Studio Dragon (253450.KQ) Re-rating is on the way Although Covid-19 effects have reduced Studio Dragon’s room for top-line Company Comment │Oct 12, 2020 growth via diversification of its programming platforms, we draw attention to stronger margins amid intensified competition among global OTTs. The stiffer ※ Refer to page 2 for competition is to boost production studios’ bargaining power and spur expansion ESG index/event tables of the global content market. We maintain Studio Dragon as our sector top pick. Buy (maintain) TP (12-mth) W110,000 (maintain) Pay attention to strengthening bargaining power and widening margins CP (20/10/08) W85,000 Sector Media/entertainment We maintain a Buy rating on Studio Dragon, continuing to suggest it as our Kospi/Kosdaq 2,391.96 / 871.62 sector top pick in respect of: 1) its increased bargaining power; and 2) intact Market cap (common) US$2,074.5mn expectations towards re-rating in response to global content market expansion. Outstanding shares (common) 28.1mn We view the firm’s recent sale of global broadcasting rights for Jirisan to iQIYI 52W high (’20/07/08) W92,500 as evidencing the emergence of OTT operators in possession of both abundant low (’19/10/10) W65,000 funding power to counter Netflix and a willingness to secure content in Asia. Average trading value (60D) US$18.3mn Accordingly, content producers are set to enjoy increased bargaining power. Dividend yield (2020E) 0.00% Meanwhile, with the company currently in talks with both Apple and HBO Max Foreign ownership 9.2% regarding global market original productions, we see opportunities for further Major Shareholders expansion into the global content market. Our earnings estimates are CJ ENM & 5 others 61.3% conservative in light of a downward adjustment in our assumption of the Share perf 3M 6M 12M number of dramas to be aired in 2021 down to 28 dramas (-13% vs our previous Absolute (%) -8.1 13.5 28.0 estimate). We note that ongoing programming disruptions due to Covid-19 Relative (%p) -19.2 -20.9 -6.7 effects has reduced Studio Dragon’s room for top-line growth via diversification 2019 2020E 2021F 2022F of its programming platforms (ie, higher non-captive programming). That said, Sales 468.7 541.2 576.7 672.8 we believe that Studio Dragon will continue to display robust margins going Chg 23.5 15.5 6.6 16.7 forward in line with: 1) an upturn in its recoup rate for new dramas; and 2) a OP 28.7 52.9 86.1 103.8 revitalization of global sales of the firm’s previously-aired dramas. Therefore, Chg -28.1 84.3 62.8 20.6 rather than being disappointed by a likely slowing in the company’s top-line OPM 6.1 9.8 14.9 15.4 growth, we advise investors more to focus upon anticipated continued NP 26.4 41.8 70.0 84.2 improvement in its profitability. EPS 941 1,488 2,489 2,994 Chg -26.4 58.1 67.3 20.3 3Q20 preview: Earnings to arrive in line with lowered consensus P/E 85.9 57.1 34.1 28.4 In line with lowered consensus, we estimate that Studio Dragon’s consolidated 3Q20 P/B 5.3 5.1 4.4 3.8 sales and OP fell to W130.1bn (-0.8% y-y) and W10.6bn (-3.2% y-y), respectively. EV/EBITDA 14.9 12.8 11.6 10.3 The firm’s earnings figure should reflect both pre-sales to Netflix (for It’s Okay to ROE 6.4 9.3 13.9 14.5 Not Be Okay, Stranger 2, and Record of Youth) and a likely continued uptrend in Debt/equity 35.8 33.9 30.8 27.9 sales of its past libraries. We expect the firm to write off amortization of intangible Net debt -100.7 -89.1 -139.6 -202.6 assets, estimating its depreciation costs for four works (including several Netflix pre- Unit: Wbn, %, won, x sale works and Once Again (KBS2)) at W33bn. In addition, expenses related to Note 1: NP excludes minority interests Note 2: EPS, P/E, P/B, ROE based on NP (excl minority interests) temporary production suspensions stemming from a re-proliferation of Covid-19 Source: NH I&S Research Center estimates will likely be booked as a one-time cost item. Looking at 4Q20, the number of domestic films to be aired in Korea should decrease q-q due to a lack of platform diversification. However, the negative impacts of such should somewhat be offset by the likely reflection of earnings for Netflix original production Sweet Home S1, which is confirmed to have a high profit margin (20%). 3Q20 preview (Unit: Wbn, %) 3Q20E 3Q19 4Q19 1Q20 2Q20 4Q20F Estimate y-y q-q Previous Consen Sales 131.2 97.4 120.3 161.4 130.1 -0.8 -19.4 138.2 123.9 129.4 OP 10.9 -4.0 11.6 16.9 10.6 -3.2 -37.3 17.7 11.8 13.8 OPM 8.3 -4.1 9.7 10.4 8.1 12.8 9.5 10.7 Pre-tax profit 13.1 -5.2 12.0 17.2 12.7 -3.2 -26.2 18.6 12.3 12.9 Hazell Lee, Analyst NP (excl minority 822)768-7535, [email protected] 11.5 -1.6 8.5 13.4 9.9 -14.5 -26.2 18.6 9.6 10.1 interests) Note: K-IFRS consolidated; Source: FnGuide; NH I&S Research Center estimates Studio Dragon www.nhqv.com Summary Studio Dragon is a drama production company that was born in May 2016 via the splitting off of CJ ENM’s drama business. The firm manages both planning and production activities for its dramas and possesses its own drama IPs. It signed a contract with Netflix to produce 21 dramas for the global OTT over three years from 2020. Studio Dragon is capable of producing about 40 dramas a year. In 2019, the firm’s sales broke down as: 1) broadcasting revenue (44.6%); 2) distribution revenue (46.8%); and 3) other sales (8.7%). We believe that Studio Dragon boasts differentiated growth potential thanks to both its strong production team lineup and its ample co-operative production experience with global players. Presenting a Buy rating and a TP of W110,000, we offer Studio Dragon as our sector top pick. Share price drivers/earnings momentum Downside risks Export contracts with non-Netflix global OTT players Defection of major scenario writers and directors Production cost hikes for original series for global OTT firms and Slowing demand from OTT players for original series resulting margin improvement Delayed resumption of exports due to Chinese government’s Resumption in exports to China upon lifting of Chinese restrictions on Korean content government’s restrictions on Korean content Disposal of CJ ENM-owned stake to financial investors (FIs) Disposal of CJ ENM’s stake to strategic investors (SIs) Cross valuations (Unit: x, %) Historical valuations (Unit: x, %) P/E P/B ROE Company Valuations 2018 2019 2020E 2021F 2022F 2020E 2021F 2020E 2021F 2020E 2021F Netflix 86.0 60.7 22.3 16.4 26.0 27.0 P/E 72.3 85.9 57.1 34.1 28.4 Walt Disney 82.6 47.0 2.7 2.6 3.2 5.5 P/B 6.5 5.3 5.1 4.4 3.8 CJ ENM 21.4 16.2 1.0 0.9 4.5 5.7 P/S 6.8 4.8 4.4 4.1 3.6 J Contentree N/A 24.2 1.4 1.3 -12.8 5.8 ROE 9.3 6.4 9.3 13.9 14.5 AStory 58.6 N/A 2.4 2.5 4.1 -1.7 ROIC 11.5 6.1 11.0 18.7 21.5 Source: Factset, NH I&S Research Center Source: NH I&S Research Center ESG index (Unit: %, years, hours, ‘000TJ, mn tCO2e, mn tons) BOD composition Human resources 2017 2018 2019 Kang Cheol-goo CEO Inside Portion of female employees 46.8 52.0 54.0 Kim Young-kyu CEO Inside Portion of contract workers 8.9 10.2 13.7 Ha Yong-soo General management Outside Avg service period per employee 1.4 1.7 2.0 Yun Seok-min - Outside Avg training hours per employee - - - Environment 2017 2018 2019 Energy consumption - - - Greenhouse gas emissions - - - Recycled water consumption - - - Recycled waste - - - Note: Joint CEO system introduced; Source: Studio Dragon, NH I&S Research Center ESG events E – N/A – Released 68-hour workweek drama production guidelines designed to avoid turn-key contracts and encourage the signing of contracts 2018.09 with individual staff members separately S 2017.12 – A drama crew member fell during a production shoot; the firm was embroiled in controversy over a breach of the Labor Standards Act 2017.04 – A program (O’PEN) designed to discover and nurture promising new writers introduced – Despite being in the net black, no dividend has been distributed; there exists room for improvement in terms of the lack of shareholder G 2020.03 return policies Source: Studio Dragon, NH I&S Research Center 2 Studio Dragon www.nhqv.com Pay attention to increased bargaining power and improving margins Reiterate Buy We maintain a Buy rating on Studio Dragon, continuing to suggest it as our sector top rating pick in respect of: 1) its increased bargaining power; and 2) intact expectations towards re-rating in response to global content market expansion.