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 EXO album 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 albums (new NCT Dream and Red Velvet 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, Apple Music, 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 Key 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.