By Mike McDermott
It’s a good time to be a growing media company in China… Or more accurately, it’s a good time to be an investment banker with Chinese media companies as clients.
Over the past two weeks, there have been four significant Chinese media IPOs listed on US exchanges. Two of them are off to an incredible start. The other two look like complete duds from the moment they began trading.
The Chinese media and entertainment industry is at an interesting juncture. On the bullish side of the argument, there is an incredible ongoing population shift in which many rural citizens are moving to large cities to find work and a better life. As the standard of living increases for the country as a whole, demand for information and entertainment will likely continue to grow.
While the population trends are largely bullish for this industry, we have been largely bearish on China securities as the country grapples with widespread inflation and potentially overheated growth dynamics. If China’s economic growth begins to stall, it will have an effect on the entire global economy. We’re already seeing cracks in bullish trends which have previously been inspired by China domestic growth.
So with this turbulent background, let’s take a look at the newest IPOs and begin to develop a trading plan for opportunities that may arise…
- Youku.com Inc. (YOKU)
Youku.com is the market leader when it comes to Chinese internet video. You could consider this company the “Netflix (NFLX) of China” as the company is in the same industry – and also enjoys a tremendous growth trajectory. By September of this year, Youku has grown its traffic to an estimated 203 million unique visitors per month and traffic continues to increase.
The company has built a substantial library of content with 2,200 movies, 1,250 Television titles, and about 231,000 hours of “professionally produced” video content. Of course, the company is limited in what content can be distributed because of Chinese censorship laws, but the heavy traffic shows that Youku content is at least competitive and appealing to viewers.
While Netflix receives most of its revenue from subscription fees, Youku currently generates the majority of its revenue through advertising. The company currently has about 340 advertising relationships (up from 230 last year) and has seen revenues increase steadily over the last several quarters.
Management has noted the goal of “diversifying revenue streams” which could imply that the company is considering moving towards the subscription model sometime soon. Since Youku is still operating at a loss, it is important for the company to find additional revenue streams to leverage its viewer-ship and begin to show shareholders a profit.
The YOKU IPO was peddled primarily by Goldman Sachs (GS) who (along with a couple of secondary underwriters) pulled down a cool $14.2 million for getting the deal done. The company itself received roughly $187 million which it intends to use to build out its infrastructure and potentially license new content.
Traders were very excited to get their hands on this China growth company. The deal originally priced at $12.80 per share, but by the close of the first day of trading, shares had reached $33.44. A stock that can generate a 161% return in the first day is certainly worth keeping on the radar from a trading perspective. The action is beginning to cool down a bit, and it would be healthy for YOKU to consolidate its gains a bit from here.
From an investing standpoint, I wouldn’t get anywhere close to owning YOKU. The company continues to post losses quarter after quarter, and with the premium price after the IPO, one has to look very far down the road to justify the price.
But from a trading perspective, YOKU looks very interesting. The stock is obviously white hot right now and will likely cool its heels. But if we begin to see an optimistic attitude for Emerging Market media stocks in the next few weeks, YOKU will likely be one of the “go-to” names for institutional investors.
Since there are only a limited number of shares available (and demand could be robust) nimble traders could pick up shares after a consolidation with a tight stop and a clear path for speculative gains.
Oh, and once the quiet period is over you can bet your last dollar that GS will issue a positive research report. There’s a good chance they recommend this stock to all of their buddies as well – part of the new issue politics on Wall Street.
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- E-Commerce China Dangdang Inc. (DANG)
If YOKU is the “Netflix of China,” then you could consider Dangdang to be the Amazon.com (AMZN) equivalent…
The company has its roots as the largest book retailer in China (primarily an online business) and boasts of an active customer base near 6 million people. Similar to Amazon, Dangdang has expanded its product offering to include a wide array of consumer-related items, and is seeing revenue trends move sharply higher.
In 2009, the company realized revenue of $217.9 million. So far 2010 has shown tremendous growth with revenue (just through the third quarter) hitting $324.8 million. For the first three quarters, this represents a 55.6% year-over-year gain and investors will be actively awaiting holiday sales figures.
The IPO transaction was jointly managed by Credit Suisse (CS) and Morgan Stanley (MS), and shares were priced at $16.00. The company received about $197 million after underwriting discounts and expects to use the capital for growth opportunities. I usually get a bit nervous when a company issues shares and essentially gives itself a blank check to “pursue growth opportunities.”
Similar to YOKU, Dangdang doesn’t look like a great investment. The stock immediately shot up to $29.91 in its first day of trading – good for an 87% return. The company is turning a small profit, but there are still so many uncertainties when it comes to long-term growth. Investors are paying a premium price to own this E-commerce company, and if China’s economic struggles hit the consumer hard – future growth could be severely crimped.
With that said, there is a lot of optimism surrounding this stock, and it will be an excellent trading vehicle for periods where the LOLO (long-only-leveraged-outright) managers decide to bid up China assets.
The stock has begun consolidating its tremendous first week of trading, and may very well slide for a few weeks. I’ll be keeping my eye on the pattern – and on general China sentiment. If and when we get a relief rally, DANG could be a great counterbalance position to our largely bearish China exposure.
- Bona Film Group Ltd. (BONA)
The BONA IPO has turned out to be a major disappointment. Shares were jointly issued by Merrill Lynch (aka - Bank of America (BAC)) and JP Morgan Chase (JPM). With these two underwriters, I would not be surprised if the majority of shares were placed with retail holders…
Imagine getting a call from your friendly neighborhood broker telling you he has a few hundred shares of a hot Chinese IPO!
The stock priced at $8.50 and never saw the light of day. By the close of the first day of trading the shares had dropped to $6.60 (I’m pretty sure that’s an unlucky Chinese number) and IPO buyers were trapped.
Bona is the largest privately owned film distributor in China which really doesn’t mean much in an industry that is dominated by government-sponsored media companies. The company gets a large portion of its revenue from a small number of “hit” movie titles each year – and of course there is no guarantee that the company will continue to luck out and have the rights to blockbuster movies.
Management plans to use the $89.3 million raised in the transaction for future acquisitions. These could be business acquisitions (think movie-theater chains) as well as content acquisitions. Given the competition with government distributors, and the censorship issues in China – I’m leery of this business model despite the profitability. It appears traders are largely in agreement here as the stock price has shown little evidence of support.
There’s no guarantee that we will have an opportunity to trade BONA – but I’m watching for two things to occur here:
- Volume Must Remain Robust: There’s nothing worse than getting trapped in an illiquid position (long or short). BONA could continue to be actively traded, but busted IPOs also have a habit of becoming illiquid after the first few weeks. My minimum threshold is about $1 million in daily dollar volume (share volume times price) but for a new stock like this I would like to see a good bit more.
- Underwriter Support: If BAC and JPM put their heads together and try to beef up the stock price, it will make for a better trading environment. Now just to note, I’m not proposing we trade WITH these guys, but rather wait for them to support it and THEN roll out our short positions.
Shorting BONA closer to the $8.50 IPO price would be a great risk/reward opportunity. We could use a stop a bit above the IPO price while understanding that the majority of trapped IPO buyers will use this opportunity to exit their positions. Shorting between $8.00 and $8.50 with the expectation of a crater could set us up to capture a swift 20% profit with tight risk controls.
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- SKY-Mobi Ltd. (MOBI)
Similar to BONA, the Sky-Mobi deal was busted from the minute it started trading. The company operates the largest mobile application store in China – allowing users to purchase and download applications such as handheld games and productivity apps.
The overall business is exciting. After all, China’s population growth and increasing standard of living means a tsunami of new potential customers are coming online. But similar to the dot-com days of the United States, investors appear to be “paying for eyeballs” in what is currently a loss-leading business.
Sky-Mobi will receive about $42 million from the IPO transaction of which $20 million will be used to expand and improve its online store, $5 million will be used for marketing, and the rest for “general corporate purposes” – again, you gotta love the blank-check concept…
The company’s revenues continue to grow – giving investors some hope of eventually cashing in on some profits. But MOBI continues to report losses with pro-forma EPS losses of $0.30 cents each in the December '09 and March quarters, and a loss of $0.12 cents each in the two most recent quarters.
Shares were offered to IPO investors at $8.00 but never crossed above $7.00 per share in exchange trading. This is another instance where I am looking for:
- Volume to stay robust, and
- The underwriters to support the stock.
If that happens, MOBI could be another bearish China play – with a good bit of volatility, an attractive risk/reward trading environment, and substantial potential profits.
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Disclosure: This content is general information only, not to be taken as investment advice or invitation to buy or sell securities. As active traders, we may or may not have positions in securities mentioned. For full disclaimer click here