Bona Film Group Limited (BONA), a leading movie production and distribution company in China, is the best way to play China's surging box office potential from the US market. The company which is overlooked and undervalued, could deliver a rally of over 30% during the rest of 2013.
The investment thesis is explained below:
1) Favorable industry fundamentals in China
China became the world's second largest movie market ($2.7 billion) in 2012 and is expected to grow at 22% between 2012 and 2016. E&Y projected that China will take over the US as the world's largest movie market by 2020. 2013 will set another new record as the total box office in China already reached RMB 11 billion Yuan (approximately $1.7 billion) during the first six months. More importantly, 62% of the box office was contributed by the locally produced films while only 37% was from imported Hollywood blockbusters, down from 52% in 2012.
2) The only direct play of China movie market for the US investors
As a leading player, Bona is well positioned to benefit from the above mentioned favorable industry fundamentals in China. And it is the only pure play available in the US as all of its major competitors are listed in China. More importantly, its "scarcity" value is fully supported by its competitive advantages:
a) Bona's vertically integrated business model covers the full value chain, including film production, film distribution, film exhibition, and talent management which diversifies the sources of cash flow and mitigates the concentration risk of relying overly on just production and distribution.
b) Bona is the largest non government owned film distributor in China with close to 20% market share. It also enjoys solid brand recognition due to its track record of commercially successful movie productions.
c) News Corp. (NWS) owns 20% of the company which brings in both overseas distribution and domestic co-production opportunities to Bona, an unique strategic edge over its competitors.
3) Good news lost in translation
Bona's Chinese website provides more information than its English one, particularly this press release titled "Shining Stars at Bona Night" which does not appear on its English site at all. Thanks to Google Translate, this press release actually features several important favorable data points that should have moved the stock higher. The highlights are as follows:
a) Bona and Noah, a US listed leading wealth management advisory firm in China (NOAH), are launching the first ever slate financing fund with a target size of RMB1 billion (around $158 million) to finance Bona's new movies over the next two years.
b) Bona has a strong release lineup with 8 movies between August and February 2014, including distribution of two Hollywood blockbusters: Red 2 and The Mortal Instruments: City of Bones. Its production pipeline during 2H 2013 and 2014 is also revealed with a slate of 10 movies.
c) Bona will open 8 more cinemas by the end of 2013 with a target of 40 cinemas under management by 2014.
4) Attractive risk and reward profile
With its stock price down 12.3% as of July 19th, Bona has significantly underperformed both its domestic and US peers so far in 2013. Bona's direct competitors in China include Hua Yi Brothers, Enlight Media and Leshi, all of which are listed on China A share market (see Table 1 below). Given the above mentioned positive industry dynamics, each of the three scored more than 100% YTD return, despite the overall dismal performance of China A shares (down 12% YTD), one of the worst in the world.
Comps in China
Hua Yi Brothers Media Corp
Beijing Enlight Media Co. Ltd
LESHI INTERNET INFO. & TECH. CORP
China A Share （Shanghai Stock Exchange Composite Index）
*YTD as of July 19th 2013
**Return as of June 4th 2013 when Hua Yi trading was suspended due to pending acquisition.
Due to Bona's small market cap, it is more reasonable to compare it with Lions Gate (LGF), DreamWorks Animation (DWA) and IMAX (IMAX), than to the big caps such as Twenty-First Century Fox (FOXA), Disney (DIS), Viacom (VIAB) or Time Warner (TWX). Bona's US peers also delivered impressive returns together with the overall positive momentum in the US.
Comps in the US
*YTD as of July 19th 2013
Bona's underperformance could be attributed to three reasons:
1) Negative sentiment toward US listed Chinese stocks. US listed Chinese stocks had lost their appeal after a series of frauds were revealed by some shortsellers over the past two years. More recently, the growing economic hard-landing concerns added further pressure on the group. Companies with strong fundamentals such as Bona have unfortunately been painted with the same negative brush.
2) Small market cap. Bona's current market cap is relatively small, technically outside the comfort zone for many of the institutional investors even if they like Bona's fundamentals.
3) Lack of effective communications. Bona could have done a better job explaining its movie pipeline, slate financing initiatives and box office dynamics in China. If this communication gap becomes a permanent hurdle on valuation, Bona should seriously consider going private and relist itself in Hong Kong or China with much higher trading multiples.
The underperformance provides a great entry point for the stock. Bona currently has a market cap of $249 million with a forward P/E ratio of 19x as per Seeking Alpha data. Since its comps in China and the US are traded around 30-35x forward P/E, Bona's target trading range could be between 25-30x P/E to take into account the discount factors such as small market cap and communications gap. This valuation would suggest a 30%-58% upside from the current level.
This upside is expected to play out over the next 6-9 months with several near term catalysts:
1) The immediate one is its quarterly earnings release on August 19th, in which management should discuss about second quarter results and elaborate on Bona's outlook for the second half of 2013.
2) The second "transcript" should be about the summer movie season - Bona will release two movies in August and two in September, including Red 2 and The Mortal Instruments. Its cinema business should also be a big beneficiary of the summer season.
3) The third catalyst will be Bona's third quarter earnings release in November.
The key challenge of being long this stock is that it is hard for US investors to assess the market potential of Bona's locally produced films due to cultural and language barriers. However, as mentioned early in the writeup, if communications gap with the US investors becomes a permanent drag on valuation, Bona should take itself private as many US listed Chinese companies have done already, which obviously provides valuation floor for Bona.
Bona is a leading film distributor in China, with an integrated business model encompassing film distribution, production, exhibition and talent representation. Bona distributes films to Greater China, Korea, Southeast Asia, the United States and Europe, invests in and produces movies in a variety of genres, owns and operates twenty movie theaters and manages a range of talented and popular Chinese artists.
Bona distributes self-produced films through nearly all of the theater circuits in China, while joint distribution agreements with state-owned China Film Group Corporation further expand the Company's film portfolio. Bona has also expanded into non-theatrical distribution channels, including home video products, digital distribution and television. Bona is the largest non government owned movie distributor in China with around 20% market share.