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China’s two biggest video websites, arch rivals Youku and Tudou, are setting aside their differences and planning a merger that will help them become the most competitive player in an industry that is growing rapidly.

The news is good news for Hollywood and other overseas shingles because both Youku and Tudou have focused on providing licensed content in recent years.

Both services started out with a similar business model of YouTube, banned in China. But in recent years both have been keen to go legit, and in the last couple of years, Chinese online video companies have started licensing content and creating their own skeins to woo auds.

Youku and Tudou have been bitter rivals in the fight to dominate the Chinese online video market, which has 400 million viewers and is emerging as the future of TV in China, where so many people watch on their handsets.

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While both are seeing rising revenues, neither is profitable because of the high cost of bandwidth in China.

Both Youku and Tudou show popular U.S. shows and allow viewers to download pics and other programming to watch on smart phones or tablet computers, which are very much the platforms of choice in China.

Youku Tudou Inc. would establish a clear and dominant leadership position in China’s online video sector,” Youku founder and CEO Victor Koo said in a statement.

Youku and Tudou were locked in a tough legal battle earlier this year, with each accusing the other of pirating their licensed video content.

The proposed merger would be a major challenge for the Chinese portal Sohu.com, which had 13.7% of the online video market in the final quarter of 2011, with 21.8% for Youku and Tudou in second place at 13.7%, the Beijing-based Analysis Intl. research firm said.

The other competitors in the market have single-digit market shares.

In August, Youku struck a deal with DreamWorks Animation for online distribution of the “Kung Fu Panda” franchise, making the studio’s films available online for the first time in China.

The two companies said the new company, Youku Tudou Inc., would be created in a stock-for-stock transaction, and is expected to be a done deal by the third quarter of this year, pending shareholder approval.