Focus Media and NetEase: Two Attractive Trading Opportunities

Includes: FMCN, NTES
by: Xiaofan Zhang

Focus Media (NASDAQ:FMCN) and NetEase (NASDAQ:NTES) are two of the best-performing stocks in the Chinese Internet and New Media sector year-to-date. My research suggests these two stocks are now attractive trading opportunities: Focus Media represents a buying opportunity, while NetEase represents a shorting opportunity.

Focus Media's turnaround story has not been fully recognized by the market. With the Chinese advertising market continuing its recovery and Focus Media increasingly refocusing on its core businesses, I forecast Focus Media will grow non-GAAP EPS by 54%-62% year-over-year to $1.05-$1.10 in 2010. According to my calculations, currently investors on average are estimating around 30% Y/Y EPS growth in 2010, much lower than my forecast range. I believe the market's conservative stance on Focus Media is due to the uncertainty regarding whether the U.S. economy is heading toward a double-dip recession, which could have a negative ripple effect on global economic growth and advertising spending. In my opinion, even in the worst-case "double-dip" scenario, Focus Media is still a turnaround story mainly because of the steps it has taken to refocus on its core businesses (Commercial, In-Store, Poster Frame networks). I believe the market will eventually become more optimistic and raise its 2010 EPS growth estimate to at least 55% for Focus Media, which implies significant upside to current stock price.

Most of NetEase's positive outlook has been priced into the stock. With the launch of World of Warcraft's "Wrath of the Lich King" expansion pack, I believe NetEase's earnings will receive a significant boost and its non-GAAP EPS will grow 10%-15% Y/Y to $2.30-$2.40 in 2010. According to my calculations, currently investors on average are estimating around 11% Y/Y EPS growth in 2010, in line with my forecast range. I thus believe almost all the positives that are based on current public information have already been built into NetEase's current share price. I attribute this situation to Activision Blizzard's excellent track record of launching content-rich expansion packs to push World of Warcraft's usage to higher levels. Facing a slowing-down Chinese online game market filled with uncertainty regarding new games' performance, investors have found certainty in NetEase shares, knowing that "Wrath of the Lich King" should do well in China because it has been very successful across the world, and the previous expansion pack "The Burning Crusade" was a big hit in China. However, I believe recent weakness of several other games including hit title Tian Xia II has not been fully reflected in the stock price partly due to NetEase's investor relations policy of not commenting on individual games' usage and revenue trends. In my view, currently NetEase shares' upside is limited due to investors' high expectations, and a short-term correction may happen after investors become fully aware of the weakness in several other games.

Disclosure: My virtual investment portfolio has long positions in FMCN and BIDU, and a short position in NTES