Brief Equities Bottom-Up: Huayi Brothers: Their Move to Theme Part Echoes A Disney Business Model Worth a Hard Look and more

In this briefing:

1. Huayi Brothers: Their Move to Theme Part Echoes A Disney Business Model Worth a Hard Look
2. The Downward Revision in FY03/19 Guidance Places Panasonic in Our Worst-Case Scenario
3. Murata Up 12.8% Following 3QFY03/19 Earnings Release
4. SNC: Downgrade to “HOLD” to Factor in Gloomy Outlook
5. Sony Revises FY03/19 Guidance Downwards; Management Announces a Surprise Buyback

1. Huayi Brothers: Their Move to Theme Part Echoes A Disney Business Model Worth a Hard Look

• Movie World park is first stage in long term plan for 20 “movie theme” cities in China.
• Jack Ma’s investment in company has grown since 2015: Its film finance.
• Company sees licensing of intellectual property rather than brick and mortar as key to best asset deployment as they diversify.

The Walt Disney Company’s just released 1Q19 earnings report held an upside surprise of $1.84 a share beating consensus of $1.57. Revenues of US$15.5bn also beat analysts expectations of US$15.180bn. Filmed entertainment was down due to tough comps from last year’s blockbuster releases. Network TV was up. But what commands our attention in this insight is results from Disney theme parks: All units showed flat to modest growth in attendance, with revenue up primarily due to raised prices. Disney Shanghai was softer than last year attributed to the economic slowdown. Yet theme parks continue to lead the Disney business units year in and year out.

 Reviewing that result in the light of ongoing research I have been working at on Asia theme park prospects, I focused in on Huayi Brothers. Their movie themed park at Suzhou opened last July. While it is too early to make a long term call on the film company’s diversification into theme parks, their move to monetize their intellectual property in that space foretells more diversification ahead.

 The Disney business model appears to be proceeding.

 Huayi Brothers Media Corporation (SHE: 300027)

(All amounts shown in CNY except where otherwise noted).

 Since an ebullient IPO debut in 2009, when on October 23^rd, HB stock skyrocketed to 63.66yuan trading was halted, the stock price has since been both spiked and rocked by events. Most recently, it fell 21% last June when news of the details of a sketchy performance contract for one of HB’s top female stars made headlines. She appeared to have made an effort to disguise her salary. The scandal broke on television. It has triggered an investigation by Beijing officials. Promptly HB founder and Chairman Dennis Wang pledged US$16m to bolster confidence the shares amid continuing disputations between the parties to the scandal.

 On a positive note, during the last five year period, Alibaba’s (NYSE:BABA) Jack Ma announced he was investing US$103M over 5 years to finance the production of 10 HB films. On that news the shares had spiked 6.6%. There are also standing deals with real estate operator Evergrande Group (HK3333) and Tencent Holding(OTC) to deploy HB intellectual property names and brands into theme parks and online social gaming.

 Out of this mix of headwinds and tailwinds in the already volatile China entertainment/film sector, we arrive at a point where HB shares have taken a long, sustained beating. We are moved to believe that now rubbing up against a 5 year low, is the stock its worthy of attention for investors who have a risk profile. One needs to be comfortable with HB’s gyrating past trading patterns to see opportunity in its future as a “Disney in the making” in the words of a film executive friend from Hong Kong.

 Price at writing: 4.51 (52wk low 4.06)

5 year high: June 5 2015: 23.26

1 year high: (2018): 10.14

3 year high: May 23 2016: 14.30

3 year low: 4.70

 Market cap at writing: 12.61bn

P/E 15.11

EPS: 0.30

Revenue: 3.93bn

Revenue growth: 12.7%

EBITDA: 625m

LTD AT WRITING: 5.92bn

Equity: 10.5bn

Book value: 3.58bn

 To get a sense of how major institutional investors were responding to the roller coaster rides of the HB trade we note here that Vanguard International Stock Index Emerging Market Fund, one of HB’s biggest investors, is still holding its position at writing 2,727,202 shares of valued at 23,567,346bn cny.

 The Disney strategy

 The company began as a film production studio in 1994 and has since expanded its TV, internet, movie theaters, talent agencies and more recently, theme parks.

 It is its foray into the theme park space that is the clearest expression of its “Disneyesque” business model. Last July HB opened a 400,000 square meter theme park at Suzhou called “Movie World”. They announced it was the first in a series of 20 “film cities parks” they would create by providing intellectual property from their film hits partnered with realty developers.

 In a study of the China film industry from Deloite Global published in 2017, the researchers noted, “With Disney as its model, HB has launched a “de-cinematic” strategy that integrates the traditional film business, internet entertainment, location-based entertainment, expanding to upstream and downstream industry chains to alleviate dependence on the film industry.”

 Current estimates are that HB revenues continue heavily in film with over 85.% of its total sales from that sector, another 7.8% from internet entertainment, and 6.6.% from brand licensing. All others contribute 0.8%.

 However its going forward strategy is not to deploy hard capex on actually building theme parks but to partner with such realty operators like Evergrande as an intellectual property provider. This veers from a Disney formula since that company has financed and developed its theme parks internally from land acquisition to design, construction and operations. But it does comport with the core Disney strategy of monetizing intellectual property sprung from its films.

 The China film industry is notably dominated by the top 15 companies, among which is HB. The sector is at the same time without a dominant cluster of “major” studios as is the case in the US and other markets. The division of market share among the top players run from the biggest, China Film, at about 4.3% to HB which at 1.3% clusters in the same area between 1% and 2% with at least 8 other producers. This is rooted in the global nature of the film business today where a given year or given share is not necessarily a function of financial or asset deployment power. It reflects in China as everywhere else, the success or failure of individual films from the number of blockbusters to the number of flops it may release in a given year.

 As Disney’s 1Q19 results show, its filmed entertainment unit was down y/y 2% in operating income largely due to 2018 comps that included several blockbuster films. At the same time, its theme parks were up 13%—almost entirely due to a 7% increase in average visitor spend. And that increase we learn, came almost entirely from raised prices. So the key here is the price elasticity in the theme park business that filmed entertainment does not necessarily provide.

 In China there is also a wrinkle to the film business that links box office grosses to the trade in studio stocks. Over the years there has been considerable concern as to the accuracy of box office grosses reported by some studios. Our Hong Kong associate in that field outlined the problem. This quote is a translation.

 “You have instances where studios or theater operators buy up seats in off peak times and theaters that are fundamentally empty. You have ghost grosses. They then report a film has done much bigger business than it actually has because they know that reports of big grosses have a direct effect on the trade of movie stocks. And you get this bizarre situation where the move guys produce phantom grosses to pump up their stock”.

 “Much of this practice has been cleaned up, particularly among the top companies like HB. But in an economic environment where there are still observers in the financial sector that are not entirely comfortable that Beijing’s own economic GDP, trade and monetary numbers are all that accurate, anything is possible”. One of the priorities long expressed by Xi Jinping has been to end the lack of confidence in government numbers. Clearly such practices as ghost numbers can migrate to the private sector.

 In any event, estimated ticket sales in 2018 are believed to be relatively accurate rising to nearly US$9bn.

 Theme Parks forward look: Aging out and creating new

 Theme parks in China are currently showing a 13% rate of growth through 2017 totaling 190m admissions. According to a theme park engineers AECOM study, China will surpass the US as the globe’s biggest theme park market by 2020. Pipeline projects, of which HB projects it will participate with movie themes, continue to dominate in south and east China locations with 42% of all projects scheduled to open there covering a population base of 528m.

Over 27% of all current pipeline projects are themed to fantasy/cartoon/movie media intellectual property bases. Projected Capex total for the theme part pipeline from 2018 through 2025 is 280bn.

 Investors in the theme park space also need to understand the ongoing need to keep pop culture icons sprung out of film blockbusters as fresh as possible. The reason is the inevitable “aging out” of the biggest, most formidable themes. Disney characters such as Mickey Mouse made their first appearances in films in the 1920’s US and did not go global until the 1960s-70s. The company has reworked the theming several times.

 Yet its newest attractions are those like Star Wars Galaxy Edge due to go live at Disney Parks by Q3 this year. The first Star Wars movie debuted in 1977. In brief, children in the 8 to 16 year old demographic cohort back then are now in their fifties. A long list of sequels through last year have kept the imagery and characters refreshed through successive generations.

 What Disney has done well is to package and repackage its core intellectual property stars like Mickey Mouse, Donald Duck and Toy Story characters like the cowboy to keep younger generations eager to experience the live attractions. This is the core dilemma of investing in any sector heavily dependent on creativity.

 The takeaway: An investment theory even based on shifting sands can sometime produce powerful results. Facing a fading film business, Walt Disney literally went into deep debt to develop the first Disneyland in 1955. Linked to a television series, the park had a built in marketing engine. Yet by the early 1980s, the aging out of the company’s core characters and poor results from its efforts in non-cartoon films, the stock had taken a hit. The board brought in a new executive team that repurposed its intellectual property, reimagined its animation business and went on to acquire valuable properties from third parties.

 So our conclusion is that the heart of an entertainment company lies in the capacity to reinvent its character stable and repurpose its original form to a diverse downstream set of revenue producing units. That is what we see in HB.

 Even though they began business in 1994, as far as their diversification strategy goes, its early stages. If they succeed in their theme park initiatives and other related businesses beyond filmed entertainment, their valuation could surge given the starting point of an effective 5 year low.

 Part of the forward valuation consideration needs to be the partnerships thus far achieved with Jack Ma ,Tencent, and Evergrande. Do these sophisticated investors see a potential Disney model flourishing downstream?

So the question is this: Beyond standard investing metrics applied to HB, do investors need to consider a broader conception of how to value a company’s future. You can’t really measure a forward EBITDA number, or pluck a one year estimated PT out of what may spring from the imagination of the creative community where blockbuster ideas are generated.

 In the end, at its current low, HB may be a very cheap entry point if it can execute a “Disney-like strategy” over the next five to seven years as its theme park plans spread across the proposed 20 China cities.

 And the model is Disney. Every time the company appeared to run out of creative gas, it managed to find new inspired

properties within the minds of its key creative people.

So at its five year low we raise the question: Does the investment community see big rewards for HB exchanged for the risks implicit in the shifting sands of artists as opposed to projectable earnings metrics?

2. The Downward Revision in FY03/19 Guidance Places Panasonic in Our Worst-Case Scenario

• Panasonic Corp (6752 JP)’s 3Q earnings were quite weak, failing to meet both consensus and our estimates. Panasonic reported revenue of JPY2,074.8bn and OP of JPY97.5bn resulting in an OPM of 4.7% compared to 5.8% in the third quarter of last year
• The majority of revenue growth came from the Automotive & Industrial Solution (A&IS) segment which saw the strongest growth in revenue at nearly 8% YoY followed by the Eco Solutions Segment. Despite the steady growth in the A&IS revenue, the segment continued to display a decline in profits by almost 13% YoY.
• A downward revision in targets was made following the weak earnings this quarter. Nine-months cumulative figures weren’t particularly attractive in the OP front as well (Revenue up 3% YoY and OP down -8% YoY as of 3QFY03/19). Panasonic is nearing our modest case scenario, although its downward revised earnings target places it in our worst-case scenario, where we expect Panasonic to be exposed to a high degree of risk, increasing its lookout for other customers. Panasonic has only tied up with Toyota Motor (7203 JP) thus far and may have to diversify its customer base further to bring earnings to a sustainable level.
• After the earnings release and news about Chinese competitor, CATL (A) (300750 CH), collaborating with Honda Motor (7267 JP) ( Honda Chooses CATL as Battery Partner for Their EVs; Panasonic Has Lost the Chance), Tesla Motors (TSLA US) announced that it was acquiring battery company Maxwell Technologies for production of its EV batteries. Panasonic fell almost -5% on Monday’s open.

3. Murata Up 12.8% Following 3QFY03/19 Earnings Release

• Murata reported 3.4% YoY revenue growth to JPY427.6bn and 89.9% YoY OP growth to JPY85.6bn in its third quarter earnings.
• Despite the strong third quarter performance, we, along with consensus, expect the company to underperform its revenue guidance. This is mainly due to the slowdown in the smartphone market, which is expected to persist in the current quarter as well.
• Based on our estimates, Murata is currently trading at a FY1 PE multiple of 17.5x, lower than its historical median of 20.5x.

4. SNC: Downgrade to “HOLD” to Factor in Gloomy Outlook

SNC’s 4Q18 net profit dropped 39%YoY to Bt72m, lowest in past five quarters.  

• The drop in sales to Bt1.288m (-19%YoY) and the rise in SG&A to sales from 6.6% in 4Q17 to 9.6% are major contributors to the drop in earnings.
• Overall, FY18 net profit was Bt431m (+6%YoY) despite 14% decrease in sales. The strong improvement in its 2018 earnings was due mainly to high restructuring costs in 2017.
• We maintain neutral view toward its 2019-20 outlook due to slow recovery in overall industry.

We cut our target price by 17% to Bt14 (9.6xPE’19E) and downgrade from “BUY” to “HOLD” for gloomy outlook. Despite limit upside, current share price is still cheap compared to historical trading and offer an attractive dividend yield (6.5% in 2019-20E).

5. Sony Revises FY03/19 Guidance Downwards; Management Announces a Surprise Buyback

• Sony’s revenue for the quarter fell by 10.1% YoY to JPY2,401.8bn while company’s OP saw a 7.5% YoY growth in 3QFY03/19. 
• Sony downgraded its FY03/19 revenue guidance following the third quarter’s earnings results. The company expects to make revenue worth JPY8,500bn for FY03/19, a 2.3% decrease from the October forecast. Sony’s OP forecast for the year still remains at JPY870.0bn.
• Following the 3QFY03/19 earnings release, the company announced that it would buyback JPY100bn worth of its own stock starting Tuesday and lasting until the 22nd of March. 
• As per consensus expectations, Sony is currently trading at a FY1 PE multiple of 7.6x, significantly lower than its historical median of 19.7x.