SM Entertainment (041510 KQ ) An entertainment powerhouse

Entertainment 3Q18 review: Earnings surprise For 3Q18, SM Entertainment reported consolidated revenue of W168.7bn (+94.6% YoY) Results Comment and operating profit of W12.1bn (+162.9%). Operating profit surpassed both our November 15, 2018 estimate (W10.4bn) and the market consensus (W10.3bn). The core music/concert businesses (parent and SM Japan) performed well, backed by a fully active artist lineup and robust domestic/overseas artist activities. Other highlights of the quarter included a healthy inflow of advertising contracts/appearance fees, advertising revenue growth (+21% QoQ), and Dream Maker’s robust concert management and organi zation (Maintain) Buy business (including the 2018 Spectrum Dance Music Festival). Parent-based revenue expanded 8% YoY W65.7bn, despite a high base of comparison Target Price (12M, W) ▲ 70,000 (due to strong sales in 3Q17). In 3Q18, weak album sales were offset by increased revenue from global music services, appearance fees, and advertising contracts. Around 550,000 (new NCT Dream and albums) were sold , Share Price (11/14/18, W) 49,900 and Japanese concerts (SM TOWN and TVXQ tours) attracted 360,000 attendees.

Expected Return 40% Revenue from music/video service platforms (e.g., YouTube, , and Spotify) has expanded from W7.9bn in 2016 to W10.3bn (+30%) in 2017 and W15.1bn (+47%) during 1Q-3Q18. Based on YouTube alone, the company’s platform revenue easily met our 3Q18 estimate (W1.4bn). OP (18F, Wbn) 51 Consensus OP (18F, Wbn) 48 4Q18 preview: Record-high OP For 4Q18, we expect SM Entertainment to post record-high operating profit of W18.7bn EPS Growth (18F, %) 632.9 (+400.2% YoY), comparable to the level in 3Q15, when the recognition of 1mn concert Market EPS Growth (18F, %) 11.1 attendees in Japan boosted operating profit to W18.6bn. In 4Q18, earnings should P/E (18F, x) 34.2 hinge on the core business, with the entire artist lineup expected to be active. We estimate domestic album sales will reach 1.9mn copies. (EXO’s new studio album has Market P/E (18F, x) 8.3 already sold 1.2mn copies, and NCT 127’s studio/repackaged album sales are expected KOSDAQ 671.56 to reach 400,000 copies.) Japanese concert attendance is projected to reach 730,000 in the quarter. Also worth noting is the successful post-military service comeback of Market Cap (Wbn) 1,148 TVXQ; the group is expected to attract 1.28mn concertgoers annually. Shares Outstanding (mn) 23 At SM C&C, earnings should improve thanks to the arrival of peak season for Free Float (%) 76.3 advertising demand. Since acquiring the ad business, SM C&C has stabilized over the Foreign Ownership (%) 18.7 past year, shifting its focus away from low-margin drama production. As a result, Beta (12M) 0.82 advertising revenue grew 21% YoY in 3Q18, and we look for significant margin 52-Week Low 33,000 improvement in 4Q18. Encouragingly, SM C&C recently added a number of major advertisers, which should drive earnings in 2019. 52-Week High 52,600 Raise TP to W70,000, reflecting upward earnings revisions (%) 1M 6M 12M We m aintain our Buy rating on SM Entertainment and raise our target price to W70,000 Absolute 5.6 37.1 39.6 (from W65,000). We revised up our 2019 operating profit estimate by 15% and applied Relative 15.0 75.3 57.2 a 12-month forward P/E of 36x, assuming: 1) revenue from global content service platforms will continue to grow rapidly; 2) artists will expand their turf beyond albums

160 SM Entertainment KOSDAQ and concerts; and 3) SM C&C’s advertising business will continue to normalize. Going forward, we believe NCT 127’s growing fan bases in Korea, Japan, and the US and NCT 140 China’s upcoming debut deserve attention. 120 The entertainment industry is undergoing a re-rating, as entertainment companies 100 have reduced earnings volatility and improved margins by extending their reach beyond concert planning to include global content (music/short video) production. In 80 addition, SM Entertainment’s eight groups of artists provide a solid stream of revenue . 11.17 3.18 7.18 11.18 We believe SM Entertainment has proven its ability to generate quarterly operating profit of more than W10bn and boasts a promising new lineup. Mirae Asset Daewoo Co., Ltd.

[ Media ] FY (Dec.) 12/15 12/16 12/17 12/18F 12/19F 12/20F Revenue (Wbn) 322 350 365 589 660 698 Jeong -yeob Park +822 -3774 -1652 OP (Wbn) 38 21 11 51 72 82 [email protected] OP margin (%) 11.8 6.0 3.0 8.7 10.9 11.7

NP (Wbn) 22 4 4 33 44 51 EPS (W) 1,048 169 199 1,458 1,929 2,227 ROE (%) 8.3 1.2 1.3 8.5 9.9 10.4

P/E (x) 41.0 153.0 174.4 34.2 25.9 22.4 P/B (x) 3.1 1.7 2.2 2.7 2.4 2.2 Dividend yield (%) 0.0 0.0 0.0 0.0 0.0 0.0 Note: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, Mirae Asset Daewoo Research estimates

November 15, 2018 SM Entertainment

Table 1. Target price calculation (Wbn, x )

Valuation - P/E 18F 12MF 19F Notes Fair market value (a) 1,311 1,526 1,551

Net profit (controlling interests) 33 42 44 Assumed artist lineup will be fully active in 2019 Applied 10% discount to sector fair multiple, reflecting risk of no new artist Target P/E 40.0 36.0 35.0 debuts in 2019 and conservative multiple for advertising business Fair target price (W) 60,240 70,124 71,270

Upside potential (%) 20.7 40.5 42.8

Source: Mirae Asset Daewoo Research estimates

Table 2. Quarterly and annual earnings (Wbn, %, mn) 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18 4Q18F 2018F 2019F 2020F Revenue 68 68 87 143 111 124 169 185 589 660 698 SM Entertainment 41 40 61 74 59 61 66 80 265 275 291 SM Japan 13 12 12 22 26 16 20 33 96 92 99 Dream Maker 6 16 8 13 7 12 18 14 51 54 55 SM C&C 15 11 10 52 38 52 44 49 184 190 205 KeyEast 38 28 66 115 120 Operating profit 1.2 1.4 4.6 3.7 10.4 10.0 12.1 18.7 51 72 82 OP margin (%) 1.8 2.0 5.3 2.6 9.4 8.0 7.2 10.1 8.7 11.0 11.8 Pretax profit -3.3 1.9 32.2 -6.4 15.1 11.1 10.9 15.9 53 69 81 Net profit -8.0 3.8 12.8 -13.3 11.4 4.0 7.3 11.6 34 50 59 Net margin (%) -11.8 5.6 14.8 -9.3 10.3 3.2 4.3 6.3 5.8 7.6 8.5 Net profit attributable to -6.8 4.2 17.6 -10.6 11.2 5.1 6.4 10.2 32.8 44.3 51.1 controlling interests YoY Revenue -24.7 -12.0 -16.8 82.3 62.5 83.8 94.6 29.3 61.1 12.1 5.8 SM Entertainment -16.4 -4.7 -0.7 48.5 46.7 49.6 8.3 7.1 22.8 3.7 5.7 SM Japan -36.8 111.1 -7.6 89.3 102.3 33.6 74.4 51.6 63.6 -4.2 8.0 Dream Maker -76.1 194.4 -54.0 202.8 19.6 -22.0 116.2 11.0 20.3 6.0 1.1 SM C&C -27.1 -55.9 -64.4 153.0 151.4 361.7 338.0 -5.5 107.5 3.4 7.7 KeyEast ------73.9 4.0 Operating profit -86.7 TTB -65.7 502.5 765.8 626.2 162.8 400.2 368.5 41.0 13.9 Net profit TTR TTB 49.2 RR TTB 6.3 -43.2 TTB TTB 46.7 17.4 assumption Concert ticket sales in Japan 0.2 0.2 0.4 0.7 0.6 0.4 0.4 0.7 2.1 2.1 2.4 Notes: All figures are based on consolidated K-IFRS; concert ticket sales volume is based on actual timing of concert and includes our estimates. Source: Company data, Mirae Asset Daewoo Research estimates

Table 3. Earnings forecast revisions (Wbn, %, %p) Previous Revised Change Notes 18F 19F 18F 19F 18F 19F - Robust revenue from global content platforms; Revenue 550 630 589 660 7.0 4.7 increased artist activities - Full -fledged improvements in SM C&C ’s advertising Operating profit 48 63 51 72 7.7 14.7 business Net profit 30 39 33 44 7.7 12.9 - Content revenue growth and resulting decline in OP margin 8.7 10.0 8.7 11.0 0.1 1.0 cost ratios Net margin 5.5 6.2 5.6 6.7 0.0 0.5 Notes: Based on consolidated K-IFRS; net profit is attributable to controlling interests Source: Mirae Asset Daewoo Research estimates

Mirae Asset Daewoo Research 2 November 15, 2018 SM Entertainment

Table 1. SM Entertainment’s YouTube-related net revenue growing rapidly on simultaneous growth of prices and volume

(Wbn) 10 YouTube 9

8 7

6 6

4 4 3 2

0 2016 2017 2018F 2019F 2020F

Source: Mirae Asset Daewoo Research

Table 2. Concert attendance in Japan by artist (assumptions)

(mn persons) 2.5 SM TOWN NCT 127 Red Velvet EXO f(x) 2.0 Girls' Generation TVXQ BoA

1.5

1.0

0.5

0.0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018F 2019F 2020F

Source: Mirae Asset Daewoo Research

Table 3. YouTube view count by artist over the past 90 days: Mix of NCT becoming similar to that of BTS; Rise in view count in developed markets to lead to higher CPM

(mn views) (%) Other countries Latin America Southest Asia Korea/Japan/Taiwan US 1,500 Other countries 100 Latin America Southest Asia 1,200 Korea/Japan/Taiwan 80 US

900 60

600 40

41.4 300 20 12.4 24.5 10.0 18.1 9.3 9.3 13.9 10.6 6.7 8.0 0 0 4.9 5.7 4.8 BTS BLACK iKON WINNER EXO NCT BTS BLACK iKON WINNER TWICE EXO NCT PINK PINK

Source: YouTube, Mirae Asset Daewoo Research Source: YouTube, Mirae Asset Daewoo Research

Mirae Asset Daewoo Research 3 November 15, 2018 SM Entertainment

SM Entertainment (041510 KQ/Buy/TP: W70,000)

Comprehensive Income Statement (Summarized) Statement of Financial Condition (Summarized) (Wbn) 12/17 12/18F 12/19F 12/20F (Wbn) 12/17 12/18F 12/19F 12/20F Revenue 365 589 660 698 Current Assets 441 592 636 733 Cost of Sales 249 384 430 450 Cash and Cash Equivalents 195 275 357 428 Gross Profit 116 205 230 248 AR & Other Receivables 121 156 138 150 SG&A Expenses 105 154 157 165 Inventories 9 11 10 11 Operating Profit (Adj) 11 51 72 82 Other Current Assets 116 150 131 144 Operating Profit 11 51 72 82 Non-Current Assets 357 463 422 416 Non-Operating Profit 13 2 -3 -1 Investments in Associates 81 105 93 101 Net Financial Income 0 -1 -1 -1 Property, Plant and Equipment 93 91 80 70 Net Gain from Inv in Associates 21 1 0 0 Intangible Assets 113 176 166 156 Pretax Profit 24 53 69 81 Total Assets 798 1,054 1,058 1,149 Income Tax 29 19 19 22 Current Liabilities 330 446 402 432 Profit from Continuing Operations -5 34 50 59 AP & Other Payables 124 160 141 154 Profit from Discontinued Operations 0 0 0 0 Short-Term Financial Liabilities 49 82 82 82 Net Profit -5 34 50 59 Other Current Liabilities 157 204 179 196 Controlling Interests 4 33 44 51 Non-Current Liabilities 31 37 34 36 Non-Controlling Interests -9 2 6 8 Long-Term Financial Liabilities 11 11 11 11 Total Comprehensive Profit -12 40 50 59 Other Non-Current Liabilities 20 26 23 25 Controlling Interests -1 43 58 68 Total Liabilities 362 483 436 468 Non-Controlling Interests -10 -3 -7 -9 Controlling Interests 345 424 468 519 EBITDA 33 74 93 102 Capital Stock 11 11 11 11 FCF (Free Cash Flow) 67 67 62 85 Capital Surplus 170 213 213 213 EBITDA Margin (%) 9.0 12.6 14.1 14.6 Retained Earnings 134 178 222 273 Operating Profit Margin (%) 3.0 8.7 10.9 11.7 Non-Controlling Interests 91 148 154 162 Net Profit Margin (%) 1.1 5.6 6.7 7.3 Stockholders' Equity 436 572 622 681

Cash Flows (Summarized) Forecasts/Valuations (Summarized) (Wbn) 12/17 12/18F 12/19F 12/20F 12/17 12/18F 12/19F 12/20F Cash Flows from Op Activities 77 72 62 85 P/E (x) 174.4 34.2 25.9 22.4 Net Profit -5 34 50 59 P/CF (x) 15.6 13.7 12.5 11.3 Non-Cash Income and Expense 53 47 41 42 P/B (x) 2.2 2.7 2.4 2.2 Depreciation 11 12 11 9 EV/EBITDA (x) 21.5 15.0 11.1 9.5 Amortization 11 11 10 10 EPS (W) 199 1,458 1,929 2,227 Others 31 24 20 23 CFPS (W) 2,218 3,642 3,980 4,403 Chg in Working Capital 46 22 -9 6 BPS (W) 16,077 18,495 20,425 22,651 Chg in AR & Other Receivables -83 -9 19 -13 DPS (W) 0 0 0 0 Chg in Inventories -1 -2 1 -1 Payout ratio (%) 0.0 0.0 0.0 0.0 Chg in AP & Other Payables 97 -1 -19 13 Dividend Yield (%) 0.0 0.0 0.0 0.0 Income Tax Paid -17 -30 -19 -22 Revenue Growth (%) 4.3 61.4 12.1 5.8 Cash Flows from Inv Activities -111 -61 8 -5 EBITDA Growth (%) -25.0 124.2 25.7 9.7 Chg in PP&E -4 -5 0 0 Operating Profit Growth (%) -47.6 363.6 41.2 13.9 Chg in Intangible Assets -25 -4 0 0 EPS Growth (%) 17.8 632.7 32.3 15.4 Chg in Financial Assets 1 -14 8 -5 Accounts Receivable Turnover (x) 4.4 4.2 4.5 4.9 Others -83 -38 0 0 Inventory Turnover (x) 36.8 59.5 62.9 67.9 Cash Flows from Fin Activities 64 69 0 0 Accounts Payable Turnover (x) 3.3 2.7 2.9 3.1 Chg in Financial Liabilities 3 33 0 0 ROA (%) -0.7 3.7 4.8 5.4 Chg in Equity 6 43 0 0 ROE (%) 1.3 8.5 9.9 10.4 Dividends Paid 0 0 0 0 ROIC (%) -1.2 14.7 23.7 29.7 Others 55 -7 0 0 Liability to Equity Ratio (%) 83.1 84.5 70.1 68.7 Increase (Decrease) in Cash 26 79 82 71 Current Ratio (%) 133.4 132.7 158.1 169.8 Beginning Balance 170 195 275 357 Net Debt to Equity Ratio (%) -31.9 -32.6 -43.2 -49.9 Ending Balance 195 275 357 428 Interest Coverage Ratio (x) 9.1 21.5 27.3 31.1 Source: Company data, Mirae Asset Daewoo Research estimates

Mirae Asset Daewoo Research 4 November 15, 2018 SM Entertainment

APPENDIX 1

Important Disclosures & Disclaimers 2-Year Rating and Target Price History

Company (Code) Date Rating Target Price (W) SM Entertainment SM Entertainment (041510) 11/14/2018 Buy 70,000 80,000 10/24/2018 Buy 65,000 08/15/2018 Buy 54,000 60,000 04/24/2018 Buy 47,000 03/11/2018 Buy 50,000 40,000 11/14/2017 Buy 44,000 20,000 09/05/2017 Buy 37,000

01/02/2017 No Coverage 0 08/15/2016 Buy 40,000 11 16 11 17 11 18

Stock Ratings Industry Ratings Buy : Relative performance of 20% or greater Overweight : Fundamentals are favorable or improving Trading Buy : Relative performance of 10% or greater, but with volatility Neutral : Fundamentals are steady without any material changes Hold : Relative performance of -10% and 10% Underweight : Fundamentals are unfavorable or worsening Sell : Relative performance of -10% Ratings and Target Price History (Share price (─), Target price (▬), Not covered ( ■), Buy (▲), Trading Buy (■), Hold (●), Sell ( ◆)) * Our investment rating is a guide to the relative return of the stock versus the market over the next 12 months. * Although it is not part of the official ratings at Mirae Asset Daewoo Co., Ltd., we may call a trading opportunity in case there is a technical or short-term material development. * The target price was determined by the research analyst through valuation methods discussed in this report, in part based on the analyst’s estimate of future earnings. * The achievement of the target price may be impeded by risks related to the subject securities and companies, as well as general market and economic conditions.

Equity Ratings Distribution & Investment Banking Services Buy Trading Buy Hold Sell Equity Ratings Distribution 73.71% 13.92% 12.37% 0.00% Investment Banking Services 82.61% 4.35% 13.04% 0.00% * Based on recommendations in the last 12-months (as of September 30, 2018)

Disclosures As of the publication date, Mirae Asset Daewoo Co., Ltd. is acting as a financial advisor to SM Entertainment for its treasury share buyback and cancellation.

Analyst Certification The research analysts who prepared this report (the “Analysts”) are registered with the Korea Financial Investment Association and are subject to Korean securities regulations. They are neither registered as research analysts in any other jurisdiction nor subject to the laws or regulations thereof. Each Analyst responsible for the preparation of this report certifies that (i) all views expressed in this report accurately reflect the personal views of the Analyst about any and all of the issuers and securities named in this report and (ii) no part of the compensation of the Analyst was, is, or will be directly or indirectly related to the specific recommendations or views contained in this report. Mirae Asset Daewoo Co., Ltd. (“Mirae Asset Daewoo”) policy prohibits its Analysts and members of their households from owning securities of any company in the Analyst’s area of coverage, and the Analysts do not serve as an officer, director or advisory board member of the subject companies. Except as otherwise specified herein, the Analysts have not received any compensation or any other benefits from the subject companies in the past 12 months and have not been promised the same in connection with this report. Like all employees of Mirae Asset Daewoo, the Analysts receive compensation that is determined by overall firm profitability, which includes revenues from, among other business units, the institutional equities, investment banking, proprietary trading and private client division. At the time of publication of this report, the Analysts do not know or have reason to know of any actual, material conflict of interest of the Analyst or Mirae Asset Daewoo except as otherwise stated herein.

Disclaimers This report was prepared by Mirae Asset Daewoo, a broker-dealer registered in the Republic of Korea and a member of the Korea Exchange. Information and opinions contained herein have been compiled in good faith and from sources believed to be reliable, but such information has not been independently verified and Mirae Asset Daewoo makes no guarantee, representation or warranty, express or implied, as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein or of any translation into English from the . In case of an English translation of a report prepared in the Korean language, the original Korean language report may have been made available to investors in advance of this report. The intended recipients of this report are sophisticated institutional investors who have substantial knowledge of the local business environment, its common practices, laws and accounting principles and no person whose receipt or use of this report would violate any laws or regulations or subject Mirae Asset Daewoo or any of its affiliates to registration or licensing requirements in any jurisdiction shall receive or make any use hereof. This report is for general information purposes only and it is not and shall not be construed as an offer or a solicitation of an offer to effect transactions in any securities or other financial instruments. The report does not constitute investment advice to any person and such person shall not be treated as a client of Mirae Asset Daewoo by virtue of receiving this report. This report does not take into account the particular investment objectives, financial situations, or needs of individual clients. The report is not to be relied upon in substitution for the exercise of independent judgment. Information and

Mirae Asset Daewoo Research 5 November 15, 2018 SM Entertainment

opinions contained herein are as of the date hereof and are subject to change without notice. The price and value of the investments referred to in this report and the income from them may depreciate or appreciate, and investors may incur losses on investments. Past performance is not a guide to future performance. Future returns are not guaranteed, and a loss of original capital may occur. Mirae Asset Daewoo, its affiliates and their directors, officers, employees and agents do not accept any liability for any loss arising out of the use hereof. Mirae Asset Daewoo may have issued other reports that are inconsistent with, and reach different conclusions from, the opinions presented in this report. The reports may reflect different assumptions, views and analytical methods of the analysts who prepared them. Mirae Asset Daewoo may make investment decisions that are inconsistent with the opinions and views expressed in this research report. Mirae Asset Daewoo, its affiliates and their directors, officers, employees and agents may have long or short positions in any of the subject securities at any time and may make a purchase or sale, or offer to make a purchase or sale, of any such securities or other financial instruments from time to time in the open market or otherwise, in each case either as principals or agents. Mirae Asset Daewoo and its affiliates may have had, or may be expecting to enter into, business relationships with the subject companies to provide investment banking, market-making or other financial services as are permitted under applicable laws and regulations. No part of this document may be copied or reproduced in any manner or form or redistributed or published, in whole or in part, without the prior written consent of Mirae Asset Daewoo.

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Mirae Asset Daewoo Research 6 November 15, 2018 SM Entertainment

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