Video content production China presents huge market potential Domestic content production market to see tailwinds from China Many domestic video content producers share a number of challenges , including 1) unreasonably low license fees compared to actual production costs , 2) the industry Industry Report practice of networks paying production companies only after a program is aired, and 3) September 30, 2014 the fact that networks rather than production companies often own the rights to content. These challenges stem from the unique structure of the domestic market, in which only a handful of networks attract the majority of viewership. Daewoo Securities CCCo.,Co., Ltd. However, things are looking better abroad. Recently, China has been overtaking Japan as [Small Cap] the biggest foreign buyer of Korean content. We believe Korean content production companies will expand their footprint into China’s broadcast network market , which Daewoo Lee remains uncharted territory. Unlike Korea, the balance of power in China is tilted +822-768-4132 towards production companies. Thus, Korean content makers’ advance into China should [email protected] bode well for profitability. China to expand collaboration with Korean firms to secure content In China, demand for content has been growing fast, in terms of bo th quantity and quality, in line with the rapid development of new forms of media. At the same time, dissatisfaction with domestically produced content is widespread among Chinese media consumers. Against this backdrop, we believe demand for Korean dramas will continue to rise going forward. Tighter regulations to spur coproductions China has continued to strengthen bro adcast regulations, but this has not stopped the country’s broadcast content market from expanding at a fast pace. Recently, government restrictions on online video streaming sites have been causing some stir. Such measures should merely adjust the pace of growth, rather than derail the overall growth trajectory of the market. We believe domestic content producers, for their part, will look towards co production with local Chinese firms to respond to various proposals for cooperation and avoid regulations on foreign-made content. Stocks to watch: SM C&C, KeyEast, and Pan Entertainment In the domestic video content production segment, we recommend closely watching three stocks: 1) SM C&C (048550 KQ), which we believe has an upper hand in negotiations thanks to its variety entertainment-oriented content, 2) KeyEast (054780 KQ), which is well-poised to enjoy a dominant position in China on t he back of its robust talent roster, and 3) Pan Entertainment (068050 KQ) in light of its attractive valuation and partnership with China’s leading production firm Zhejiang Huace. Growth of content demanddemand:: MMMobileMobile internet penetration rate in China sharply increasincreasinginginging (mn persons) (%) 600 Mobile internet users in China (L) 100 Mobile users out of total internet users (R) 500 80 400 60 300 40 200 20 100 0 0 2007 2008 2009 2010 2011 2012 2013 Source: CNNIC, KDB Daewoo Securities Research 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 DISCLOSURESDISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT. September 30, 2014 Video content production China presents huge market potential 1. A challenging domestic environment The recent bankruptcy of Four Seasons, a well-known documentary producer that has been in the business for over 30 years, underscored the harsh reality facing many Korean video content production companies. Compared to documentary and informational program studios, drama and entertainment show producers are generally better off, as they can sell their programs in secondary markets (IPTV and overseas markets). Still, many domestic video content producers are struggling with a number of common challenges. First, license fees are unreasonably low compared to actual production costs. Second, it is a common industry practice for networks to pay production companies only after a program is aired. Lastly, it is often the network, not the production company, that owns the rights to content. These challenges stem from the unique structure of the domestic market, in which the three major broadcast networks control the majority of viewership. FigureFigureFigure 111.1. Proportion of Korean content FigureFigureFigure 333.3. Content producers’ operating loss FigureFigureFigure 222.2. Content producers’ OP margin levelslevelslevels producers making operating profitsprofits////losseslosseslosseslosses levelslevelslevels (%) (%) (%) 50 50 50 40 40 40 30 30 30 20 20 20 10 10 10 0 0 0 Profit BEP Loss Source: KISDI, KDB Daewoo Securities Research Dramas have accounted for the bulk of networks’ profits. Indeed, drama programs command higher ad prices and space compared to other types of content. FigureFigureFigure 444.4. Cost of television aaadvertisingadvertising by programming type (Wmn/15 seconds) 10 9 8 7 6 5 4 3 2 1 - Children's Sports Drama News Educational Source: KBAC, KDB Daewoo Securities Research More importantly, dramas are playing a leading role in driving exports of Korean content. China has been emerging as a major foreign buyer of Korean content, alongside Japan, while exports to other regions like the US and Europe are also on an upward trend. KDB Daewoo Securities Research 2 September 30, 2014 Video content production Table 111.1... Success of www.dramafever.com highlights popularity of Korean dramas in the US Details on www.dramafever.com In April 2014 (one-month # of visitors 18mn period ) Launch of webwebwebsiteweb sitesitesite 2009 Growth in # of visitors Over 100% per half-year Over the past five years NonNonNon-Non ---AsianAsian Americans out of 84% Subscribers aged 18-34 total visitors Race White (40%), Hispanic (26%), African American (16%) AgeAgeAge High proportion of subscribers aged 18-24 Gender 63% of subscribers are women Source: KOCCA, KDB Daewoo Securities Research 2. Tailwinds from China (1) Chinese online video streaming sites are fast growing Demand has been cooling in Japan, which was once the biggest foreign buyer of Korean content, partly due to worsening bilateral relations. Still, we believe Korean dramas are demanding a price of around W100mn per episode in the country. More recently, however, China has been emerging as a major foreign buyer of Korean content. In a short period of time, the price of Korean dramas has doubled from around W100mn per episode to W200mn per episode. FigureFigureFigure 555.5. Average perper----episodeepisode sales of Korea dramadramassss on CCChineseChinese online streaming sitesitessss My Love from the Star 40 Three Days 50 Doctor Stranger 80 It's Okay, That's Love 120 Fated to Love You 120 My Lovely Girl 200 (Wmn) 0 50 100 150 200 250 Note: All aired in 2014 except My Love from the Star , which aired in 2013 Source: Company data, KDB Daewoo Securities Research Such price increases have mostly been led by Chinese online video streaming sites like Youku Tudou and Sohu. The primary catalyst was the popular Korean drama The Heirs , which was serviced on Youku Tudou in 4Q13 and helped attract a greater Chinese audience to Korean dramas. The show’s success was followed by another hit, My Love from the Star , triggering an intense battle among video streaming sites to secure license rights. This quickly pushed up prices, as the growth in traffic to Korean dramas helped Chinese video firms gain major advertisers and raise ad revenue. Thanks to the looser regulations on online media, Chinese streaming sites are able to update content frequently, and many also support video access via mobile devices. We believe Chinese streaming sites will continue to see strong growth for some time on the back of the spread of mobile devices. Currently, the four largest Chinese online streaming providers—Youku Tudou, Sohu, iQIYI, and Tencent—are looking to set themselves apart by producing original content independently or through outside companies. Youku Tudou is specializing in entertainment shows, Tencent in news and sports, Sohu in documentaries, and iQIYI in lifestyle programs. As of April 2014, Youku Tudou had 33 original programs (total airtime of 414.7 hours or 1.14 hours per day), the largest number among the four sites. KDB Daewoo Securities Research 3 September 30, 2014 Video content production FigureFigureFigure 666.6. 1) Breakdown of independently produced programming on four largest Chinese online streaming sitesitessss and 2) detailed breakdown of entertainment/music programming Entertainment/music News Sports Entertainment news Star interviews Talk shows Video editing Documentaries Lifestyle Performance shows Music Talent shows Internet one-act plays Animation Nature shows Large events 2% 2% 2% 4% 12% 6% 7% 44% 8% 1,057.5 hours 24% 653.3hours 62% 10% 25% Source: KOCCA, KDB Daewoo Securities Research FigureFigureFigure 777.7. TrafficTraffic----boostingboosting effect of My LLLoveLove from the SSStarStartartar forforfor online FigureFigureFigure 888.8. Revenue breakdown of Chinese online streaming sites streaming site iQIYIiQIYIiQIYI ('000 persons) (%) Other value- 400 0.5 Viewers of My Love from the Star added services MUV 16% 350 0.45 0.4 300 Video services 0.35 3% 250 0.3 200 0.25 Copyright sales 0.2 13% 150 Advertising 0.15 68% 100 0.1 50 0.05 0 0 6/13 8/13 10/13 12/13 2/14 4/14 6/14 Source: Compete.com, TNmS, KDB Daewoo Securities Research Source: iResearch (2012), KCC, KDB Daewoo Securities Research These online streaming sites share the following characteristics: 1) Entertainment shows account for the largest proportion of their content. 2) They combine content and marketing by actively using product placement advertising; the rapid growth of these sites has been consistent with the fast growth of China’s consumer market. 3) Although many programs are fresh and unique, the sophistication or extent of production expertise still lags far behind that of broadcast networks. 4) Content, not picture quality, plays a key role in determining viewers’ choice of platform.