Focus Media / Sina Transaction: Think Outside the Box to Make Profits

Shareholders of Focus Media Holding Limited (ADR) (FMCN) and SINA Corporation (USA) (SINA) were met with a surprise on Monday. The boards of both companies have agreed to a transaction whereby Focus Media will sell the majority of its LCD display network, its poster frame network, and its in-store network to SINA. In return for these businesses, Focus Media shareholders will receive 47 million shares of SINA Corporation.

Now if you’re like me, your immediate thought is “what is left of Focus Media?” The trite answer would actually be “not much.” According to the press release, the businesses in question account for 52% of Focus Media’s revenue and about 73% of gross profits. (This is calculated using the last nine months of reported data.) Focus Media will be left with its Internet advertising network, its movie theater advertising, and certain traditional billboards. These businesses are still profitable, but are simply not what FMCN shareholders owned the stock for.

Despite feeling a bit frustrated at losing what I considered to be a good growth opportunity (I’m not all that excited about owning SINA shares yet), some of the specific terms of the transaction are quite interesting. According to the release, the SINA shares received will not be held on the balance sheet of Focus Media. Instead, shortly after the transaction closes, these shares will be distributed to FMCN shareholders.

Since my background includes a bit of work for a risk-arbitrage hedge fund, I was immediately compelled to “do the math” on the transaction, and was a bit surprised at what I came up with. There are currently 128.6 million shares of FMCN outstanding and SINA is paying for the transaction by issuing 47 million shares. That equates to roughly 0.365 shares of SINA for each share of FMCN. Using the SINA closing price of $23, and assuming that each share of FMCN will receive 0.365 shares, the actual value of the SINA payment comes to $8.40 per FMCN share. So this implies that the rest of FMCN’s business is only worth $1.20 per share. That seems a bit low for the remaining business which still produces 27% of gross profits.

So the arbitrage play would be to buy 100 shares of FMCN assuming that you are going to get 37 shares of SINA distributed to you. You could short 37 shares of SINA now which is essentially selling those shares that will be given to you. The difference in purchase price for the FMCN and the proceeds from the SINA sell should be roughly $1.20. So once the transaction is complete, your SINA shares are distributed and paired off against your short position, you will be long 100 shares of the remaining FMCN stock with a cost basis off $1.20. It's not a risk-less play, but it certainly seems that this sets up a very good value for owning what is left of Focus Media.

This current market environment requires a bit more creativity in finding returns and managing risk. Situations like Focus and SINA give us a chance to make profits in a less traditional manner. So investors willing to think outside the box and look closely at such non-traditional transactions may have an upper hand over the coming months and years.

Special thanks to reader Boris B for pointing this transaction out to me.

FMCN Notes

Disclosure: Author does not have a position in FMCN or SINA.

Comments

[Savage Capital:]

1. what happened to FMCN's strong fundamentals mate? companies with strong fundamentals dont get forced into selling the crown jewels. how did they get backed into selling the only piece of the company worth anything? they started by shooting their credibility time and time again (why else would a stock with those kind of analyst growth projections sit at such an attractive valuation for so long?). then they filed to spin/jv/ipo/sell their internet business, which is actually a good one. when they couldnt get a buyer (because no one wants to deal with this management team and their fiction), they started scrambling.

2. arb trade on this one? really? you're running out in front of a steamroller to pick up a few nickles. dont do that. theres plenty of opportunity out there with better risk/reward characteristics.

3. i actually think that when you strip out the SINA shares, valuation looks pretty attractive for the rest of the business (then again, it looked cheap as a whole FMCN at 50, and 40, and 30...........and if you're mr.scheidt, even at 10.......what a deal!). that said, i still wouldnt touch it with a 20 foot pole. its china and its advertising; ad lags in and it lags out, there is no rush.

4. hopefully you read my comments on this guys last FMCN post.

all that said, the band kept playing their instuments as the titanic went down- for all their follies, at least this management team was smart enough to sell their fiddles before china gets even worse. the smart move is proababally for you to do the same.

2008 Dec 26 10:41 AM

[Zachary Sch...:]

savagecapital - Thanks for the comments. You are right in that FMCN has met with more challenges than expected. Much of this, however, is related to the macro picture as everything in China has seen huge multiple contraction.

Your analysis of FMCN selling a profitable business is spot on. I'm actually quite disappointed that this business unit will go away. I'm not a big fan of owning FMCN long-term anymore, but find it interesting that the stub is being priced at $1.20 per share. You're not really running in front of a steamroller on this one because all you risk is $1.20 per share if you set it up right. the potential is for FMCN stub to trade higher (maybe $5 to $7) and make a very nice return.

Best to you in the new year - thanks for the comment!
Zach
zachstocks.com

2008 Dec 27 10:08 AM

[punter888:]

Focus has had very little growth in cash inflow...nothing like the growth in reported revenue. Accounts receivable days has gone from like 65 to 130 days. Cash coming in the door actually declined last quarter (from memory), even though (again from memory) there was something like 75% revenue growth.

So one has to wonder, are the revenues real? Is the bottom line earnings real? (Sina management, for what it claims, says that receivables are lower on the screens business).

Why is it that LCD's are such a successful business in China, but yet this advertising medium doesn't exist outside of China (to my knowledge). Is it a real business, or is the supposed success of Focus derived from some highly questionable accounting and business practices?

If you make sufficient provisions to bring Focus' accounts receivable days back into line with China media industry norms of 60 days, and if one strips out the offending revenues from the P&L, then the 20% odd margin quickly becomes zero profits. This inconvenient truth just so happens to triangulate with the reality that there are no other LCD media companies thriving in the world today.

Lets think about VISN. Their cash inflow (revenues plus beg of period A/R less ending A/R) showed a decline in Q3, at the same time that the reported P&L showed huge growth (I can't remember whether 100% or 300% but it was huge). Where in the world are there material companies providing advertising on buses and trains?

Talk about Air Media. Where in the world are there material companies/businesses focusing exclusively on purchasing space from a couple of airports. I would like to see the one sell side report that looks for global comparisons in this business nice. Rather it seems like every research report accepts the business viability and accounts at face value and obsesses over the next quarterly earnings number.

Bottom line, in China, what you see isn't always what one gets. I have been amazed reading and communicating with the leading sell side analysts covering Focus, how the A/R problem has been overlooked. In my opinion, this isn't some obscure metric or KPI measuring management performance. This is the canary in the coal mine, that lets you know whether you are being taken to the cleaners.

The sad part is that sometimes watching A/R isn't even enough. If one thinks that channel stuffing to inflate revenues at listing doesn't happen, then think again.

The bull market created so many stories where investors and bankers conveniently overlooked proper due diligence and dropped standards, and bought into all sorts of stories. Focus falls into this category.

So as to the theory that the rump of Focus is worth something? If Sina's guidance on A/R is correct, then A/R for the Focus rump is off the map, and therefore, the rump's revenues and profits, are likely to be not real. Hold a gun to my head, and I would guess that the rump will go to zero long term, or have residual value only as a shell.

Disclosure - have made money as a Focus short previously. Currently no position.

Jan 17 03:02 AM

[kagame:]

Allyes will be part of the stub, and will IPO for a huge profit for FMCN. FMCN is currently valued at less then the value of the SINA shares one will recieve for holding FMCN.

And you want to short it? Short a stock already at zero?

Stop obsessing over accounting.

Mar 20 06:23 PM

[Violent Cap...:]

I agree with punter, but doesnt mean you cant win big in this transaction

as Scheidt exlpained, you can employ merger arbitrage to lock in the gains. However, now the spread has widened to 40%+ and the rest of FMCN's business is considered worth nothing (I'd assume its worth 1-2/share after the latest results)

In addition you can lock in a $/share for FMCN shares by buying some puts. In the end the whole strategy can pay off 85%+!!

violentcapitalist.com

for the complete breakdown-

Apr 16 12:07 AM

[JudeJin:]

this has been a sucker's play. merge spread swung to -40%. somebody got margin calls employing your strategy i'm sure.

Jun 03 04:44 AM