FMCN: Buy as it heads into managaeable expectation

Focus Media (FMCN) was just initiated in FilthyRich 2007 ideas. The company reports Nov earning results after the market close tomorrow (Monday 20th).

FMCN is a Chinese media/ad company. In 2003, the company successfully transformed itself from an advertising agency to an operator of out-of-home advertising network. The company targets ad markets based on flat panel displays in commercial building network, in-store network, and other outdoor LED network. The company recently pushed its business into poster frame network and mobile handset network. Last two years, the company went on a torrid acquisition trail, gobbling up many small players in this space and defining new business based on the flat panel displays. Now FMCN owns 90% market share in this ad segment and has near monopoly-like position. The revenue growth, via both organic and acquisitions, have been outstanding. In 2004, the company posted topline number of 29.2 mil. In 2005, this number grew to 68.2 mil which represented ~135% growth. In 2006, the revenue number is estimated to be 212 mil which represents whopping 210% YOY gain. In 2007, the current estimate is 346 mil, which would be about 63% rise from 2006 level. Although the growth rate will likely to slow down from the current torrid pace, it will still remain above 40% level for the foreseeable future. 2007 EPS estimate is now at $2.60 but there could be upside as the margin could improve as the acquisitions are digested and the synergy kicks in. At the current price of $61.73, it is trading with PE slightly greater than 23. With growth estimated to exceed 40%, PEG is 0.6 and the valuation looks attractive for the risk tolerant investors.

Although the shares have risen more than 200% since its IPO in fall of 05, the stock has done nothing since June of this year. In fact, the shares have seen steady decline over last several months. What is causing the stock to lose steam? In June of 06, there was a secondary offering of shares which did not please the investors. Last earning call was also less than enthusiastic with the management being cautious about the future guidance. In addition, Wal-Mart buying Trust-Mart, a FMCN customer casted doubt whether Wal-Mart would renew relationship with FMCN. However, it is noted that Trustmart represent only 1.3 % of the total revenue. There has been some concern about increased competitions from Oriental Pearl and BAMC. There has been talk about increased lease cost on the commercial building display site which will have negative impacts on the bottomline. Finally, CEO's selling call option of the company and buying put options (involving 2m of his own shares) weighed heavily on the stock price.

Due to this negative events that has unfolded last two months and cautious management guidance on the upcoming Q, I believe that the shares are heading into the earning with the reduced expectation. Normally, high flyers stocks need to beat the earning expectation by a solid margin to sustain its upward momentum. But for FMCN, just slightly beating the estimate may trigger relief rally and hence I see more room for appreciation near term. I believe that some of the shares that you want to purchase can be bought ahead of the earning on Monday before the market close.

In case that the earning just meet the expectation and the shares sell off somewhat, I think that would provide us with a nice chance to average down. Long term, as we near the 2008 Chinese Olympic, I expect the Chinese display market to be very vibrant. With more network deployed as the time progress, room for the margin expansion is significant. Better margin among higher business volume means a lot of earning for the company and happy smiles on the shareholders.