June 24, 2011

SM Entertainment (041510 KQ) Entertainment

Buy Chang-kwean Kim +822-768-4321 [email protected] Jee-hyun Moon +822-768-3615 [email protected] TP: W30,000/MktCap: W3,126bn

An irresistible Buy!

 Global expansion efforts beginning to bear fruit SM Entertainment (SM) is growing as a global player in the music industry, tapping into the European, North American, and South American markets (on top of the Asian market). Indeed, songs, music videos, and concert footage featuring SM artists are spreading around the world through social media websites such as YouTube and Facebook. The global music market should offer numerous new opportunities to SM, as the companyÊs content development capability has proven to be superior to that of its domestic rivals. We maintain our Buy call on SM with a target price of W30,000 (vs. current share price of W18,900).

 1H11 Japanese performance has already exceeded full-year 2009 figures SM delivered an earnings surprise in 2010 with an operating profit of W25.5bn, which was primarily driven by overseas sales. We believe that last yearÊs robust overseas sales were largely the result of the recognition of sales related to the boy band TVXQÊs strong popularity in Japan in 2009. In 2009 alone, TVXQÊs CD albums sold 942,000 copies in Japan (624,000 singles and 317,000 full albums; retailers normally sell singles and full albums for W20,000/copy and W50,000/copy, respectively). In that same year, TVXQ attracted 374,000 fans to its Japanese concerts (based on official maximum capacity figures). Concert tickets are generally priced at around W150,000 each in Japan. In 2011, due to the earthquake and subsequent nuclear leaks, SM postponed its Japanese album releases and concerts by three to four months. However, thus far in 2011, TVXQ (now a duo) has sold 284,000 copies of its „Why‰ single in Japan and plans to release another single in July. In June, SMÊs girl group GirlsÊ Generation released its first Japanese full album (600,000 copies of which were ordered by retailers). This album is estimated to have sold more than 370,000 copies thus far. SMÊs boy band SHINee released its first Japanese single on June 22nd; 120,000 copies had been ordered by retailers. Another boy band, Super Junior, which released its first Japanese single in June, is scheduled to hold a showcase in Japan in July. All in all, we project SMÊs 2012 album sales volume in Japan to reach 2.02mn copies (doubling the companyÊs 2009 figures), which should be reflected into the companyÊs 2012 earnings. Furthermore, the attendance numbers for SMÊs 2011 Japanese concerts are likely to significantly exceed the companyÊs 2009 figures. SMÊs 1H11 concerts, including SM Town at the Tokyo Dome and GirlsÊ GenerationÊs Japanese tour, should be able to accommodate 432,000 fans. In addition, SHINee plans to embark on a concert tour to JapanÊs five major cities in July.

§ Earnings & Valuation Metrics FY Sales OP OP Margin NP EPS EBITDA FCF ROE P/E P/B EV/EBITDA (Wbn) (Wbn) (%) (Wbn) (W) (Wbn) (Wbn) (%) (x) (x) (x) 12/09 62 9 15.0 4 278 12 11 7.3 16.2 1.2 3.7 12/10 86 25 29.5 22 1,342 28 23 29.1 12.6 3.3 8.2 12/11F 90 17 19.2 15 901 20 21 16.0 21.0 3.2 11.7 12/12F 145 52 35.9 44 2,637 54 43 36.0 7.2 2.2 3.4 12/13F 159 59 37.0 50 3,029 60 51 29.8 6.2 1.6 2.2 Source: Company data, Daewoo Securities Research estimates

This document is a summary of a report prepared by Daewoo Securities Co., Ltd. („Daewoo‰) and published on our website. Please review the compliance notices contained in the original report. Information and opinions contained herein have been compiled in good faith from sources deemed to be reliable. However, the information has not been independently verified. Daewoo makes no guarantee, representation or warranty, express or implied, as to the fairness, accuracy or completeness of the information and opinions contained in this document. Daewoo accepts no responsibility or liability whatsoever for any loss arising from the use of this document or its contents or otherwise arising in connection therewith. Information and opinions contained herein are subject to change without notice. This document is for informational purposes only. It is not and should not be construed as an offer or solicitation of an offer to purchase or sell any securities or other financial instruments. This document may not be reproduced, further distributed or published in whole or in part for any purpose. June 24, 2011 SM Entertainment

 Royalty income (as a percentage of total Japanese sales) is on the rise SM boasts a diverse set of Japanese profit sources, including CD albums, concerts, digital music, and DVDs. In Japan, the digital music business makes up 30% of the music market (excluding concerts and sales of goods such as towels, photos, and T-shirts, etc.), while the concert/music video DVD business accounts for 11.6%. In addition, SM can generate profits from artistsÊ appearances in TV shows and commercials and merchandise sales (priced at JPY500~5,000/unit). We estimate that SM (which holds the copyrights to its artistsÊ CD albums and digital music) takes 15% of Japanese album sales and 30% of Japanese digital music sales. With regard to concerts, SM shares profits (after costs such as appearance fees, venue rentals, and other personnel expenses) with a Japanese entertainment agency. Profits from artistsÊ TV show and commercial appearances are minimal, as most of the associated income (excluding commissions to a Japanese agency) goes to the artists. In 2009, SMÊs royalty income was equivalent to around 20% of total Japanese sales related to the company's artist (TVXQ). However, this percentage is estimated to have risen to 30~40% since 2010.

Daewoo Securities Research