Almost Time to Short Focus Media (FMCN)

| About: Focus Media (FMCN)

I’ve been tracking this Chinese company for awhile. Before I tell you what they do, let’s start with Focus Media’s (NASDAQ:FMCN) market valuation today: $2.74 billion off of $91 million in trailing revenues, although with $30 million in net income (which is better than Google’s net margins).

So what does Focus Media do to deserve this stellar valuation? You’d think they’d be curing the bird flu or something incredibly difficult with huge growth potential.

Nope. Instead, the company owns and operates 50,000 LCD flat panels that they place in Chinese office buildings and 30,000 LCD’s that they place in retail locations such as supermarkets and convenience stores. The company runs advertisements on the screens, and updates the advertisements weekly by sending someone with a flash drive or DVD, typically someone riding on a bicycle.

That’s it. I think as the company’s contracts start to come up for renewal, there will be significant pricing pressure.

Already, my friends over at the China venture firm AsiaVest tell me that they don’t have a day go by where they don’t see a business plan on a Focus Media competitor startup. The problem for FMCN is that they have a very successful business model that is ultra-profitable — and with pretty much ZERO defensibility outside their contracts with real estate managers.

New entrants into this business can signicantly undercut Focus. And if there’s one thing Chinese companies are exceptionally good at, it’s being extremely efficient and ruthless on price.

There are several people who have written good analysis of the company. So I won’t bore you with regurgitating the facts, but instead I’ll point you to some good resources.

From Seeking Alpha, Readers Express Caution on Focus Media Holding :

Focus Media have been successful at filling a niche, however like many Chinese companies their future growth prospects will be determined by how quickly they come up against the state owned companies. In their case if CCTV and other state owned TV stations feel that Focus Media are taking too many advertising dollars away from them then they will find a way to hit back, most likely through regulatory means.

In the same Seeking Alpha article (scroll down), the China Market Research Group reports:

Focus Media will have a tough time sustaining its high valuation. Right now MNCs are dying to get eye balls from Chinese consumers. With the lack of efficient channels to advertise in China, Focus Media has taken advantage of this and has provided a way for MNCs to get information out. However, the efficacy of the commericals are in doubt which questions the long-term viability of the business model.

Then, there's Motley Fool's take:

With the very low barriers to entry (namely the cost of the LCD screens), and the lack of exclusive contracts in the space, Focus Media could end up in the dumpster in a hurry. For example, Inside Value pick Wal-Mart (NYSE: WMT) and Carrefour both have substantial operations in China, and both are taking different approaches. Wal-Mart is relying on the experience they have on operating their own in the U.S, and Carrefour is using CGEN, another Chinese competitor. Investors would do well to keep this in mind, since the growth expectations embedded in the stock price, well, might just be too optimistic.

And then there are folks who are more positive on the stock. Some of these folks have very good reasons for being bullish, including Focus Media’s recent acquisitions that help them expand the scope of their business and enter wireless advertising as well as non-electronic advertising:

According to Piper Jaffray:

Price Target and Valuation. We are increasing our price target from $63 to $71, maintaining our previous multiple of 40x ‘07 PF EPS. The 40x multiple remains less than the Focus Media’s ‘07 PF EPS growth rate of 43%, and we believe our estimates remain conservative. We believe a 40x multiple is warranted given Focus Media’s growth rate and its insulation from the volatility inherent in most Chinese Internet and wireless companies. The relative stability of Focus Media and its insulation from regulatory and competitive volatility, we believe, will command a high premium from investors compared to other Chinese names. We also note that U.S. comparable companies with similar growth rates trade at 40x-50x multiples.

Finally, there's the China, Tech, and Business Blog (towards the bottom of the page):

- Finding growth - Growth in the nascent mobile ad segment is likely to outpace growth in the in-building A/V advertising, where Focus already has 90%+ coverage of major targeted Tier 1 buildings.

What’s next for Focus? Its hard to say but I’d expect Focus to maintain its aggressiveness. With few well capitalized players in the outdoor media industry, its probably a good time for Focus to go decidedly low-tech and enter billboards - in the same way Google has experimented with print advertising in the US.

In spite of FMCN’s new businesses, I believe their valuation doesn’t nearly justify the company’s financials and growth profile. It will be awhile before the company can successfully get into these new lines of business and add both topline and bottom line growth. I’ll be looking for a good short entry point if the stock climbs back nearer to the $70 level.

FMCN 1-yr chart:

FMCN 1 yr