Huace Film&TV(300133):TV drama guru-initiating with Buy

Leading TV drama maker - strong on content and channels

    We initiate coverage on Zhejiang Huace Film&TV with a Buy recommendationand a target price of RMB38. Huace is the leading TV drama producer in China.We believe the company's competitive advantage encompasses its richresources and pipeline of IP and its solid relationships with leading TVstations/video websites. In addition to the TV drama business, Huace is tryingto diversify its products, recently extending into film production andentertainment programs. Huace is our top pick in the media sector.

    TV drama is the trump card

    Huace has successfully maintained its leading position in Chinese TV dramawith 10% market share. We have seen a strong pipeline in TV drama for 2H15-2016 that already has a broadcasting license. Our channel checks support ourview that Huace is expanding from traditional TV to video websites such asiQiyi, Sohu and LeTV. Huace’s TV dramas are broadcast on both traditional andnew media channels. As a result, we believe TV drama will continue to be thecompany’s earnings driver over the next three years.

    Beyond TV drama - movies and entertainment programs

    Although movies and entertainment are new to Huace and account for only1% and 0.2% of 1H15 revenue, respectively, we expect synergies with the TVdrama segment. We believe that with a strong IP pipeline, TV dramas, moviesand entertainment programs can be manufactured as a one-stop productchain. This should help increase the efficiency and fully monetize Huace’s IP.

    Valuation and risks

    We value the company at RMB38 on a DCF-based valuation (WACC of 8.7%and terminal growth rate of 4%). The company trades at 43x our 2016E EPS,implying a PEG of 0.9x on two-year earnings CAGR. Key downside risksinclude 1) piracy issues, 2) tightening SARFT policies, 3) increasingcompetition from self-produced internet dramas, 4) delays in distribution, and5) uncertainty in new business segments.