Entertainment (Music) Content to drive blockbuster growth in 2013 SM to top 2012 annual Japanese concert attendance with 1H13 concerts alone We have recently seen a number of indicators suggesting that domestic music firms are remaining resilient despite headwinds from yen depreciation. First, SM Entertainment’s Entertainment Japanese concert attendance (1.37mn based on maximum seating capacities and confirmed tour schedules) for 1H13 is expected to be 1.28 times greater than its 2012 Anchor Report annual figure (1.07mn based on maximum seating capacities). April 16, 2013 Furthermore, SM Entertainment’s dome (i.e., large stadium) concerts as a percentage of total concerts have increased from 46.3% in 2012 to 81.7% in 2013, a positive development given that dome tours tend to generate royalty income (per 10,000 Daewoo Securities Co., Ltd. attendees) twice as high as that of regular concerts (capacity of 40,000-50,000 per Internet/Game/Entertainment concert for dome tours vs. 10,000-15,000 for regular tours). Chang-kwean Kim Also, a number of Chinese concerts were added to 2013 ex-Japan tour schedules for the +822-768-4321 first time. TVXQ is set to hold a concert in Beijing in March, while G-Dragon is scheduled [email protected] to tour Beijing, Shanghai, and Guangzhou this May. Boy band Super Junior’s 2013 Super Show 5 will include a tour in Latin America, which we expect will draw 200,000 concertgoers. In 2013, we believe the Chinese performance market will begin serving as a medium- to long-term growth driver for Korean music companies (following a pattern seen in many other consumer industries). Gov’t support to nurture entertainment giants; Music companies to take the lead In our view, the new administration’s strong commitment to support the content industry will act as a major upside catalyst. The Ministry of Science, ICT and Future Planning intends to: 1) effectively coordinate the interests of industry parties on copyrights, etc., 2) relax regulations, and 3) create a new ecosystem across the entertainment industry to foster the digital content market (VOD, digital music, etc.). We expect this to give rise to domestic entertainment giants that are integrated across music, film, television series productions, distribution, and other sub-segments. In particular, we believe domestic music companies are best positioned in this regard, given their strong financial strength and growing global reputations. Maintain Buy on SM (TP: W72,000) and YG (TP: W94,000) On a P/E basis, leading domestic music companies are currently undervalued compared to major domestic and foreign entertainment firms as well as the broader media sector. The US media and entertainment sector is now trading at an average 2013 P/E of 27.1x, underpinned by solid growth prospects. Global media stocks are trading at a 2013 average multiple of 22.9x. We maintain our Buy rating on SM Entertainment (041510 KQ) with a target price of W72,000. We also reiterate our Buy call on YG Entertainment (122870 KQ) with a target price of W94,000. Annual earnings and valuation metrics (Wbn, x, ‘000 people) 2009 2010 2011 2012 2013F Revenue 62 97 143 241 290 Operating profit 9 20 26 61 74 SM Entertainment Net profit 5 17 23 40 59 P/E 16.0 16.0 33.0 22.8 16.3 Overseas concertgoers 424 236 1,009 1,604 2,769 Revenue 36 45 78 107 137 Operating profit 7 10 18 22 32 YG Entertainment Net profit 4 10 13 19 29 P/E 22.1 33.3 26.8 Overseas concertgoers 180 175 1,258 1,834 Note: 2009-10 figures are based on K-GAAP. Figures for 2011 and beyond are based on consolidated K-IFRS Source: Company data, KDB Daewoo Securities Research Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including the U.S. April 16, 2013 Entertainment (Music) Investment summary 1. The music industry is still growing and evolving The success of entertainment companies hinges on their ability to produce competitive content. The entertainment industry boasts stronger operating leverage than any other industry, which should enable the sector’s companies to see their margins soar once revenue begins to outstrip fixed costs. Lately, Korean music companies are showing revenue growth on the back of favorable market changes and their diversified artist lineups. In particular, the quality of earnings from Japan—in which Korean firms are seeing market share expansion—is improving. Also, outside of Japan (e.g., Taiwan, Hong Kong, and Singapore), Korean artists attracted more fans to concerts last year than in 2011. This year, many Korean artists are scheduled to hold tours in China (a key market) and Latin America. As for SM Entertainment, profitable dome (large stadium) concerts are expected to account for a whopping 80% of overall concerts (vs. 46.3% in 2012). And YG Entertainment is likely to improve the efficiency of its tours this year by concentrating schedules in specific periods and areas. New artists’ activities should be noteworthy. We expect SM’s new boy band EXO-M to gain popularity in Greater China in 2013 with the release of a full album. For YG, Psy has just rolled out his new album, and new artists (e.g., Kang Seung-yoon, a new girl band) are scheduled to launch new albums sometime soon. Given that the Korean music industry represents only 1.7% of the global market, domestic operations appear insufficient to keep Korean firms in the black. However, SM and YG recorded respective operating profits of W60.5bn and W21.5bn in 2012 on the back of their competitive content. On April 13th, Psy’s fans around the world watched his Sangam-dong concert live via YouTube, and gave real-time feedback via Twitter and Facebook. Indeed, the internet is proving to be a key marketing tool, presenting Korean entertainment companies with new opportunities to diversify markets. The government hopes that, along with the music business, other content businesses (e.g., movies, dramas, online and mobile games) grow significantly enough to create jobs and attract foreign tourists. We note that the music industry has enhanced its global competitiveness on the back of industry realignment. In our view, in order for other content businesses to thrive, big players with diverse product lineups, capital, planning capabilities, distribution power, and marketing know-how need to take the lead. And we expect terrestrial broadcasters, cable channel operators that are affiliated with chaebols, and pure entertainment companies to attempt to become such big players this year. Figure 1. SM’s revenue, OP, and monthly share prices (Wbn) Chinese operations + SM C&C (W) 390 Revenue (L) OP (L) Price (R) entering growth period 75,000 60,000 SM Entertainment 290 Japan drove SM's Preparing to enter overseas rapid growth 45,000 markets 190 30,000 90 15,000 -10 0 00 02 04 06 08 10 1214F 14 Source: Company data, KDB Daewoo Securities Research 2 KDB Daewoo Securities Research April 16, 2013 Entertainment (Music) 2. 2013 earnings and indicators Table 1. SM's annual earnings trends (Wbn, %) 2007 2008 2009 2010 2011 2012 2013F Revenue 31 40 62 86 143 241 290 CD 9 11 15 15 20 22 23 Digital 4 5 9 9 6 6 9 Overseas 6 9 16 37 81 129 158 Management 12 16 22 26 36 36 39 Other 0 0 0 0 0 48 61 YoY Revenue 27.9 54.1 39.9 65.6 68.7 20.3 CD 21.3 35.7 2.1 32.0 13.3 1.5 Digital 8.9 98.1 -10.2 -26.2 1.2 49.4 Overseas 52.0 84.1 133.1 120.6 58.6 22.7 Management 28.4 37.3 19.6 37.2 0.9 7.8 Other 28.7 Proportion CD 28.4 26.9 23.7 17.3 13.8 9.3 7.8 Digital 14.0 11.9 15.3 9.8 4.4 2.6 3.3 Overseas 18.0 21.4 25.5 42.6 56.7 53.3 54.3 Management 39.6 39.8 35.5 30.3 25.1 15.0 13.5 Other 0.0 0.0 0.0 0.0 0.0 19.8 21.1 Operating profit -4 -2 9 20 26 61 74 YoY -48.6 -586.4 118.5 26.5 136.4 22.2 OP margin -11.8 -4.8 15.0 23.4 17.9 25.1 25.5 Net profit -8 4 4 17 23 40 59 YoY -156.1 4.5 282.8 33.0 75.3 48.1 NP margin -24.3 10.7 7.2 19.8 15.9 16.5 20.3 Notes: Pre-2011 figures are based on K-GAAP. Other figures are based on consolidated K-IFRS Source: Company data, KDB Daewoo Securities Research Table 2. SM's annual overseas CD and concert ticket sales (‘000 copies, ‘000 seats, %) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013F CD 177 1,692 1,534 902 1,409 885 914 914 1,162 1,770 2,919 1,748 2,500 YoY 855.3 -9.3 -41.2 56.2 -37.2 3.2 0.0 27.1 52.3 64.9 -40.1 43.0 Japan Concert - - 37 171106 41 160 337 374 13 655 9031,700 YoY 356.9 -38.0 -60.9 285.3 111.3 11.0 -96.5 4,937.6 63.7 58.6 Concert - - - - - - - 55 50 223 354 532 1,069 Ex-Japan YoY -9.1 346.0 58.7 50.3 100.8 Notes: Based on album release dates, concert dates, and maximum seating capacities; 2013 figures are our estimates based on confirmed schedules as of April 12, 2013 Source: KDB Daewoo Securities Research Table 3.