奥飞娱乐(002292)

We initiate coverage of Alpha Group, the leading kids and comics IP company in China, with an Outperform rating and TP of RMB13.58. We like the company’s rich IP resources and its strategy to transform into an IP licensing company from a toy manufacturer. The over-diversification in 2015-2016 has eroded its earnings in 2016-17 and sent its valuation to a trough of 31.2x18E PER (vs historical average of 42x). We think that suggests a decent buying signal in light of the inflection point where Alpha sits, thanks to strategy realignment. Our TP of RMB13.58 is based on a 39x 18E PE, or 25% upside.

From toy manufacturing to entertainment & licensing

The company is at its initial stage to transform itself into an IP licensing company from a toy manufacturer. Its key IP, Pleasant Goat and Big Big Wolf (喜羊羊与灰太狼), is one of the best-known Chinese cartoon series and its newly launched K12 IPs Super Wings (超级飞侠) also has gained wide popularity among Chinese kids. In 2017, Alpha had a mere 2.9% of revenue from IP licensing, which is compared to international companies such as Hasbro’s 10% and eOne’s 51%. We expect that figure to expand to 4.4% in 2020 and help improve the gross margin of Alpha by ~1ppt a year. The licensing is not just among K12 products, but also mass market products, e.g. FMCG, F&B, hotels, given the fame of the IPs.

Comic IPs geared to rising demand from OTT platforms

Alpha owns U17, the second largest online comic platform in China. That is geared to the rising original IP demand from iQiyi/Youku/Tencent Video, which are keen to increase original TV drama series to attract subscribers and lower costs. We see comic IP-based TV dramas in China jumping to 13 series in 2017 from 1-2 series in 2015-16. Along with regulators’ encouragement in contentbased on original IPs, we see growing value to quality IP libraries such as U17.

K12 IPs benefit from lift of one-child policy

New births in China should finally see a 3% CAGR from 2015-25E, estimated by NBS, after a chronic 1.5% decline since 1990, thanks to the lift of the one-child policy. Alpha Group, which has around 60% sales exposure in K12 and 30% in juvenile products, will benefit directly. Based on the company’s plan, there will bemore K12 educational products based on its key IPs to come. They also aim to prudently expand the IP-based indoor kids’ playground business at a low cost by partnering with mall developers. Its home-grown IPs fit well with the government’s attempt to cultivate domestic brands in culture fields.

Strategy realigned to focus on core IPs; initiate with OP

The company realigned its strategy to focus on core IPs from 2018, after suffering from over-diversification in 2015-17, which has sent its valuation to a trough of 31x 18E PER (vs historical average of 42x). Our TP is based on a 39x PER to factor in the execution risk of its new strategy. We expect the earnings to return to a growth trajectory in 2018 with a 185% CAGR in 2017-19E, after a 42% decline in 2014-17E. Initiate on the company with an Outperform rating.

Risks: execution risk, competition from foreign brands, over-diversification