CJ E&M Studio Dragon Is Doing Well

Earnings Preview

CJ E&M Studio Dragon is doing (130960 KQ) well

HJ Kim Kim Soo-min BUY maintained; 6M TP raised 20% to W120,000 - We have arrived at a new target price based on the sum-of-the-parts method in which [email protected] [email protected] the operating value of CJ E&M was added to the value of the stakes in NetMarble and Studio Dragon. Meanwhile, our residual income model puts the value of the company Rating BUY at W137,000. maintain - The target price hike owes to the increased combined value of the aforesaid stakes. The value of NetMarble has risen from W10tn to an average of W13tn following its IPO, 6M TP (W) 120,000 while we assume Studio Dragon is worth W1.3tn.

raise

CP (W) Christmas holidays are a high-demand season for movie theaters (17.12.08) 89,100 - Usually, the third quarter of the year is a high-demand season, but the movie-goer tally Media for 3Q17 rather fell 12% due to the delayed openings of the four most anticipated movies and the calendar distortion caused by the Chuseok holidays. As a result, CJ KOSDAQ 744.06 E&M and other movie-theater stocks retreated in unison. Market cap (Wbn) 3,451 Market cap portion (%) 1.26 - A string of new blockbuster movies will hit the screens for Christmas: Steel Rain (Dec Paid-in capital (common; Wbn) 194 14; New), Along With The Gods: The Two Worlds (Dec 20; Lotte), and 1987 (Dec 27; 52w high/low (W) 97,300 / 57,600 CJ E&M). It is rare in Korea that the openings of blockbuster movies are concentrated 120d avg. trading volume (Wbn) 22.5 on the year-end period. The movie audience in the quarter to date as of December 9 is Foreign ownership (%) 28.30 up by 14% yoy. Now is time to focus on the movie industry again. Major CJ+5: 42.86% shareholders Wellington Mgmt. Hong Kong Ltd.+1: - CJ E&M’s share price dropped 20% from the April peak to the August low, driven by 6.11% concerns over possible poor box office result of The Battleship Island. A single movie has only so much impact on overall earnings as: 1) the whole movie unit accounts for (%) 1M 3M 6M 12M only 12% of CJ E&M’s annual revenue; and 2) the company produces about 15 Abs. return -0.3 17.4 10.0 54.7 movies a year. Nevertheless, investors tend to react sensitively to the box office result Rel. return -5.0 3.2 -1.0 21.5 of the biggest movie of the year. Fortunately, The Battleship Island broke even, luring

(W(천원1K) ) CJ E&M E&M((LHS)좌) (%) 6.5 million people within Korea alone. Since August, the share price has risen to hit a 104 Relative to KOSDAQ to KOSDAQ(우) 45 record high of W98,500 led by positive catalysts such as Studio Dragon’s IPO and 99 40 NetMarble’s share price rally. 94 35 89 30 - 1987, CJ E&M’s second biggest budget movie of the year, will hit the screens on 84 25 December 27. Its break-even point is estimated at 4.33 million people, given that it cost 79 20 74 15 CJ E&M about 65% of what the company spent on The Battleship Island. We view that 69 10 it will far surpass the break-even point partly because it is based on a real story about 64 5 Korea’s pro-democracy movements of that year. 59 0 54 -5 (Wbn, %) 16.12 17.03 17.06 17.09

4Q17(F) 1Q18 4Q16 3Q17 Previous Daishin Daishin YoY QoQ Consensus YoY QoQ estimate estimate estimate Revenue 489 440 472 472 -3.5 7.2 511 407 3.2 -13.8 OP 2 13 33 28 1,386.5 120.0 25 24 4.4 -12.9 NP 4 13 28 34 801.2 158.3 33 41 23.8 19.1

2017(F) Growth 2015 2016 Previous Daishin Chg Consensus 2016 2017(F) estimate estimate Revenue 1,347 1,538 1,731 1,731 0.0 1,767 14.2 12.5 OP 53 28 93 88 -5.5 86 -46.9 213.6 NP 54 62 484 486 0.4 484 14.4 681.6 Source: CJ E&M, WISEfn, Daishin Securities Research Center

This report has been prepared by Daishin Securities Co., Ltd. SEE APPENDIX FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATION. Company Analysis 20171211 www.daishin.com

CJ E&M (130960 KQ)

Operating results and major financial data (Wbn, W, %) 2015A 2016A 2017F 2018F 2019F Revenue 1,347 1,538 1,731 1,731 1,779 OP 53 28 88 110 127 Pretax profit 59 68 654 221 257 NP 53 61 486 168 195 NP (controlling int.) 54 62 486 168 195 EPS 1,403 1,605 12,542 4,331 5,032 PER 57.4 44.2 7.1 20.6 17.7 BPS 40,058 39,922 52,265 56,098 60,532 PBR 2.0 1.8 1.7 1.6 1.5 ROE 3.6 4.0 27.2 8.0 8.6 Note: EPS, BPS, and ROE are based only on the controlling interest.

Source: CJ E&M, Daishin Securities Research Center

Yearly earnings forecast revision (Wbn, W, %, %p) Previous Revised Chg

2017F 2018F 2017F 2018F 2017F 2018F Revenue 1,731 1,731 1,731 1,731 0.0 0.0 Selling & adm. expense 361 419 381 419 5.6 0.1 OP 93 110 88 110 -5.5 -0.1 OP margin 5.4 6.3 5.1 6.3 -0.3 0.0 Non-operating profit 559 36 567 112 1.4 210.8 Pretax profit 652 146 654 221 0.4 51.9 NP (controlling int.) 484 110 486 168 0.4 51.9 NP margin 27.9 6.4 28.1 9.7 0.1 3.3 EPS (controlling int.) 12,492 2,852 12,542 4,331 0.4 51.9 Source: CJ E&M, Daishin Securities Research Center

Studio Dragon is doing well

- Studio Dragon, a CJ E&M subsidiary producing and distributing TV dramas, is now listed on the stock market. We estimate that it is worth W1.3-1.5tn. CJ E&M has strong share price upside potential even if we conservatively assume Studio Dragon is worth W1.3tn. - Studio Dragon’s value is closely related to that of CJ E&M. CJ E&M owns 71% of Studio Dragon, whose major role is to produce and distribute TV dramas for tvN and OCN. - Its TV dramas struggled with low viewership ratings (2-3%) after Goblin posted 20.5% in 1Q17, but started rebounding in 4Q17: Avengers Social Club (6.3%), Because This Is My First Life (4.9%), and Wise Prison Life (6.2%). - The average ad fee is also rising: W9.2mn for Avengers Social Club to W13.80mn for Wise Prison Life (6th episode).

DAISHIN SECURITIES

Tab 1. CJ E&M SOTP valuation (W”00mn, x)

Item Value Discount rate Fair value Per share value A Operating value 21,451 0% 21,451 55,384 OP 603 Dep. 3,330 EBITDA 3,933 EV/EBITDA 5.5 20% off from the 2014-2016 average of 6.8x B Non-operating value 37,934 29,319 75,697 Investment securities 37,934 29,319 75,697 NetMarble 28,717 30% 20,102 51,900 Studio Dragon 9,217 0% 9,217 23,797 C Total value (A+B) 59,385 50,770 131,080 D Net borrowings 4,462 4,462 11,520 E Shareholder value (C-D) 54,923 46,308 119,560 Note 1: Assuming NetMarble is worth W13tn (post-IPO average) and Studio Dragon is worth W1.3tn. Note 2: EV/EBITDA of 5.5x is derived by giving a 20% discount to the 2014-2016 average of 6.8x. Source: Daishin Securities Research Center

Fig 1. Movie-goer tally for 4Q17 up 14.1% yoy (as of Dec 9)

Movie3Qaudience관객수for 3Q Movie4Q 관객수audience for 4Q

7,23972.39만명 mn 6,39663.96만명 mn

3,87538.75 만명mn 3,39633.96 만명mn -11.6%

+14.1%

3Q16 3Q17 4Q16(12/9) 4Q17(12/9)

Source: Korea Film Council, Daishin Securities Research Center

Fig 2. CJ E&M dramas tend to post high viewership ratings in the fourth quarter of the year

(%) (W1K)(천원) tvN 주말드라마 tvN 월화드라마 tvN 수목드라마 CJ E&ME&M share 주가 (pricesRHS) 25 120 Weekends Mon-Tue Wed-Thu (RHS) dramas dramas dramas 100 20

80 15 60 10 40

5 20

0 0 14.1 14.5 14.8 14.12 15.4 15.8 15.11 16.3 16.6 16.10 16.12 17.3 17.7 17.11 Source: AGB Nielson, Daishin Securities Research Center

CJ E&M (130960 KQ)

Fig 3. 22:00 ad fees rising fast

((Wmn백만원) ) AvgCJ .E&Mfor 22 22h.:00 평균 CJWeekday E&M 22평일:0022averageh 평균 14

0 14.1 14.6 14.11 15.4 15.9 16.2 16.7 16.12 17.5 17.10

Source: CJ E&M, Daishin Securities Research Center

Per share intrinsic value Residual Income Model (Wbn, W, %) 2017F 2018F 2019F 2020F 2021F 2022F 2023F 2024F 2025F 2026F

Ⅰ NP (contr. int.)(Note 2) 486 168 195 218 244 281 323 371 427 491

Ⅱ Shareholders’ equity (contr. int.)(Note 2) 2,024 2,173 2,345 2,535 2,748 2,994 3,232 3,507 3,785 4,105

Estimated ROE 27.2 8.0 8.6 8.6 8.9 9.4 10.0 10.6 11.3 12.0

Ⅲ Required rate of return (Note 3) 5.1

Risk free rate of return (Note 4) 2.3

Market risk premium (Note 5) 4.0

Beta 0.70

Ⅳ Spread (estimated ROE – required rate of return) 22.1 2.9 3.5 3.5 3.8 4.3 4.9 5.5 6.2 6.9

Ⅴ Required income 79 103 111 119 129 140 152 165 178 193

Ⅵ Residual income ( l -Ⅴ) 407 65 84 98 115 141 170 206 248 298

Present value factor 1.00 0.95 0.91 0.86 0.82 0.78 0.74 0.71 0.67 0.64

PV of residual income 407 62 76 85 94 110 126 146 167 191

Ⅶ Sum of residual income 1,463

Ⅷ PV of residual income following forecasting period 2,303

Terminal growth (g)(Note 6) 0.0%

Ⅸ Beginning shareholders’ equity 1,546

Ⅹ Fair market cap (Ⅶ+Ⅷ+Ⅸ) 5,312

Total number of shares (thousands) 38,732

Ⅹl Per share value (W) 137,160

Current share price (W) 89,100

Potential (%) 53.9% Note 1: Under the residual income model (RIM), we add the current shareholders’ equity to the residual income based on the earnings forecast for the next ten years before adding the result to the residual income after the forecasting period to derive the value of shareholders’ stakes. The RIM is considered less subjective than similar valuation models such as DDM, DCF, and EVA. Note 2: The RIM reflects consolidated subsidiaries’ earnings not in their entirety but only for the stake controlled by the company. Note 3: The required rate of return (i.e., cost of equity) is the rate of return expected by the shareholders who take risks. It is derived by the capital asset price model: Cost of equity = Risk-free interest rate + Beta * Market risk premium. Note 4: The yield on five-year government bonds was used as the proxy for the risk-free interest rate. Note 5: Market risk premium refers to the gap between the expected return on the market portfolio and the risk-free interest rate. It has been lowered from 6- 8% to 3-5% in reflection of the current low-growth environment. Note 6: The terminal growth was assumed to be zero.

DAISHIN SECURITIES

Financial statements

Income statement (Wbn) Balance sheet (Wbn)

2015A 2016A 2017F 2018F 2019F 2015A 2016A 2017F 2018F 2019F

Sales 1,347 1,538 1,731 1,731 1,779 Current assets 940 996 1,112 1,134 1,153

Cost of goods sold 1,019 1,190 1,262 1,202 1,266 Cash & cash equiv. 47 81 201 223 226

Gross profit 328 349 469 529 513 Trade & other receive. 434 553 615 615 631

SG&A expenses 275 321 381 419 386 Inventories 4 5 5 5 5

OP 53 28 88 110 127 Other current assets 454 357 291 291 291

OP margin 3.9 1.8 5.1 6.3 7.2 Long-term assets 1,425 1,797 2,409 2,522 2,687

EBITDA 373 428 445 488 487 Tangible assets 77 275 287 314 342

Non-OP 7 40 567 112 130 Investments in affiliates 495 463 485 610 753

Income from affiliates 129 81 599 147 166 Other long-term assets 852 1,059 1,637 1,599 1,592

Financial revenue 19 19 13 15 15 Total assets 2,365 2,793 3,521 3,656 3,840

FX related gains 0 0 0 0 0 Current liabilities 642 937 866 766 770

Financial expense -21 -37 -23 -26 -26 Payables & other liab. 418 480 497 496 501

FX related losses 5 8 6 8 9 Borrowings 55 268 268 168 168

Others -120 -24 -23 -24 -25 Current portion of LT debts 121 101 0 0 0

Income before taxes 59 68 654 221 257 Other current liabilities 48 88 102 102 102

Income tax expense -6 -7 -168 -54 -62 Long-term liabilities 162 240 540 620 620

Income from cont. op. 53 61 486 168 195 Borrowings 131 170 470 550 550

Income from discont. op. 0 0 0 0 0 Convertible securities 0 0 0 0 0

NP 53 61 486 168 195 Other long-term liab. 31 70 70 70 70

NP margin 3.9 4.0 28.1 9.7 11.0 Total liabilities 805 1,177 1,406 1,386 1,390

NP for non-contr. interest -1 -1 0 0 0 Controlling interest 1,552 1,546 2,024 2,173 2,345

NP for contr. interest 54 62 486 168 195 Capital stock 194 194 194 194 194

Valuation of AFS fin. assets 1 -8 -8 -8 -8 Capital surplus 973 973 973 973 973

Other compreh. income -2 -95 7 7 7 Retained earnings 370 420 898 1,046 1,218

Comprehensive income 52 -42 485 167 194 Other capital changes 15 -40 -40 -40 -40

Comp. income for non-contr. Int. -2 -1 0 0 0 Non-controlling interest 9 69 91 97 105

Comp. income for contr. int. 54 -41 485 167 194 Total shareholder’s equity 1,560 1,616 2,115 2,270 2,450

Net borrowings -54 367 446 404 401

10 11 12 13 14

Valuation metrics (W, x, %) Cash flow statement (Wbn)

2015A 2016A 2017F 2018F 2019F 2015A 2016A 2017F 2018F 2019F

EPS 1,403 1,605 12,542 4,331 5,032 Operating cash flows 295 259 610 257 236

PER 57.4 44.2 7.1 20.6 17.7 NP 53 61 486 168 195

BPS 40,058 39,922 52,265 56,098 60,532 Non-cash items 332 366 439 242 214

PBR 2.0 1.8 1.7 1.6 1.5 Depreciation 320 400 357 378 360

EBITDAPS 9,621 11,040 11,479 12,594 12,578 FX gains -1 0 0 -1 -1

EV/EBITDA 8.3 7.4 9.0 8.1 8.1 Equity method gain 0 0 -45 -147 -166

SPS 34,785 39,720 44,699 44,689 45,931 Others 13 -34 127 12 21

PSR 2.3 1.8 2.0 2.0 1.9 Chg in assets & liab. -42 -168 -139 -92 -104

CFPS 9,938 11,014 23,879 10,585 10,561 Other cash flows -48 0 -176 -60 -69

DPS 200 200 500 600 700 Investing cash flow -189 -534 -1,068 -591 -624

Investment assets -1 -88 -536 -125 -143

Financial ratios (W, x, %) Tangible assets -8 -212 -41 -43 -45

2015A 2016A 2017F 2018F 2019F Others -180 -234 -491 -423 -436

Growth potential Financing cash flows -94 306 288 57 73

Sales growth 9.3 14.2 12.5 0.0 2.8 Short-term borrowings 7 200 0 -100 0

OP growth TTB -46.9 213.6 25.1 16.1 Bonds payable 0 140 300 80 0

NP growth -77.3 15.0 698.2 -65.5 16.2 Long-term borrowings 0 0 0 0 0

Profitability Rights offering 0 0 0 0 0

ROIC 4.1 1.9 4.1 5.2 6.0 Cash dividends 0 -8 -8 -19 -23

ROA 2.2 1.1 2.8 3.1 3.4 Others -101 -25 -5 96 96

ROE 3.6 4.0 27.2 8.0 8.6 Net chg in cash 14 34 120 22 3

Stability Beginning cash balance 34 47 81 201 223

Debt ratio 51.6 72.9 66.5 61.1 56.8 Ending cash balance 47 81 201 223 226

Net borrowings ratio -3.4 22.7 21.1 17.8 16.4 NOPLAT 47 25 65 83 97

Interest coverage ratio 3.8 2.3 6.6 8.5 9.9 FCF 24 -146 -11 94 75

Source: CJ E&M, Daishin Securities Research Center

Appendix

[Compliance Notice]

In accordance with Subparagraph 5 of Paragraph 1 of Article 4-20 of the supervisory regulations for the financial investment industry, we confirm that no information or content has been shared prior to its release on Daishin’s website, and that the analyst has not received nor will receive direct or indirect compensation in exchange for expressing specific opinions. Daishin is not affiliated with the company presented in this report. This report has been presented without any undue external influence or interference, and accurately reflects the personal views of the analyst who is responsible for its content. This report is distributed for the purpose of helping investors make informed decisions. This report has been prepared from the data and information believed to be correct and reliable, but Daishin Securities does not make any guarantee as to the accuracy thereof. Investors reading this report should make final decisions based on their own judgment.

For U.S. persons only: For U.S. persons only: This independent third party research report is a product of Daishin Securities, which is the employer of the research analyst(s) who has prepared the research report. The research analyst(s) preparing the research report is/are resident outside the United States (U.S.) and are not associated persons of any U.S. regulated broker-dealer and therefore the analyst(s) is/are not subject to supervision by a U.S. broker-dealer, and is/are not required to satisfy the regulatory licensing requirements of FINRA or required to otherwise comply with U.S. rules or regulations regarding, among other things, communications with a subject company, public appearances and trading securities held by a research analyst account.

This independent third-party research report is distributed in the United States (“US”) to Major US Institutional Investors (as defined in Rule 15a-6 under the Securities and Exchange Act of 1934, as amended) by Maybank Kim Eng Securities USA Inc. (“Maybank KESUSA”) and Auerbach Grayson and Company LLC, broker-dealers registered in the US (registered under Section 15 of the Securities Exchange Act of 1934, as amended). All responsibility for the distribution of this report by Maybank KESUSA in the US shall be borne by Maybank KESUSA. All responsibility for the distribution of this report by Auerbach Grayson and Company LLC shall be borne by Auerbach Grayson and Company LLC

If the recipient of this report is not a Major Institutional Investor as specified above, then it should not act upon this report and return the same to the sender. Further, this report may not be copied, duplicated and/or transmitted onward to any U.S. person, which is not the Major Institutional Investor. In reliance on the exemption from registration provided by Rule 15a-6 of the Exchange Act and interpretations thereof by the SEC in order to conduct certain business with Major Institutional Investors, Daishin Securities has entered into an agreement with two U.S. registered broker- dealers, Maybank Kim Eng Securities USA Inc and Auerbach Grayson and Company LLC. All U.S. persons receiving and/or accessing this report and wishing to effect transactions in any security mentioned within must do so with: Maybank Kim Eng Securities USA Inc. 777 Third Avenue 21st Floor New York, New York 1- (212) 688-8886 or Auerbach Grayson and Company LLC 25 West 45th Street, New York, NY 10036 and not with the issuer of this report.

[Investment rating & Target price history]

CJ E&M (130960 KQ) Investment rating breakdown and framework (Dec 8, 2017)

(원(W)) Adj. Price Adj. Target Price BUY MARKETPERFORM UNDERPERFORM 140,000 120,000 Ratio 81.3% 16.7% 0.5% 100,000 Sector ratings breakdown 80,000 - Overweight: industry indicators are expected to outperform the 60,000 40,000 market over the next six months. 20,000 - Neutral: industry indicators are expected to be in line with the 0 market over the next six months. 15.12 16.04 16.08 16.12 17.04 17.08 17.12 - Underweight: industry indicators are expected to underperform the Date 17.12.11 17.10.09 17.08.31 17.02.28 16.08.28 16.03.31 market over the next six months. Rating Buy Buy 6M passed 6M passed Buy Marketperform

Target price 120,000 100,000 91,000 91,000 91,000 79,000 Diff. (avr. %) (12.63) (15.09) (13.82) (21.68) (11.12) Company ratings breakdown

Diff. (max./min., %) (2.70) (12.53) (2.97) (2.53) (0.76) - Buy: the stock is expected to outperform the market by at least Date 16.02.05 15.12.13 Rating Marketperform Buy 10%p over the next six months. Target price 96,000 96,000 - Marketperform: the stock is expected to either outperform or Diff. (avr. %) (23.33) (11.59) Diff. (max./min., %) (18.02) (2.60) underperform the market by less than 10%p over the next six Date months. Rating - Underperform: the stock is expected to underperform the market by Target price Diff. (avr. %) at least 10%p over the next six months. Diff. (max./min., %) Date Rating Target price Diff. (avr. %) Diff. (max./min., %)