Following comprehensive analysis of public information and extensive on-the-ground due diligence, our research team concludes in our full length report (here) that China Mass Media (NYSE:CMM) is a stock to avoid for the time being.
China Mass Media is essentially a middle man, buying advertising space from China Central Television (CCTV) and selling it to clients including Samsung (OTC:SSNLF), McDonald’s (NYSE:MCD) and China Mobile (NYSE:CHL). The company’s success – indeed its very existence – derives largely from the personal contacts of CEO Wang Shengchang, who was previously employed at CCTV.
China Mass Media generates more than 90% of its revenue from the sale of TV advertising time slots (here); the remainder comes from producing programs, for example, public service announcements that are broadcast on CCTV. Revenue peaks when CCTV airs large events such as its Chinese New Year Gala, the FIFA World Cup, and the Olympic Games. However, since these events are infrequent, China Mass Media must find ways to maintain a steady stream of revenues in the cyclical gaps.
In the past few years, the company’s net income has dropped off sharply. Meanwhile, competitors SinoMedia Holdings (0623.HK) [no relation to China Economic Review’s publisher] and Charm Communications (NASDAQ:CHRM) posted fairly steady growth in net income since 2007 – excluding a downturn in 2009 as a result of the global financial crisis.
The cause of China Mass Media’s dwindling profits is its over-dependence on CCTV, which has been systematizing some of its ad business.
From 2008, CCTV started selling China Mass Media ad slots in blocks at a fixed rate, rather than based on client demand. China Mass Media began recording the purchase of these slots as a cost of revenue – previously it didn’t do this because clients had already committed to buying ad slots when China Mass Media commenced negotiations with CCTV – and so profit has plunged.
In 2009, CCTV switched to an auction-based sales system that left its former favorite China Mass Media scrambling to compete. A year later, China Mass Media was outbid for the 2010 New Year Gala program, the country’s most-viewed program, for which it had been the exclusive ad agency from 2004 to 2009. This single contract had previously accounted for almost 10% of the company’s annual revenue (here).
China Mass Media has also seen an increase in prices for ad slots – in 2009, the media fees for CCTV4 programs rose by over 40% (here). However, intense competition among agencies means it is unable to pass on all of these costs to clients.
The combination of the auction loss and price hike contributed to China Mass Media’s year-on-year profit margin falling from 34.2% to 25.1% for the fourth quarter of 2010 (here).
Obviously, some of these challenges affect all industry participants, so how come SinoMedia Holdings and Charm Communications have been able to maintain profit growth while China Mass Media has not?
One major factor is China Mass Media’s failure to diversify its business. Charm Communications has gained footholds into satellite TV, and internet and outdoor advertising, while SinoMedia Holdings recently announced an agreement to sell ad space for MediaCorp, Singapore’s largest media company.
Consolidation and diversification should therefore be high on China Mass Media’s agenda and it’s not like the company can’t afford to act – it currently holds just over US$100 million in cash and short-term investments, with little or no debt.
But China Mass Media seems unable to execute sensible and successful deals. In October 2010, it announced a tie-up with outdoor media company Goto Media. However, Paul Liang, China Mass Media’s financial controller, acknowledged that this was an intangible arrangement with no financial basis. He also admitted that it was unlikely to generate significant revenue and that television advertising was likely to remain the primary source of income for China Mass Media in the foreseeable future.
China Mass Media did attempt to acquire more advertising time slots from CCTV, but its efforts ultimately proved fruitless. There are two reasons for this. First, CCTV-Español and CCTV-Français – from which the company pre-purchased blocks of time slots in 2008 – are much less popular than CCTV1 and CCTV2. Second, the two channels are not broadcast within China and therefore less attractive to advertisers keen on reaching the mainland market. The following table summarizes China MassMedia's purchase and sale advertising time slots.
Announcing its 2010 fourth quarter results on March 14, management indicated that it was looking to expand business beyond television advertising. Adjustments have been made to existing operations and a content production venture was mooted as a means of boosting revenues. Wang, the CEO, has also stated this year that China Mass Media has begun to move towards the production of film and TV programs. The extent of the company’s involvement remains unclear.
If China Mass Media does indeed manage to expand its operations, it may be able to recover financially. For the moment, though, it remains dependent on its relationship with CCTV – a high-risk strategy given rising costs and competition I the light of changes in the broadcaster’s approach to advertising.
In this sense, 2011 could be a make-or-break year for China Mass Media. Until management offers more insight into its commitment to diversification and offers concrete plans to boost revenues, this stock is one to avoid. A full length analysis is available here.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.