China Mediaexpress Holdin (PINK:CCME)

Global Hunter on CCME:

*Summary:** We are currently on a due diligence trip in China and as part of our ongoing work on CCME, we talked again to a number of advertisers and bus operators and observed CCME's buses during this trip. We also checked government certificates/documents and the ranking from China Advertising Association, which in 2009 ranked CCME #6 in China by outdoor advertising revenue. During the last seven months, we have done extensive due diligence on the company, including interviews with advertising customers, bus operators, regional managers and CTR, an independent market research firm. We have visited Starr International and talked to the company’s independent auditor, Deloitte. We feel comfortable with CCME’s business and continue to believe in CCME’s growth potential. We maintain our Buy rating and $26 price target. ***

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*Highlights*

*Interviews with advertisers and bus operators.* In the last few days, we talked to a number of CCME’s customers and bus operators. The advertiser customers we spoke to confirmed their 2010 revenues with CCME, and stated that they continued working with CCME in 2011. Among the customers, Shanghai Apollo, a company owned by Shanghai People’s Fine Arts Publishing House, a state-owned company with 50+ years history and strong industry relationships, confirmed that they bought approximately 7 minutes (~RMB50MM revenue) in 2010 and expect to buy similar amount of advertising time from CCME in 2011. These advertisers and bus operators confirmed that CCME is the only inter-city bus media company with a national coverage and quality services.

*Experiencing the bus rides.* We again rode on the company’s airport buses in different cities. The following videos in Guangzhou and Chengdu airports, which are similar to our experiences, we believe can give investors a feel of CCME’s operations. http://www.soku.com/search_video/q_CCME<.

*Checked government documents.* We checked with China Advertising Association (CAA), an official government agency that all advertising platforms in China must register with. In 2007, CAA ranked CCME’s operating entity Fujian Fenzhong Media #15 by total advertising revenue http://www.cnadtop.com/news/FHDT/2009/2/6/b98600ff-c4d3-4646-ab84-fe9a5764b33a.htm, and #6 by outdoor advertising revenue in 2009 http://www.cnadtop.com/news/vision/2010/8/2/578d5f78-6a1a-4ff3-aa7e-d6bf2fcd55d0_3.htm;. The company is also a Class I Advertising Enterprise; we checked the company’s certificate issued by CAA. We have also reviewed the company’s five-year contract with TTAVC, an agency under the Ministry of Transport, which granted CCME the rights to operate copy rights protected contents on inter-city buses in the country.

*Reviewed various contracts and other channel checks.* We have in the past few months reviewed the company’s list of customers and bus operators. We reviewed the company’s contracts with advertisers and bus operators, rate cards, and we have also reviewed the company’s bank statements. We talked to CTR, an independent market research firm, who monitors over 70% of the media companies in China. CTR is conducting a comprehensive research on CCME, which evaluates the company’s business model, market share, customer feedback, and media value. We expect CTR to issue such research within the next month. We also learned Deloitte has done its initial part of the annual audit, and will continue after the Chinese New Year holiday. We expect the company to issue audited annual report in early March.

*Maintain Buy.* During the last seven months, we have done extensive due diligence. We interviewed a number of advertising customers, bus operators, and the company’s regional managers. We also talked to CTR, the third-party market research firm, visited Starr International’s office in Shanghai and talked to the company’s independent auditor, Deloitte. We have taken CCME’s buses in different cities and checked its advertisements and programs. We have also looked at CCMEs contracts with customers and bus operators, and government certificates and documents. We feel comfortable with CCME’s business and continue to believe in its growth potential. We therefore maintain our Buy rating and $26 price target.

Global Hunter on CCME

China Media Express Holdings (Accumulate) CCME: Q3 beat. Shares exceed price target;

Lowering from Buy to Accumulate China MediaExpress (CCME) reported strong Q3 results that beat our/consensus estimates, driven by continued network expansion and favorable margin mix. The company generated strong operating cash flow and further strengthened its balance sheet with $170MM in net cash by quarter end. Management raised its FY10 net income guidance. We are increasing our FY10 and FY11 estimates. Shares are trading at 8x our FY11 EPS estimate, which we still consider as inexpensive. However, shares have rallied 180% from its bottom since September, and exceeded our previous price target of $21. We expect some profit taking after this substantial rally. We wait for further indication from management on the use of cash, including a potential dividend policy. We believe a dividend distribution would certainly help unlock the remaining value for shareholders and could serve as the next catalyst for the stock. However, given the appreciation in shares, we are lowering our rating from Buy to Accumulate while raising our 12-month price target from $21 to $24, representing 9x our updated FY11 EPS estimate.

Key Points:

Q3 beat. CCME reported Q3 revenue of $57.0MM, slightly ahead of our/consensus estimates of $55.6MM/$56MM. This represented 118% YoY growth and 6.4% QoQ increase, primarily driven by continued expansion in network coverage. Net income of $31.1MM or $0.81/share exceeded our estimate of $27.6MM or $0.76/share. The company generated strong operating cash flow of $31MM for Q3 and $69MM for the first three quarters. At the end of Q3, CCME had $170MM in cash and no debt, up from $139MM net cash at Q2 end.
 
Network expansion continued. The company increased the number of bus operators and number of buses from 59 and 22,775 at the end of Q2 to 63 and 24,400 at the end of Q3, respectively. The network now covers 18 regions in China. The company plans to add another 1,000-2,000 buses before year end. During Q3, CCME expanded its airport bus network to include Changsha and Chongqing airports in addition to the airports in Guangzhou, Fuzhou, Beijing, and Qingdao.
 
Gross margins maintained at high levels. Q3 gross margin was 76.8%, which was relatively stable from 78.7% in Q2 and compared to 67.0% in 3Q09. The YoY improvement was primarily due to increased contribution from its higher-margin airport bus segment, which contributed $15MM, or 26% of Q3 revenue, up from $13.1MM (or 24%) in Q2 and $7MM (or 16%) in Q1. In addition, increased contribution from embedded advertising and sales to direct advertisers which carry higher margins also contributed to margin improvement. Management expects gross margins to stay above 65% in the next 2-3 years as increasing concession costs are expected to be partially offset by ASP increases and the potential launch of new higher-margin services.
 
FY10 guidance raised. Management raised its FY10 net income guidance from the prior $82MM-$85MM to $100MM-$104MM, driven primarily by network expansion. The guidance indicated Q4 net income expectations of $22MM-$26MM. Although management expected additional expenses in Q4 related to new projects such as tour buses, and some marketing costs to promote the company's brand name, we view the new guidance as conservative because Q4 is typically a peak season for adversing business.
 
·         Raising estimates. For FY10, we are increasing revenue estimate slightly from $211MM to $213MM, net income from $100MM to $104MM, and EPS from $2.61 to $2.67. For FY11, we are increasing revenue from $288MM to $291MM (37% YoY), net income from $131MM to $133MM, and EPS from $2.65 to $2.69. We expect the growth during the next year to be driven by continued network expansion and higher ASP's. The company plans to increase ASP's by roughly 15% in January given fairly full utilization. In addition to network expansion, the company also considers increasing advertising time slots available from the current 20 minutes to 30 minutes to add capacity.
 
Raising price target but lowering rating from Buy to Accumulate after the recent rally. We expect the company to continue growing driven by market demand, network expansion, and increasing ASPs. We believe shares are still inexpensive at current levels, trading at 8x our FY11 EPS, or 6.3x if backing out net cash of $4.40 per share. However, shares have climbed 180% from its bottom in September and exceeded our previous $21 price target. We expect some profit taking by investors after the substantial rally. Therefore we are lowering our rating from Buy to Accumulate, although we are raising our price target from $21 to $24, which is 9x our increased FY11 EPS estimate. We wait for further indication from management on the use of cash, either for new projects or for a dividend. We believe a dividend policy would help unlock the remaining value for shareholders and could serve as the next catalyst for the stock.

Global Hunter:

Estimates Revision: We expect revenue to be roughly in line with our estimate, but we are increasing our gross margin estimate to 75% from our previous conservative estimate of 64%. We are raising our Q3 EPS estimate from $0.59 to $0.76, as we are also lowering our diluted share count. For ’10 we are maintaining our previous revenue estimate, but increasing our EPS from $2.38 to $2.61. For ‘11, we are maintaining our revenue estimate at $288MM, but increasing our EPS from $2.55 to $2.65, as a result of increased gross margin assumption in ’11 from 65% previously to 67.4%.

China Media Express Holdings, Inc (Buy) CCME:
Our extensive due diligence reinforces our thesis; Reiterate Buy

During our recent trip to China, we conducted extensive due diligence and channel checks on CCME’s business. We met with the company's entire management team including six regional managers, checked CCME’s sales contracts and bank statements, and interviewed advertising agencies, direct advertisers and bus operators.

We took buses in Beijing, Fuzhou and Guangzhou to view the company’s operation and advertising programs. In addition, we met with a representative from CTR, a market research firm, and two directors at Starr International. Our due diligence results reinforce our thesis on the company and we continue to believe that CCME is a leader in its niche market. We believe the fundamentals of the business remain solid. Thus, we reiterate our Buy rating. Please let me know if want the full note.

Key Points:
 
Interviews with advertising customers. CCME works with ~30 ad agencies who contribute ~70% of total revenue, with the remaining 30% from direct advertisers. We interviewed a number of ad agencies and direct advertisers, including agencies which purchase advertising time in Beijing and Guangzhou airports. The revenue amount these agencies disclosed to us matched that in the sales contracts and the customer list and revenue breakdown presented by CCME. These customers represent annual contract value of approximately RMB400MM ($60MM), or ~30% of our estimated ‘10 revenue. The agencies receive business either directly from brands or from 4As or other large advertising agencies. These advertisers stated that CCME’s large network and quality customer service make it the top choice in the inter-city bus market.
Interviews with bus operators. CCME’s network currently covers over 60 bus operators and close to 25,000 buses. The bus operators we interviewed ran a total of 4,000 buses. They receive concession fees ranging between RMB600 and RMB1,500 per bus per month, which we view as considerably low as compared to its peers in other outdoor media markets. We believe the low cost is due to a lack of major competitors in this niche market as well as weak bargaining power from bus operators who operate in a highly fragmented market. Concession fees typically account for 70%+ of COGS of a media company. Continuing to control concession fees is a key task for a media company. We believe this low level of concession charges explains CCME’s high margin profile.

Taking the rides. We took CCME’s buses in Beijing, Fuzhou and Guangzhou to view its operation and programs. The programs were rotated with 30 minutes of entertainment content and 10 minutes of advertisements. We saw brands including multinational names such as Pepsi-Cola, P&G, Coca-Cola, Siemens, and Samsung, and well-known domestic brands such as China Mobile, China Post, Wanglaoji Beverage, Tongyi Green Tea, Huangjin Dadang Nutrition and Yili Dairy, among others. Bus operators expressed favorable feedback from passengers; we believe the availability of various entertainment content makes passengers more receptive to advertising programs.

Meeting regional managers. We met with regional managers in charge of sales and customer service in Beijing, Guangdong, Sichuan, Jiangsu, Hubei and Fujian. We cross checked with them the number of buses, top agency customers and total revenues in each region. Currently there are ~30 people in each region who provide customer service to existing customers and develop new local customers (esp. direct advertisers) in the region.

Visit to Starr International. We visited Starr’s Shanghai office and met with directors who stated they have done a thorough due diligence before their $30MM investment in January, including hiring ACNielsen to conduct due diligence and market research, and Deloitte to audit CCME’s financials. They indicated that they monitored CCME’s operation and financial results on a monthly basis and continued to believe in its fundamentals, which is further evidenced by Starr’s additional investment of $13.5MM announced earlier this week to purchase 1.5MM common shares from early investors of the company.

Reiterate Buy. We have spent substantial time and effort in our ongoing due diligence over the last three months, the results of which reinforced our thesis. Shares are currently trading at just 6x our ’10 EPS (or 4x after backing out $139MM or $3.89/share in net cash). We expect more positive catalysts in the near term as the company continues to expand its network. As such, we reiterate our Buy rating and $21 price target, which is 9x our ’10 EPS of $2.38.

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