CFA Institute Research Challenge Hosted in Beijing Tsinghua University CFA Institute Research Challenge November 29th, 2013 Huayi Brothers (300027.SZ) Sector: Consumer Cyclical Industry: Media – Diversified Investment Highlights Fundamentals and valuation methodologies indicate BUY. Based on Discounted Cash Flow RECOMMENDATON: BUY valuation methodologies, we arrive at the target price of RMB 46.9, a 48.3% upside from close price as of Nov. 29, 2013. We believe Huayi Brothers will outperform due to the promising ￥ PRICE TARGET: 46.90 prospect of its integration of business line, which successfully mitigates content quality risk from vertical integration and creates synergy across different business line through horizontal integration. Market Data Huayi Brothers (SZSE:300027) Huayi’s vertical integration of film business can effectively reduce its exposure to content Market Capitalization 36,675M quality fluctuation and increase gross margin. The company has established a synergetic Shares Out.（mn) 1,209.60 Main share Holders: business line from vertical integration in its film business, consisting of production and - Zhongjun, Wang 23.90% investment, distribution, film exhibition and talent agency. The distribution business successfully - Zhonglei, Wang 7.32% - Tencent Holdings Ltd. 4.60% smooth content volatility and thus provides stronger downside protection via (1) advanced Free Float (%) 64.18% decision of the best timeslot in releasing films, (2) provision of sufficient screening schedule rate, Last Share Price 31.6 and (3) effective advertising campaign to attract customers, while the theatre business provides 1 year Range 12.09-79.30 its distribution business strong negotiating power with theatre circuits, maximizing the return from Beta 0.9 the film production. P/E(TTM) 151.6 Huayi has the best horizontal integration in the industry, enabling it to largely diversify EPS(TTM) 0.2 EV/EBITDA (2013E) 52.5x content risk and fully utilizing its content resource, and brings huge positive synergy. The ROE 12.6 integration of mobile gaming with film allows Huayi to fully utilize premium film and drama BV per share (2013E) 17.8 resources, on a recursive basis. Integration of TV drama series and music with film allows sharing of resources, and gives Huayi positive synergy. Integration of travel with film has a huge potential with a downside protection. Current stage of development of the Chinese film industry remains the growth period, providing a good opportunity in investing in industry leader. In recent years, China’s film industry has been growing steadily. The industry continuously grows overall with high profits and low levels of competition. But it is still marginal in the media industry, implying a huge room for future expansion. The immature state of the market provides potentials for investment and a good sign for the industry leader, Huayi, due to its occupation of first-mover advantage. Business Description Huayi is one of the largest private-owned listed media companies in China Founded in 1994 by the Chairman & CEO Mr. Wang Zhongjun and President Mr. Wang Zhonglei, Huayi Brothers (“Huayi”) is one of the largest private entertainment players in China. Huayi got listed on ChiNext in 2009 with a current market capitalization of approximately RMB 33bn, among the largest companies listed on ChiNext. Figure 1: Huayi’s revenue structure Emphasis stressed on integration and aiming at full coverage of media industry 100% 90% The Beijing-based company first started out with film production, and later expanded into talent 80% 70% management and TV drama production. In July 2013, the company announced its acquisition of 60% mobile game developer Yinhan Technology to expand into game content creating, showing an 50% 40% attempt to execute a broad entertainment strategy consisting of 6 components, namely, film 30% 20% production and distribution, TV drama production, talent management, movie theatres, music, 10% 0% gaming and derivatives (i.e., theme parks). (Figure 1) 2007 2008 2009 2010 2011 2012 Film business chain: Huayi itself produces and distributes films. It also has an interest in Film TV drama Assault Films (founded by Wu Yanzu and Feng Delun) and Eastern Legend (a joint venture with Talent agent & music Theater Game Legend Film Company). Huayi has several overseas companies to help distribute their films. Source: Huayi annual reports Additionally, Huayi holds theater subsidiaries to occupy whole produce-distribute- show value chain. 1 CFA Institute Research Challenge November 29th, 2013 Talent management: Huayi’s subsidiary Shidai Agent manages talent agent business; Lanhai Huayi, a joint venture with Jiangsu broadcasting and TV bureau, organizes vocal live shows. Shishang Media engages mainly in super model agent. TV drama production: Huayi’s subsidiary Yule Investment produces and distributes TV drama series. Besides studios incorporated, Huayi also have subsidiaries named Zhengjiang Tianyi and Zhejiang Film Investment. Music: Subsidiary Huayi Music engages in music. Derivatives: Huayi holds an interest in Ourpalm Technology, an A-share listed mobile game company; Huayi announced acquisition of Yinhan Technology, also a mobile game maker; Giant Information conducts the online game business; Shijing Entertainment takes part in theme part and tourism business; Huayi Vision does advertising business. Successful and sustainable production of high-quality movies On the back of first-in-class talent management franchise and near exclusive relationship with highest-grossing directors in China, Huayi is China’s most accomplished and consistent movie producer with a track record of delivering regional blockbusters including, If You Are the One (2010), After Shock (2010), Painted Skin (2012), CZ12 (2012) and Young Detective Dee (2013), all with box office results in the region of multi-hundred million RMB. Industry Overview & Competitive Positioning Industry overview Current stage of development of the Chinese film industry remains the growth period, Figure 2 but still marginal in the media industry, implying a huge room for future expansion Chinese film industry growth In recent years, China’s film industry has been growing steadily. (Figure 2) Despite a gradual 60% 50% decline since 2010, the industry continues to grow overall with high profits and low levels of 40% competition. Compared with the film industry in North America, China’s film industry may not be 30% as stable, due to the lack of capital. However, the immature state of the market provides 20% potentials for investment. Moreover, revenue for the film industry only makes up 3% of the entire 10% 0% cultural industry, implying a huge room for future growth and expansion. (Appendix 1) 2006 2007 2008 2009 2010 2011 2012 2013 Highly competitive and volatile nature of the movie production and distribution industry Source: Enn As in the production side, in 2012, China's top ten movie companies took 37% of market share, with the most remarkable of these companies being Enlight Pictures, Huayi Brothers and China Film Group. Looking at both the number of productions in which they were involved and their box office shares, these companies have shown considerable stability. (Figure 3) Figure 3: Market share in film production industry 2011 2012 Market No. of Market Company share films Company share No. of films 1 China Film Group 4.39% 18 Enlight Pictures 7.23% 10 2 Bona Film 3.81% 10 Huayi Brothers 6.82% 8 3 Huayi Brothers 2.42% 8 Yingyitong 3.14% 1 4 Galloping Horse Film 2.20% 4 Zhengledao Media 3.14% 1 5 Movie Channel Center 1.98% 14 H/B Studio 3.14% 1 6 Shanghai Film Group 1.60% 7 China Film Group 2.70% 17 Hangzhou Culture 7 Zhonglian Jinghua 1.64% 3 Radio Film 2.35% 3 8 Henan Film Group 1.63% 2 H&R Century 2.30% 2 9 Guoli Changsheng 1.58% 2 Huashu Media 2.30% 1 10 Anhui Media Group 1.49% 2 Sichuan Zhonglan 2.30% 1 In distribution side, five companies with the largest market shares in distribution accounted for 82.7% of the nationwide market, which was a noticeable increase over the 77.6% concentration 2 CFA Institute Research Challenge November 29th, 2013 in the market in 2011. (Appendix 2) Notably, private companies are becoming more active and four companies split market share for each season. (Appendix 3) Content exposure remains the theme of risk in film industry The fate of film companies largely depend on the unpredictable quality of content The inherent nature of the film industry is the co-existence of high investment, high risk and high return, with the risk largely owing to the unpredictability of the boxing performance, which in essence is the uncertainty of content quality and creation. Also, the impact of such exposure would be enhanced by the increasing requirement of initial capital of the film production. Cases include MGM’s failure on Wingtalkers, which later induces the resignation of senior management and acquisition by SONY Corp. While Enlight used Lost in Thailand to jump from number 15+ in 2011 to the first place in 2012 among China's movie companies. (Figure 4) Figure 4: Enlight Media stock performance In 2012, beside the top 3, the remaining 7 companies all rose to top 10 solely because of their participation in one of the hottest movies, with 3 of them in Lost in Thailand and the other 4 in Painted Skin: The Resurrection. The downside potential of content exposure could be mitigated by vertical integration Figure 5: The similarity in marketing An example would be a business model that combines the film production and distribution. As methods between the two industries Film industry FMCG the film industry is quite similar to the cosmetics industry in the demand end, where the High screening consumers’ perception of the quality of goods and movies play an important role. Such nature schedule rate Intensive sales web determines that the loss from a poorly produced film could be partially compensated by the Massive subsequent marketing effect.