Focus Media: Will Massive Accounts Receivable Lead to a Future Write-Down?

Focus Media (FMCN), the People's Republic of China 's [PRC] largest digital media company, posted Q208 revenues of $211.7M, up 106.8% from the same period in 2007 and net income of $36M down slightly from 2007 due to acquisition related charges. In addition to the robust revenue and net income results, the company reported a healthy net cash position of nearly $362M at the end of the quarter.

With results like these, and a future that seems as bright as one of those digital billboards on a Beijing skyscraper, one would expect the company to be trading at or near its projected 2008 revenue growth rate. So why is the company trading at a significant discount?

A review of the company's financials quickly reveals the reasons.

First, while revenue was up nearly 107% for the quarter, an unspecified amount of the gain can be attributed to the various acquisitions the company has made over the past year. In addition, revenue growth declined from 214.7% in Q108 and is projected to decline further to around 60% in Q3. Without another acquisition this year, the company will loose the acquisition "turbo boost" next year, likely leading to further declines in the rate of revenue growth.

While the decline in revenue growth is a concern for many momentum stock investors, it's an inevitable occurrence that eventually happens to all great companies. The item of most concern to this investor is the company's disproportionately large accounts receivable [AR] balance.

At the end of Q2, Focus Media's AR balance was $321M, equal to approximately 152% of the company's reported revenue for the quarter. Management attributed the unusually high AR balance to their online advertising business which they claim has longer payment terms than their other business units.

With this in mind, I did some research to see how FMCN compared to other online related advertising companies in both the US and the PRC.

As the results listed in the table below illustrate, a review of (6) online advertising related firms had an average AR to revenue ratio of 51.3% for their most recently reported quarter, with SINA (SINA) being the highest at 82.2% and Baidu.com (BIDU) the lowest at just 10.3%.

At 151.8%, Focus Media's current AR to revenue ratio is more than three times the average of these companies and is nearly twice that of SINA, the company with the next highest AR to revenue ratio on the list.

click to enlarge

Based on the fact the company was still in the midst of fully integrating their various acquisitions, I gave the management the benefit of the doubt regarding the AR situation in Q1, however I expected a significant reduction in the AR balance in Q2. Anticipating a reduction in the range of $60 to $70M, which would have put the balance in a more acceptable range, instead the balance ballooned by some $60M to $321M.

This is quite concerning, and makes one ponder if the company will be forced to write down a portion of the balance in future quarters. I believe at some point, the company will no longer be able to "kick this can down the road" and will have to do so. As a shareholder, you just don't want to be long the stock when this happens.

In spite of the AR issue, the company's decelerating revenue growth rate and a worldwide bear market, many analysts still maintain lofty price targets well above $50 for FMCN shares. While I believe the shares could eventually get back on a growth track to $40 and beyond, I just don't see the price rising above the low thirties, until overall market conditions improve and the company's AR matter is fully resolved.

Since the Q2 earnings announcement, shares have risen over 15%, in spite of the overall markets being down by several percentage points. I look for shares to top out in the low thirties and trade back down to the mid to high twenties over the next few weeks.

Disclosure: Author currently has no equity position in shares of Focus Media, but has held long positions in the past.

Comments

[glassbox:]

Wouldn't it be more useful to look at AR in days over the last 8 quarters rather than AR/Revenue?

2008 Aug 22 11:50 AM

[Upperman33:]

"Based on the fact the company was still in the midst of fully integrating their various acquisitions, I gave the management the benefit of the doubt regarding the AR situation in Q1, however I expected a significant reduction in the AR balance in Q2. Anticipating a reduction in the range of $60 to $70M, which would have put the balance in a more acceptable range, instead the balance ballooned by some $60M to $321M."

Focus is still in the process of integretating the CGEN acquisition, which is party responsible for the high A/R. They said there would be a "significant reduction" of the A/R this quarter. I believe there will be a lot of improvement in this area next quarter because it seems like management is hitting on all cylinders.

We will wait and see.

2008 Aug 22 12:38 PM

[anonemouse:]

% AR to revenue for previous quarters:
Q1/08 158%
Q4/07 114%
Q3/07 111%
Q2/07 110%
Q1/07 162%

As glassbox said you should be comparing Q to Q. I think its something to definitely keep an eye on but no immediate need to panic based on comparison to peers.

2008 Aug 22 01:35 PM

[David Wolf:]

The other factor that bears examining when comparing AR numbers among FMCN and its peers is the nature of FMCN's client portfolio. As a rule, large Chinese enterprises tend to pay advertising and other marketing fees somewhat more slowly and less systematically than their MNC peers.

If FMCN's clientele are skewed heavily toward the domestic side, average AR aging will be considerably longer than peer companies whose customers are primarily MNCs. That is not something they're likely to be talking about, so it would be a good question for their next conference call.

2008 Aug 24 10:05 PM