FMCN (Focus Media): focus on the improving margin

Focus Media reported earning after the market close on Monday. Heading into the earning, many nervous traders sold shares as the stock close down by a couple of percentage point to $59.86. I outlined some of investors’ concerns heading into the earning but did see continued strong growth in the topline number and possible earning upside due to an improving margin trend.

(see http://www.investorhives.com/msgd.php?msg_id=218)

FMCN put all the investors' concern into rest by delivering solid topline performance and exceptionally strong bottom-line results. The revenue came in at 61.1 mil slightly above 59.7 mil expectation. The EPS results blew away the estimate by healthy 6 cents, coming in at 55 cents on a Non-GAAP basis. The guidance was even stronger. The company sees the revenue number somewhere between 67 to 69 mil for the next Q. And it sees the EPS number somewhere between 62 to 64 cents, significantly above the current estimate of 56 cents.

The theme of this earning call is the improving gross and operational margin of the company amid the brisk revenue growth. The company has been deploying its LED flat panel network (commercial, in-store, etc). As these build out of the networks are largely complete and as they generate revenues, the gross margin is improving. The company improved the gross margin by whopping 640 bps to 65.3%. Even more impressively, the company is forecasting the GM to achieve mid 70% level long term. OP ex margin is going up even faster, up by 820 bps to 44.9%. As the current tax rate is only 5% for the company and this rate remain at this level for the entire 2007, the net profit margin could exceed 40%!!.

The company thinks it can achieve 20% Q to Q growth. If you extrapolate this for the quarters in 2007 with 40% margin, EPS estimate can exceed $3.5 and hence the current EPS estimate that some analysts are using are way too low. In this optimistic scenario, the share can reach $100 as we head towards 2007. Ad market environment for FMCN will even look better as China prepares for 2008 Olympics. FMCN reports all ad space in Tier 1 cities are sold out till the year end and this trend is expected to hold also in 2007.

Due to rather strong earning results, I would expect to see momentum coming back to the stock and we may retest our high of $70 level soon. I would not be discouraged by steep share price rise and use any pullbacks to build position. If you bought some shares ahead of the earning, congrats to you.

Conclusion

Even conservative growth in the topline number still yields great EPS growth due to earning leverage. Depending how fast the revenue ramps up, FMCN is poised to be one of the most exciting China stocks along with CTRP that we cover in FilthyRich group. Maintain $80 target but it appears as though this target is very very conservative number.