Analysts predict two upcoming initial public offerings by leading online video providers in China will receive a warm reception, but investors should beware: there are layers of deep uncertainty in the space, including stiff competition from the country's search giant.

Within days of each other in November, the online video giant Tudou.com filed on Nasdaq and Youku.com filed on the New York Stock Exchange to raise US$120 million and US$150 million respectively to sustain and grow their expensive businesses.

Often referred to as "YouTube clones", the websites host a mix of user-generated video and professional licensed content. Youku recently started producing its own content to host on the site. In terms of revenue and users, Tudou and Youku are the leaders in a crowded field, but in the fast-shifting sands of China's internet market their success is not guaranteed.

Steep operating costs, uncertainty over regulation, a wary state broadcaster and a challenge by the deep-pockets search company Baidu all threaten Tudou and Youku's bottom lines, despite impressive revenue and traffic numbers registered by each.

Some analysts say the timing of the filings illustrates the fact that Tudou and Yukou are losing money. "They're struggling – they're looking for ways to get funding," said Ben Cavender, an analyst with the Shanghai-based China Market Research Group. "It's hard for us to understand where the real value is sometimes with these firms, and how ultimately they're going to become profitable."

Neither Tudou nor Youku are profitable, although Tudou, by clamping down on costs, narrowed its losses in the first nine months of 2010 compared to the $15.1 million loss it reported for the same period last year.

According to Beijing-based research firm Analysys International, Youku controls 20 percent of the online video market in China, while Tudou clings to 16 percent. Youku claims 203 million monthly visitors and in 2009 it pulled in $29.3 million in revenue. Tudou, meanwhile, claims 71.7 million registered users and in 2009 pulled in $16.9 million in revenue. In the first nine months of 2010, it has already garnered $33.8 million.

The companies rely chiefly on advertising for income, although both are looking to branch out to premium services in order to find new revenue streams. Meanwhile, however, they are burdened by huge operating costs, including for server space and bandwidth, which is more expensive in China than in the US because of the provider duopoly of China Unicom and China Telecom.

"Between the two of them they have spent something along the lines of US$300 million so far and they're still some ways to really sustainable profitability," says David Wolf, CEO of Wolf Group Asia, a Beijing-based technology consultancy. "They need more and it's going to take longer, probably another year to two years before these companies can be finally into the black."

In the meantime, both companies will be looking nervously over their shoulders at Baidu's new online video play, Qiyi.com, launched in April. The search giant owns 51 percent of the video service in a joint venture with US firm Providence Equity Partners. Qiyi is modelled on Hulu.com and hosts only professional content. Baidu uses information gleaned from search data – because it can see what users are searching for, it can predict which videos will be most popular – to efficiently monetize Qiyi's content.

Baidu says its goal for Qiyi is to surpass Tudou and Youku within the next 12 months to become the biggest online video site in the country. The site is already attracting 86 million users per month, and with the deep pockets of Baidu and Providence to draw on, it looks to be in the game for the long haul.

There is also the possibility that Baidu may begin to tweak its video search results to favor content from Qiyi over other sites. For the time being, those results remain unbiased, but that may not always be the case, especially as the company doesn't see search as neutral in the mold of Google, which so values its "Don't be evil" mantra. Baidu has in the past been accused of manipulating search results to favor paid advertisers – but such shady practices might be on their way out.

"I think that Baidu has begun to realize that the practices they you could pursue at an earlier stage of your development, you cannot pursue when all of a sudden you're the only player on the market," says Wolf, noting that Baidu is effectively the sole search player since Google withdrew from the market earlier this year (www.google.cn now redirects users to www.google.com.hk).

"To toy with that mix right now invites local competitors who could stand up and say, ‘We don't toy with results, come and work with us'." Such competitors include Microsoft's Bing, which recently forged an alliance with Alibaba's search service, Taobao, and, potentially, QQ, owned by internet behemoth Tencent, which could soon launch a new search service.

"When you see those two players sitting in the wings, you don't necessarily want to mess with the quality of your search results," Wolf offers, before adding, wryly, "but I wouldn't put it past them."

Beyond the challenge from Qiyi and the quest for profitability, Tudou and Youku face other unknowns. The first comes in the form of the state broadcaster, CCTV, which so far has ignored the services as largely irrelevant. For the time being, online video sites don't threaten CCTV's healthy advertising revenues, but if in the future the broadcaster starts to leak viewers to the upstart competitors, it and the Communist Party might start to look at the likes of Tudou and Youku more warily. Says Wolf, "If the state broadcasters no longer reach the people, what is their legitimacy in the eyes of the party?"

So far, too, the sites have had a lucky run with the state regulators who have taken an approach of "benevolent neglect," Wolf says. If at some point the authorities were to point out that all video content on the sites had to be pre-approved by the State Administration of Radio, Film and Television (SARFT), Tudou and Yukou would have yet more headaches.

But for now, they can relax. It's IPO time and they can afford to party like it's 1999. Ultimately, says Wolf, there is room enough in this huge market for both players to thrive.

"These guys are going to have fantastic IPOs," he says. "They're going to be very, very successful. They're going to attract an awful lot of attention. If I were the folks running Qiyi, I'd be calling my investment banker right now."