July 13, 2011 Company Report SM Entertainment (041510 KQ) Entertainment Key earnings indicators to provide investors with clues Chang-kwean Kim +822-768-4321 [email protected] Raise TP to W35,000 on success in Japan Jee-hyun Moon We maintain our Buy call on SM Entertainment and raise our target price to +822-768-3615 W35,000 (from W30,000). We revised up our 2011F and 2012F EPS by 13.9% and [email protected] 16.1%, respectively, to reflect the companyÊs greater-than-expected success in Japan. Sales volume for GirlsÊ GenerationÊs (SNSD) first full Japanese album st (released on June 1 ) has significantly exceeded our forecast. Indeed, the album achieved double-platinum status (certified by the Recording Industry Association of Japan), which means that its sales volume reached 500,000 copies. We raised our assumptions for the companyÊs 2011 and 2012 Japanese album sales (key variables for royalty income forecasts) to 630,000 copies (from 550,000) and to 2.19mn copies (from 2.02mn), respectively. We were conservative in our Buy (Maintain) 2011 forecast, as a portion of album sales for the year may be deferred to 2012 Target Price (12M, W) 35,000 (given that SNSDÊs album was released in June). Share Price (07/12/11, W) 26,950 We derived our target price by applying a target P/E of 11.3x (30% discount to the Expected Return (%) 29.9 average 2012F P/E of the music industry) to our 2012F EPS of W3,062 (earthquake EPS Growth (11F, %) -23.5 effects should dissipate next year, in our view). Market EPS Growth (11F, %) 22.7 P/E (11F, x) 26.3 Earnings tend to surge two quarters after successful concerts in Japan Market P/E (11F, x) 10.7 KOSDAQ 490.63 In our historical analysis of SMÊs Japanese album sales and concert performances, Market Cap (Wbn) 446 we found that the companyÊs earnings have been more affected by concerts than Shares Outstanding (mn) 17 by album sales. With regard to album sales, the profit-sharing ratio remains little Avg Trading Volume (60D, '000) 670 changed (the IFPI recommends that copyright holders collect around 15% of album Avg Trading Value (60D, Wbn) 14 sales and 20~30% of digital music sales). Meanwhile, SMÊs royalty ratio from Dividend Yield (11F, %) - Japanese concerts (paid by Japanese management firms) has surged to 70% of Free Float (%) 75.6 concert sales, from only 30% in 2009. 52-Week Low 11,850 In 1Q10, SM posted an operating profit of W10.4bn, on historic-high overseas 52-Week High 26,950 royalty income (W13bn), two quarters after TVXQ had attracted 274,000 fans to its Beta (12M, Daily Rate of Return) 0.6 Price Return Volatility (12M Daily,%,SD) 3.8 Japanese concerts (in 2Q09). The companyÊs 2Q10 operating profit reached Foreign Ownership (%) 6.9 W8.2bn, on overseas royalty income of W9.7bn, two quarters after TVXQ had lured Major Shareholder(s): 100,000 fans to its Tokyo Dome concert (in 3Q09). As of now, we forecast SMÊs SM Lee and et. Al (24.43%) Japanese concerts to attract 479,000 fans this year. KB Asset Mgmt. (10.46%) Partners Venture Capital and et. al (7.25%) Several Japanese albums to be released in 2H Price Performance TVXQ, which saw sales volume for its first single album of the year reach 284,000 (%) 1M 6M 12M copies, plans to release another single album, titled Super Star, on July 20th.And Absolute 45.7 37.5 118.2 other SM artists·GirlsÊ Generation, SHINee, Super Junior, and BoA·are also likely Relative 40.6 45.9 119.4 to release albums in Japan in 2H11. Earnings & Valuation Metrics Share price 290 KOSDAQ OP EV/ Sales OP NP EPS EBITDA FCF ROE P/E P/B FY Margin EBITDA 240 (Wbn) (Wbn) (Wbn) (W) (Wbn) (Wbn) (%) (x) (x) (%) (x) 190 12/09 62 9 15.0 4 278 12 11 7.3 16.2 1.2 3.7 140 12/10 86 25 29.5 22 1,342 28 23 29.1 12.6 3.3 8.2 12/11F 92 20 21.7 17 1,026 22 23 18.0 26.3 4.5 16.3 90 12/12F 154 61 39.6 51 3,062 63 50 39.9 8.8 3.0 4.9 40 12/13F 167 70 41.9 59 3,587 71 60 32.6 7.5 2.1 3.5 7/10 11/10 3/11 7/11 Note: On parent basis under K-GAAP, Source: Company data, Daewoo Securities Research estimates Please read carefully important disclosures at the end of this report. July 13, 2011 SM Entertainment Table 1. 2011 Release schedules in Korea and Japan (copies, seats) GirlsÊ Super Date BoA TVXQ SHINee f(x) Others Korea Japan Generation Junior 1/5/11 Single: Why? [Special Ver.] 230,922 1/12/11 Single: Why? [Normal Ver.] 1/25/11~1/26/11 26,000 Concert: SM Town Live (Yoyogi park) 1/26/11 284,410 Single: Why? 2/7/11 Pictorial GirlsÊ Generation DVD Preview 2/18/11~2/20/11 36,000 Concert: Super Show 3 3/16/11 55,234 Single: Why? repackage 4/20/11 58,419 ALBUM1: Pinocchio 4/27/11 159,568 Single: Mr.taxi, RDR 5/31/11~7/18/11 114,000 Concert: Arena Tour 6/1/11 500,000 Album: Girls' Generation 100,00 6/8/11 Single: Bonamana 0 6/14/11 26,616 Album: Hot Summer repackage 6/22/11 100,000 Single: Replay 6/22/11 M&D Digital Single: Close Ur Mouth 7/8/11 Cheon Sang Ji Hee Digital Single: One More Chance To be 7/20/11 Superstar released 7/22/11~8/11/11 9,441 Concert: Debut Premium Reception To be Aug~Sep/11 Super Junior - M, Mini album released 9/3/11~9/5/11 150,000 Concert: SM Town Live (Tokyo Dome) 2H11 2H11 Cheon Sang Ji Hee Album To be 2H11 Single released To be 2H11 Album released 2H11 To be released Album 2H11 24,000 Concert: Super Show 4 Note: 2H11 Schedule is provided by the company and is subject to change; Data of CDs sold after Jun 2011 is the official total quoted from RIAJ and the Japanese press (as of July 12) Source: Company data, RIAJ, Oricon Japan, Gaon Chart Korea, Daewoo Securities Research Figure 1. CD sales trend of GirlsÊ Generation in Japan (copies) (copies) 250,000 Album: Girls' Generation (L) 25,000 Single: Mr. Taxi/Run Devil Run (L) DVD: New Beginning Of Girls' Generation (R) 200,000 20,000 150,000 15,000 6th week 100,000 21,344 copies 10,000 10th week 1,886 copies 50,000 47th week 5,000 1,845 copies 0 0 1st 11t 21 31 41 rities Research Daewoo Securities Research 2 July 13, 2011 SM Entertainment Key earnings indicators for industry pioneers SMÊs key earnings Investors are always skeptical of industry pioneers, as it is difficult to estimate the earnings indicator: size of of companies that have entered new industries. Initially, estimates are primarily based on Japanese concerts subjective explanations. However, we successfully identified the key earnings indicators of NHN and NCSoft, pioneers of the internet and on-line game industries, respectively. In line with the identification of these key earnings indicators, the earnings outlooks for these companies have become clearer. For NHN, the key earnings indicator is search page views; for NCSoft, it is unique visitor trends. We found the biggest factor affecting SMÊs royalty income in Japan (which drives the companyÊs earnings growth) is the size of its Japanese concerts. We calculated Japanese concert sales by multiplying maximum seating capacity by ticket price (assumption: the total number of tickets sold will be similar to maximum seating capacity). Although the company has a subsidiary in Japan (SM Entertainment Japan), a Japanese agency produced the concerts until 2009. However, starting this year, concerts will be co-produced by the Japanese agency and SM Entertainment Japan. SMÊs royalty ratio from Japanese concerts has surged to 70% of concert sales, from only 30% in 2009 (minus expenses including artist appearance fees, venue rental, stage production, labor costs, marketing, etc.). Figure 2. Japanese CD sales and overseas sales trend Figure 3. Max seating capacity in Japan and overseas sales trend ('000 copies) Success of (Wbn) ('000 seats) (Wbn) 2,400 TVXQ 16 480 Girls' Generation Tour 16 CD copies sold (2Q delayed, L) Girls' Concert seat capacity (2Q delayed, L) + SM Town at Tokyo Dome, Overseas sales (R) Generation Overseas sales (R) SHINee, Super Junior + SHINee, 1,800 Super Junior 12 360 12 Success of BoA TVXQ Tour (*concert at Tokyo Dome) 1,200 8 240 8 BoA Tour 600 4 120 4 0 0 0 0 1Q01 1Q03 1Q05 1Q07 1Q09 1Q11 1Q01 1Q03 1Q05 1Q07 1Q09 1Q11 Note: Please see data in <Table 2>, Source: Daewoo Securities Research Note: Please see data in <Table 3>, Source: Daewoo Securities Research Figure 4. NHNÊs share price and NaverÊs search page view trend Figure 5. NCsoftÊs share price and Lneage2Ês unique visitor trend (W) (bn page views) (W) Lineage 2's unique visitors (R) Share price (L) ('000) 320,000 Search page views (R) 6 120,000 640 Adjusted share price (L) CBT OBT Commercialization 240,000 5 90,000 480 160,000 3 60,000 320 80,000 2 30,000 160 0 0 0 0 10/02 10/03 10/04 10/05 10/06 10/07 4/02 10/02 4/03 10/03 4/04 10/04 Source: Koreanclick, Daewoo Securities Research Source: Koreanclick, Daewoo Securities Research Daewoo Securities Research 3 July 13, 2011 SM Entertainment Figure 6.