, Alibaba is buying fast growing companies with potential to add to its own appreciation. If the transaction succeeds, Youku will be similar to Alphabet’s YouTube segment.

Online video is certainly a growth market. Many investors believe the Internet will disrupt television and movies in the same way that it disrupted newspapers and print media earlier in the century. The average Iinternet connection speed is getting faster, and people are more comfortable paying for things online. If just a fraction of the money spent on television makes its way to the online video world in China, Alibaba’s Youku purchase will be a home run. With around 300 million customers, its connections to Hollywood movie studios, and large financial resources, Alibaba doesn’t need much to make the deal work.

In the next page, we will analyze the hedge fund sentiment toward Youku and Alibaba.

According to our data of around 730 elite funds, hedge funds were bullish on Youku Tudou Inc (ADR) (NYSE:YOKU) in the second quarter and they amassed over 11% of the company at the end of June. A total of 20 funds reported stakes worth $544.45 million in aggregate in the last round of 13F filings, up from 14 funds and $322.23 million respectively a quarter earlier. Among the lucky hedge fund holders was Lei Zhang‘s Hillhouse Capital Management, which owned 6.63 million shares, and Kerr Neilson’s Platinum Asset Management, which reported 8.43 million shares.

Many hedge funds also held shares of Alibaba Group Holding Ltd (NYSE:BABA). A total of 85 investors among those we track reported stakes with a total value of $4.77 billion as of the end of the second quarter, representing 2.30% of the company’s float. That compares to 86 funds with $5.8 billion worth of Alibaba shares a quarter earlier. Rob Citrone‘s Discovery Capital Management owns 6.52 million shares of Alibaba, while Andreas Halvorsen’s Viking Global is long 6.04 million shares.

Disclosure: none