Media Content The next players of China’s growth A look into the growth pattern of China’s culture industry Overweight (Maintain) China has become a central player in almost every industry across the world. The media content industry is no exception. In our recent overseas marketing trip, we met many Industry Report foreign investors asking about Korean content stocks, and were left with the impression March 23, 2016 that investors were looking for the next players to benefit from China’s growth. In 2015, the tertiary industry contributed to more than half of China’s GDP for the first Daewoo Securities CCCo.,Co., Ltd. time ever, signaling a change in global stock leadership. China’s box-office market has been growing at an astonishing rate, outpacing forecasters’ predictions. Historically, US [Telecom Service / Media] cultural spending increased significantly when the country’s GDP per capita rose from Jee-hyun Moon US$4,000 to US$20,000. At present, China’s GDP per capita is just US$8,000. +822-768-3615 Furthermore, the Chinese government has pledged to develop the culture industry into [email protected] one of the backbones of its economy. Nu-ri Ha With infrastructure nearly complete, next big investment will be in content +822-768-4130 [email protected] China’s culture industry now has most of the necessary infrastructure in place. The boom in multiplex theater co nstruction has led to a considerable rise in the number of Hong-mei Cui screens, and box-office revenue is surging in third- and fourth-tier cities. As for internet, +822-768-3439 which is considered the basic infrastructure for digital video content, China’s penetration [email protected] rate already passed 50% in 2015. The country’s LTE penetration rate is also expected to surpass 50% this year. Simply put, the conditions are in place for Chinese users to enjoy video content through omni-channels. Many Chinese companies that own offline/online/mobile infrastructure and platforms are expanding their operations into investing and producing video content. Korean content companies are also increasingly broadening their presence in China. At the same time, Chinese money flowing into Korean firms in t he form of M&As is also on a sharp rise. With China’s cultural infrastructure and platform mostly complete, we believe much of the focus will now shift to the final component of the ecosystem: content. China presents an opportunity for Korean content companies, too We believe the growth of China’s culture market also presents an opportunity for Korean content companies. In particular, we think leading players that have survived the highly competitive, saturated domestic market on the back of strong co mpetitiveness are well-positioned to take advantage of this opportunity. Given that Chinese companies already have established infrastructure and platforms, we think it is crucial for Korean companies to secure intellectual property (IP) in order to ensure a sustainable presence in China. In our view, companies that are expanding their value chains and reinforcing their content development capabilities deserve attention. Korean companies are increasingly benchmarking China by adopting the country’s production practices and business models. This has led to noticeable changes in industry dynamics. We believe video content producers will see opportunities to enhance their enterprise value as uncertainties in the business environment subside. Top picks are CJ E&M and Showbox; Also watch four noteworthy stocks We recommend an Overweight position on the media content sector, which is fast becoming China’s next player. We present CJ E&M and Showbox as our top picks. Other stocks worth noting are J Contentree, Next Entertainment World, and Dexter. This year, major Korean content firms are stepping up their advances into China, armed with full-blown lineups (rather than a single project). With these new opportunities, we believe both earnings and valuations have the potential to improve. Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including t he U.S. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT. March 23, 2016 Media Content C O N T E N T S Drivers of cultural growth in China 3 1. Economy: Structural growth of cultural spending 3 2. Policy: Building a “xiaokang” society 4 3. Culture policies mentioned during China’s biggest annual political events 5 Cultural infrastructure of China 6 1. Offline: Growth of multiplex theaters 6 2. Online: Broadening internet access and video platforms 7 3. Mobile: LTE proliferation and growth of mobile video platforms 8 China turning its eyes to content investment 9 1. Offline infrastructure firms expanding investments in content 9 2. Chinese digital infrastructure firms are expanding content businesses 10 3. Korean content firms’ entry into China and flow of Chinese capital into Korea 12 4. Performance of Chinese culture plays 13 Opportunities for Korea and outlook 15 1. Robust Chinese movie market growth Need for film lineups and technology 15 2. Chinese mobile video market Greater need for video content supply 17 3. China’s tough screening leads to advance production 18 4. Sustainability of Chinese operations hinges on expansion of value chain 19 5. Introduction of Chinese models Chinese standard to take root 20 Key Recommendations 21 CJ E&M (130960 KQ) 22 Showbox (086980 KQ) 25 J Contentree (036420 KQ) 28 Next Entertainment World (160550 KQ) 31 Dexter (206560 KQ) 34 KDB Daewoo Securities Research 2 March 23, 2016 Media Content Drivers of cultural growth in China 1. Economy: Structural growth of cultural spending China’s culture industry is expanding sharply. The National Bureau of Statistics of China reports that the industry has expanded at a CAGR of 21.6% over the past decade—far higher than the country’s annual GDP growth of 9.7% over the same period. The industry’s GDP share also increased from 2.15% in 2004 to 3.76% in 2014. This figure, however, is still below the global average of 5.3%, which suggests China’s culture industry has ample room for growth. The expansion of China’s culture industry is also evident in per capita cultural spending, which rose faster than the country’s overall consumption in 2014-15. Income growth and the resultant change in consumption patterns are the key drivers of China’s culture industry growth. (Higher income allows consumers to spend on nonessentials.) In the US, cultural spending increased significantly when the country’s GDP per capita rose from US$4,000 to US$20,000 (late 1960s to late 1980s). At present, China’s GDP per capita is just US$8,000. This suggests the country’s culture industry growth is set to accelerate going forward. Figure 222.2. Education/cultuEducation/culture/entertainmentre/entertainment consumption Figure 111.1. Share of Chinese culture industry in GDP keeps rising growth exceeds overall consumption growth (RMBtr) (%) (%, YoY) China's overall consumption growth 15 3.0 Output of culture and related industries (L) 4.0 China's per capita consumption growth in Culture and related industries' share of GDP (R) education/culture/entertainment 12.2 9.9 2.0 10 7.50 3.0 6.90 1.0 5 0.0 2.0 0 2004 2006 2008 2010 2012 2014 2014 2015 Source: WIND, KDB Daewoo Securities Research Source: WIND, KDB Daewoo Securities Research Figure 333.3. Culture/entertainment consumption growgrowthththth accelerates when GDP per capita is between USUSUS$4,000US $4,000 and USUS$20,000$20,000$20,000;; China has entered a period of accelerated growth (US$) (%, YoY) 60,000 US GDP per capita (L) 20 Cultural spending grew significantly when GDP Cultural/entertainment spending growth (R) per capitarose from US$4,000to US$20,000 50,000 16 40,000 12 30,000 8 GDP per capita of China 20,000 in 2015 4 10,000 0 0 -4 60 65 70 75 80 85 90 95 00 05 10 Source: WIND, KDB Daewoo Securities Research KDB Daewoo Securities Research 3 March 23, 2016 Media Content 2. Policy: Building a “xiaokang” society Another factor brightening the future of China’s culture market is government support. The Xi Jinping government continues to promote the idea of a “xiaokang” society, i.e., one in which most people are moderately well-off in all aspects. The idea was first proposed by Deng Xiaoping in the late 1970s. Importantly, one of the key elements of building a xiaokang society is nurturing a rich culture. The culture industry represents a small sliver of China’s GDP (3.6% as of 2013 vs. 24% in the US, 10% in Japan, and 7% in Korea), and thus has ample room for growth. However, the industry faces as many challenges as opportunities, including 1) disproportionately large contributions from small- and medium-sized firms, 2) labor shortages, and 3) low market concentration. 1) Nurturing culture as a pillar industry of China In China’s latest five-year plan, released in November of last year, the government pledged to develop the culture industry into one of the pillars of the country’s economy. The plan’s details are summarized below: Table 111.1... ChinaChina’’’’ss 13th fivefive----yearyear plan: Details pertinent to culture industry Details Accelerate the culture industry revolution; Engage in large cultural projects; Culture system Construct mass cultural system and mass cultural market Improve mass culture service system Pillar industry Develop culture industry into one of the pillars of the national economy Develop popular culture industry standard; Pursue balanced development; Encourage spread Combining