Youku.com, China's largest online video company, said on Monday that it has inked a merger deal with its main rival, Tudou Holdings Ltd., in an unexpected move that the company claimed would form an industry leader in the world's biggest Internet market.

The two companies will merge through a 100 percent stock swap to forge a combined entity named Youku Tudou Inc., according to their joint statement.

Once the deal is completed, Youku shareholders and holders of its American depositary shares will own about 71.5 percent of the new entity, and those of Tudou will get the remaining 28.5 percent.

The announcement came as a surprise as the two companies had been engaged in a bitter rivalry involving allegations of copyright misuse and unfair competitive practices.

Analysts said that the alliance of the two rivals was the result of fierce competition in the world's largest Internet market, which has over 500 million users.

Under the agreement terms, Tudou's shares will be canceled, while Youku's will continue to be traded on the New York Stock Exchange.

After the merger, which is expected to be completed in the third quarter of 2012, the combined entity will hold more than a third of the country's online video advertising market, according to Internet research firm Analysis International.

Liu Xingliang, a senior Internet observer, said the merger of the two giants will help them take the lion's share of China's online video market, and force other rivals to seek a differentiated pattern of development in order to retain their market status.

Currently, market players, including the two heavyweights and online video branches of IT giants such as Baidu and Sohu, are providing Internet users with a wide range of films, TV dramas and other video clips.

China's online video watchers totaled 325 million in 2011, accounting for 63.4 percent of the country's overall Internet users, official data showed.

Meanwhile, the market value of the online video industry almost doubled in 2011 to hit 6.27 billion yuan (about 1 billion U.S. dollars), and the snowballing growth is expected to continue, said a report by Beijing-based IT consulting firm iResearch.

The merger will lead to a reshuffle in the industry, Liu said. And others fret over a looming monopoly following the deal.

"I'm afraid that the country's online video industry will be monopolized by the Youku Tudou Inc. This may put great pressure on some of its rivals including 56.com and ku6.com," Wang ShuaiCyril said on Twitter-like service Sina Weibo.

Gong Yu, CEO of iQIYI under the Chinese search giant Baidu, dismissed the monopoly worries, citing the market shares in terms of viewers' time spent watching online video.

According to Gong, Youku now takes around 28 percent share of the market, while iQIYI and Tudou have respectively 14 percent and 12 percent.

His words were echoed by other Internet users. A Weibo user nicknamed Hg Yan Xiaojun said the merger does not mean that the two companies are without competitors. Success will still depend on their performance in the future.

The two giants might hardly be relieved upon the deal, as analysts pointed out that the sector has long been mired in debt, based on soaring costs and meager revenue.

A scramble to buy rights to the most popular movies and TV series has pushed up costs for online video companies who are dying to attract massive website traffic, according to a report by the China Internet Network Information Center(CNNIC).

On the other hand, companies have limited ways to generate revenue apart from advertising. But the charge for online ads is much lower than traditional media, and the revenue is far from offsetting costs, the CNNIC said.

The merger of the two companies came after both of them reported net losses last year. Tudou witnessed a net loss of 511.2 million yuan for the fiscal year of 2011, while Youku also reported Monday a net loss of 172.1 million yuan.

"The merger will help the two companies slash copyright purchase and other operational costs to boost their ability to profit," said Huang Meng, of Analysis International.

Upon the deal, Youku's share price opened 19 percent higher at 29.8 U.S. dollars on the New York Stock Exchange, while Tudou saw a 175-percent surge at the opening of Nasdaq.