China MediaExpress: China's Hidden Gem, Part 1

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 |  Includes: AMCN, CCME, FMCN, SINA, SOHU, VISN
by: Chimin Sang

Click to enlargeChina MediaExpress’s (OTCPK:CCME) business has a wide moat and untapped pricing power but its stock is currently priced less than half of its closest peers' stocks, providing a significant margin of safety.

It will announce earnings report for 2010 Q1 Friday morning, which it already pre-announced a couple of days ago. I expect that instead the typical 'sell on news,' this stock will go up on old news since it is very undervalued and under-recognized now.

New Media as the Secular Trend

China MediaExpress falls into a sector that I am most familiar with: the New Media in China. In the past, I have followed quite a few stocks in this sector, such as Sina (NASDAQ:SINA), Sohu (NASDAQ:SOHU), Focus Media (NASDAQ:FMCN), AirMedia (NASDAQ:AMCN) and VisionChina (NASDAQ:VISN), and invested in several.

The New Media is a very attractive sector for several reasons. First, it is a natural monopoly/oligopoly business. Once a media company dominates a particular type of media channel, the same channel can hardly survive a second competitor. Second, the old media -- newspaper, magazine, radio and TV -- is on a secular down trend. The emergence of Internet has permanently changed the world we live in. People now can now pick and choose the media they read, watch or listen. Advertisement industry, accordingly, is adapting to this secular trend. Businesses allocate more budgets to Internet and outdoor media, where China MediaExpress has a strong position.

Hereafter I will mention China MediaExpress by CME and its stock ticker by CCME.

CME’s Business Is Incredibly Lucrative

CME’s business model is to have on-bus LCDs to show travelers a combination of entertainment program and commercials on long distance express buses in China. Their revenue comes from advertising spend, either indirectly from advertising agencies or directly from end companies. Their cost is mainly on the leases they sign with the bus operators. The high fixed cost in its cost structure provides high operating leverage to the company.

Before CME listed on AMEX, three China outdoor media companies listed on Nasdaq. They are: Focus Media, AirMedia and VisionChina. Focus Media started this business sector by placing commercial-playing LCDs in front of elevators in commercial buildings. It became hugely successful and continued its success by acquiring other media companies before mired in the troubles caused by its reckless expansion.

AirMedia differentiated itself by focusing on the media in airport and on airplane, but it almost has never made money for its investors due to its inefficient cost structure. VisionChina runs TV programs and commercials on city buses, and it followed Focus Media’s example to expand by acquisitions, and that practice soon proved unwise.

CME, by comparison, is a much better run business. The company’s inter-city express bus LCD business does not overlap with any of the public companies mentioned above (reminder: FMCN – indoor LCD business, AMCN – Airport commercials, VISN – City bus LCD), and it is the dominant firm in the niche market it occupies by controlling about 50% of it.

All the other players in the niche market have inferior routes and are much smaller in size. The company has been growing by the organic way only and is thus free from the acquisition problems Focus Media and VisionChina messed up, and its income statement shows that it is very profitable, unlike AirMedia.

CME has been quite lucky, or smart, in its early development. It has done several things right in retrospect. First, it entered a market without too much competition and signed long term contracts with the bus operators. Second, it expanded with organic growth, instead of acquisitions. Third, its media channel is more effective than companies like Focus Media and VisionChina. The audience is committed to stay with the media for the whole long-distance journey.

As the following financials reveal, CME runs an incredibly lucrative business. It has fast growing revenue, expanding margins, low capex and fast growing free cash flow. Its ROE for 2009 was a jaw-dropping 87%. Such an ROE is almost impossible in other industries, but CME monopolized its niche market.

USD (million)

2009

2008

2007

2006

Revenue

96

63

26

4

COGS

33

25

13

2

Gross Profit

63

38

13

3

Selling

4

1

1

0

G&A

3

2

1

1

Op Profit

57

35

11

2

Net Income

42

26

7

1

Gross Margin

65.63%

60.16%

49.22%

62.50%

Op Margin

58.96%

55.71%

42.64%

40.00%

Net Margin

43.44%

41.75%

27.13%

22.50%

Depreciation

3

3

2

0

Investment

2

4

7

1

FCF

43

25

2

1

Cash

57

30

6

2

AR

13

6

3

0

PP&E

11

11

9

3

Assets

83

49

19

5

ST debt

0

0

0

0

AP

2

2

1

0

Equity

48

35

8

2

ROE

87.42%

75.14%

92.11%

56.25%

Click to enlarge

CME’s Reverse Merger Into TM Under Microscope

Before we go on to the valuation of CME, I would like to have my readers understand its public listing history, which is essential to know in order to understand the gap between its intrinsic value and its current price.

CME got listed on AMEX after it reversely merged into a Blank Check Company, TM.

I strongly recommend that you read the details here.

In my version of summarization, it goes like the following:

TM went IPO on October 17, 2007, raising net proceeds of $79 million. They issued 10.255m units (each unit include one common share and one warrant executable at $5.5/share) to the public. The management issued themselves 2.25m shares and 2.1m non-callable warrants executable at $5.5 on a cashless basis. In case of failing to find a target to merge, TM would use all the cash to reimburse external investors and the shares of the management would become worthless.

During the following years, TM was searching for targets using Pali Capital as the advisor. TM described in its SEC filing four unfruitful attempts it made on different targets before landing on CME. In November 2008, TM started to negotiate with CME for a merge. Previous to that, CME prepared an F-1 filing for public offering in the US market but decided not to file due to the poor market situation.

During the negotiation, CME offered the following historical financials and projections.

(in million USD)

2006

2007

2008

2009E

2010E

2011E

Net Sales

4.0

25.8

63.0

104.2

196.6

305.5

Gross Profit

2.5

12.7

37.9

71.5

140.9

219.5

EBITDA

2.0

12.6

38.0

65.5

128.5

197.8

Pre-Tax Income

1.6

11.0

35.2

60.2

119.4

186.1

Net Income

0.9

7.0

26.4

42.1

83.6

130.3

Click to enlarge

Based on the proposed valuation of CME and share prices in April 2009, the following comparable table was what negotiating parties used for valuation. It is worth noticing that Focus Media, the China outdoor media flagship company, was not included in this comparable table because it was having internal problems and writing off assets so that its data were not reliable.

EV/Revenue

EV/EBITDA

P/E

2008

2009E

2010E

2008

2009E

2010E

2008

2009E

2010E

VisionChina Media (VISN)

2.2

1.6

1.3

5

3.5

2.8

8.4

7.7

6.2

AirMedia (AMCN)

1.5

1.1

0.9

5.3

6.3

3.2

11.7

15.1

8.8

Baidu (NASDAQ:BIDU)

14.2

11.4

8.4

31.2

25.4

18.8

42.8

36.5

27.5

Sohu (SOHU)

3.4

2.9

2.5

8.1

6.8

5.9

11.5

10.8

9.8

Sina (SINA)

2.6

2.5

1.7

11.3

8.1

5.7

15.6

18

14

TM/CME

2.8

1.7

0.9

4.6

2.7

1.5

9.8

6.3

3.9

Click to enlarge

An earlier comparable table used in December 08, which includes Focus Media, is quoted here:

P/E

2008E

2009E

2010E

VisionChina Media (VISN)

8.3

6.5

5.3

AirMedia (AMCN)

11.7

8.7

7.1

Focus Media (FMCN)

5.1

4.7

3.7

TM/CME

8.2

4.5

2.5

Click to enlarge

On October 15, 2009, shareholders of both companies approved the deal and the merge took effect. TM paid 20.915 m shares and $10m cash, at the initial valuation of $178m. If CME management may earn up to 15 million more shares if they achieve certain benchmarks. When TM warrants get converted, CME can also get $20.9 million cash from it, thus valuing CME at a maximum of $319m, assuming TM stock price of $8.

At the time of merge, TM also offered its existing shareholders an option to convert their shares to cash. The majority took the offer. 9.6 million out of 10.255 million outstanding public shares converted to $7.91 per share, taking down $76m from the balance sheet. This is very typical for Blank Check company investors as they can now reduce their exposure to the acquired company by redeeming the original outlaid capital and keeping the upside with warrants.

On December 8, 2009, the merged firm upgraded its auditor to Deloitte.

On December 29, 2009, the call option on the warrants was triggered because the stock price stayed above $11.50 for 20 trading days in the last 30. When the redemption was consummated on January 29, 2010, nearly all warrants were converted. $47m was received and $20.9 was paid out to the original CME owners according to previous agreement. Before the warrant triggering, the company managed to redeem 1.9 million at 50 cents each, reducing the share dilution.

On January 12, 2010, the company had Starr International, whose ultimate owner is Hank Greenberg, the legendary CEO who reigned AIG (NYSE:AIG) for almost 40 years, to invest $30m in the business to exchange 1m preferred shares, which is convertible to 3m common shares, and 1.5m warrants executable at $6.47.

Since the majority of TM shareholders chose to sell back the shares but to keep the warrants, TM used all of its cash for the conversion, leaving no cash to CME. In order to make the benchmark that is hinged on net income, not EPS, CME raised fund from Starr International for potential future acquisitions, effectively selling shares at $8.8/share. This transaction is dilutive to the existing equity holders, but on the other hand, Hank Greenberg’s reputation helped endorsing CME, supporting the business in the long run.

And here is a complete count of major capital structure changes.

  1. TM started with 12,505 m share, 10.255 m callable warrants executable at $5.5, 2.1 m non-callable warrants executable at $5.5, which is convertible on a cashless basis.

  2. TM issued to original CME share holders 20.915 m shares, $10m cash, and $20.9 million extra cash from warrants redemption.

  3. TM issued to the finder 0.1m share.

  4. TM issued to Pali Capital 0.33 m share and .33 m warrants.

  5. TM redeemed 9.6 million shares with $76 million cash.

  6. CME, after reverse merge, issued convertible shares equivalent to 3m shares and 1.5m warrants to Starr International for $40m consideration.

  7. CME redeemed 1.9m warrants at 50 cents each.

  8. CME converted 8.08m warrants, collecting $47m and paying out $20.9m to the original CME owners.

  9. CME issued 1m shares to the original CME owners for making the 2009 net income targets.

  10. If CME makes 83.5m net income in 2010, the original owner will get 7m more shares. If CME makes 130.2m net income in 2011, the original owner will get another 7m more shares.

As of the end of the first quarter 2010, the share count is 36.9m, with contingent 14m pending on operation in 2010 and 2011. Outstanding warrant count is 3.6m, 2.1m belong to the original TM owners and 1.5m belong to Starr International. Total diluted share count is 40.5m, combing the above two items. The company has over $110m cash in hand and its equity after all the transactions is about $102m, roughly $3 book value per share.

Disclosure: Author long CCME

>> Continue to Part 2

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