分众传媒(002027)

A different outlook now, downgrade to HOLD

We downgrade Focus Media (FM) to Hold from Buy with a revised price targetof RMB6.8/share. Externally, we believe the industry landscape has changedwith new competitors such as Xinchao Media (funded by Baidu) aggressivelyfighting for market share with a “low price” strategy. Internally, FM has expandedits screen network aggressively to penetrate low tier cities since 1H18 (shiftedits strategy from previous “milder capacity growth” to “gaining more marketshare”). However, we believe: 1) macro weakness is likely to impact profitabilityof FM’s advertisers and this will cause its revenue growth to slow down; and 2)competition and aggressive expansion will also hurt its margins significantly in2019E. Although FM’s share price has fallen c.50% YTD (the SZ index was downc.27% YTD), we believe its current valuation (15x 2019 PER) is NOT attractive(valuation seems only fair vs. its future earnings growth of mid-single digits) and,therefore we downgrade the stock to HOLD.

Competitor is knocking the door, more uncertainties ahead

The market share of FM in the inner building media segment was once more than90%. Its dominant position is changing, as Xinchao Media (not listed), establishedonly three years ago and recently received investment and funding from Baidu,has now gained a c. 25-30% market share with a primary focus in tier 2-3 citiesin China. Xinchao is not listed and its operational and financial disclosure islimited. However, intensifying competition is likely to result in: 1) price war amongadvertisers, and 2) rising inner building rental cost. We attribute the decliningshare price to such uncertainties.

FM needs to compete in lower tier cities, too

FM has expanded its total inner building terminals (include both LCD playersand poster frames) to 2.17 million, covering more than 200 cities in China asof 1H18 and representing a gain of 58%. Management has guided that most ofthe incremental terminals are in tier 2-3 cities where Xinchao has an first-moveradvantage. However, revenue growth is not driven by expansion of terminals.Revenue is driven primarily by the contract order of each advertiser, which willbe determined in the following year. Therefore, with such a big jump in totalterminal growth, FM’s 3Q core net margin narrowed 5.2 ppt, a result of increasedrental cost. In addition, we believe revenue growth will not immediately reflect theterminal growth as it is primarily in lower tier cities which may not be recognizedby advertisers.

We cut our FY2019 earnings significantly

We believe FM is facing a landscape change at the moment, and hence weshould rebuild all assumptions used to model FM. We cut our earnings by 28%for FY2019 and 40% for FY2020, mainly due to margins. FM’s net margin hasbeen high (c.50%) historically, as shown in figure 1. This is mainly because it lackscompetitors, giving FM high bargaining power over advertisers and rental cost.However, we believe its dominating position is likely to be challenged from 2019.

Valuation and risks

Our primary valuation methodology is based on DCF (10.1% WACC and 3% TGR,unchanged). FM is currently trading at PER of 15x on our 2019E core earningsestimate (excluding government subsidy), which we believe is fair (vs. 13-18x ofmedia/movie industry). Our new target price implies a target 2019E PER of 17x.Key downside risks: 1) intensifying competition in inner building media; 2) threatsfrom other advertising modes; and 3) a slowdown in the internet/FMCG sectorgrowth. Key upside risks: 1) better-than-expected cost control and 2) faster-thanexpectedinternet/FMCG sector growth.