Since our first report on 8/8/13, Phoenix New Media ("[[FENG]]", or "the Company") reported two consecutive quarters of strong earnings. The market's response to each earnings release was surprisingly divergent. After crushing 2Q 2013 EPS estimates, FENG's share price rose 7.42% to $9.07 on its way to a 52-week high of $13.38. And yet, after similarly exceeding 3Q 2013 EPS estimates, FENG's share price fell 11.23%, although it has rebounded a bit since then. We believe the market's response to Q3 earnings shows how poorly the majority of investors understand FENG's strategy and what really matters to the long thesis.
Amid the post-Q3 sell-off, the market missed the most important takeaways from FENG's results:
- Continued strong market share gains in an environment where others are doing well to just maintain share
- Strong growth in pricing and number of advertisers, which point to additional momentum in 2014
- Momentum in mobile and online video, the two most strategically important segments of FENG's overall business
- Transition away from the low-margin legacy 2G business to the higher-margin mobile advertising, online video, and online gaming businesses
I. 3Q 2013 Results Review
Perhaps the most important point to consider when analyzing the quality of FENG's quarterly reports is that not all revenue should be valued the same way. As discussed in our original report , we view FENG as having a high-growth business and a legacy business (2G feature phone-driven revenue) that we liken to a slowly melting ice cube that will contribute earnings and cash flows until it fully transitions (to 3G smartphone-driven revenue). Clearly, revenue contributed by the legacy business should not be valued anywhere near as highly as the rest of FENG's revenues. Keeping track of this transition and the continued momentum in FENG's high-growth business is one of the keys to measuring the Company's success.
FENG reported 3Q 2013 sales of RMB 378.7 million, near the high end of its guidance of RMB 367-382 million and Bloomberg consensus estimate of RMB 378.4 million. Most importantly, the Company strongly beat its Net Advertising revenue guidance of RMB 207-217 million, reporting Net Advertising revenues of RMB 223.8 million (59.3% YoY growth). Weakness in its least important business, legacy 2G, resulted in Paid Services revenue of RMB 154.9 million, lower than the previously guided RMB 160-165 million.
Margins continued to expand, helped by ad rate card pricing increases, mix shift away from 2G sales, and lower bad debt expense. Reported non-GAAP EPS was RMB 1.06 vs. Bloomberg consensus estimate of RMB 0.73.
Bloomberg Error Causes Sharp One-Day Drop
Of note, even though FENG beat earnings expectations by ~45%, Bloomberg initially reported incorrectly that FENG significantly missed estimates, confusing the majority of investors who are not close enough to the Company's numbers.
Bloomberg's error, which triggered a one-day double-digit sell-off, was only corrected the subsequent day, but the delayed reaction to the actually strong earnings that drove the share price back to where it was failed to improve it.
Although 4Q 2013 sales guidance of RMB 368-378 million was just shy of Bloomberg consensus estimate of RMB 385.8 million, more importantly, the Q4 Net Advertising revenue forecast of RMB 244-249 million was higher than most expected (e.g. Morgan Stanley's forecast was RMB 231 million). Paid Services revenue guidance continues to be weaker than expected as the 2G business transitions, with the Q4 forecast of RMB 124-129 million trailing most sell-side estimates (e.g. Morgan Stanley expected RMB 150 million). In other words, FENG is executing beyond expectations as the legacy transition occurs faster than anticipated by the sell side.
II. Key Takeaways
We note the following important takeaways that the majority of investors focused on overall headline numbers appear to have missed:
1. iFeng.com continues to gain market share from its competitors
While most other portals continue to report flat or declining PC user traffic, FENG is seeing strong double-digit growth in its flagship property. Importantly, iFeng.com has strongest share in China's most developed Tier 1 cities, where all of its competitors are also strongest and overall Internet growth is weakest (relative to more underdeveloped lower-tier cities that represent future growth opportunity). Tier 1 city-focused third-party research firm iResearch noted daily unique visitors to iFeng.com grew 20% YoY to 40 million in September 2013. The following charts from a JPMorgan research report illustrate the consistent traffic growth year-to-date:
Most notable about iFeng.com's traffic growth is the manner in which FENG generates it. Traffic is increasing due to improved product features and user experience which are driving viral referral and increasing loyalty, as opposed to incurring incremental user acquisition cost through paid marketing.
FENG's differentiated content continues to drive share gains from larger portals such as SINA and SOHU, as evidenced by the sharply higher portal growth rate FENG enjoys. Going forward, we believe the relative value of content will be even more pronounced as the leading Internet incumbents battle to retain share, with much of the value creation accruing to companies with compelling differentiated content. The global history of media has consistently shown that monetization always follows eyeballs and we believe the trend in China's Internet will be no different.
iResearch recently ranked FENG sixth in terms of monthly unique users among its peers. This illustrates why FENG is compelling as a long-term investment. It is, both a leading traffic share gainer in monthly unique visitors and user time spent, as well as the company with the lowest market value ascribed to its users.
2. Strong growth in pricing and number of advertisers, which point to additional momentum in 2014
The strength of FENG's differentiated content throughout the three dominant digital channels: mobile, video and PC-manifests itself in traffic share gains and large increases in advertisers, both of which will ultimately result in sustained pricing power. No other major media company in China can offer a combination of TV (which FENG can offer via parent company Phoenix TV), Web, mobile, and online video exposure, certainly not at the scale that FENG can.
The table below illustrates how average revenue per advertiser (ARPA) has increased YoY for every publicly disclosed quarter.
3Q 2013 ARPA grew 13.8% YoY, but declined sequentially due to historical 3Q seasonality and the large increase in new advertisers. New subscribers tend to ramp up ad spending over time and FENG had the strongest YoY growth (40%) in advertisers since 1Q 2011.
FENG's management team has historically focused on gaining share of advertisers by offering substantial discounts relative to other top display advertising competitors such as SOHU and SINA, which has allowed the Company to quickly gain large advertising customers across a variety of high-growth consumer segments. As FENG's customer base grows, the management team has slowly started to increase prices closer to their fair market rates. In 2013 YTD, FENG has increased its premium PC ad rate twice (15% on January 1, 2013 and18% on July 1, 2013), video ad rate once by 48% and its mobile ad rate 3 times (once each quarter).
Management noted on the earnings conference call that they expect continued increases in the number of advertisers and ARPA. They specifically discussed how the CPM rate for iFeng.com's cover page will increase significantly, which is a sign of FENG's growing influence and prominence.
The frequency and magnitude of FENG's price increases bring to mind a famous quote by Warren Buffett:
The single most important decision in evaluating a business is pricing power. If you've got the power to raise prices without losing business to a competitor, you've got a very good business.
Despite substantial and frequent price increases in 2013, FENG is gaining market share versus its competitors, which suggests that FENG is a very good business indeed.
3. Momentum in mobile advertising and online video
FENG has continued to report hyper-growth in mobile advertising and online video, two segments that are increasingly important to both domestic and multinational advertisers and, therefore, also to investors.
As content consumption via mobile devices continues to overtake that of the Web, the single most important strategic imperative for content publishers is managing that transition. FENG's 3Q 2013 results indicate that FENG is managing the transition seamlessly: Mobile consisted of over 1/3 of the Company's total traffic, with 22 million daily active users (vs. over 39 million DAUs on PC-based ifeng.com). Daily users of FENG's mobile news app grew 400% in August 2013, per iResearch, albeit, from a low base. Furthermore, mobile advertising sales growth accelerated to 160% YoY, compared to 159% YoY growth in the 2Q 2013. On the 3Q 2013 earnings conference call, management disclosed that mobile advertising is now 10% of total ad sales and they expect FENG's growth rate to lead the industry.
FENG's video ad sales also accelerated and rose to 16% of total ad sales in 3Q 2013. Profitable FENG is now growing faster than industry leader Youku Tuduo ( YOKU ) which has yet to turn a profit. YOKU's 3-4x premium on EV/Sales is striking.
The launch of 4G LTE networks next year by China's three telecom carriers will spur increased mobile video consumption. Due to slow broadband and lack of access to mobile data usage, viewers in lower tier cities tend to download videos onto their phones when they have access to Wi-Fi. They then watch the videos at a later time instead of streaming through mobile broadband. As videos downloaded in this manner do not carry advertisements, faster mobile broadband will increase monetization of the entire online video industry. FENG's video platform is well suited for small-screen consumption with higher ad frequency, given its emphasis on professionally edited short form news clips.
According to the "China Mobile Internet 2012 Review" by Umeng, China's largest mobile app analytics platform, video apps had the highest growth by far amongst app categories. A mobile user's average total time spent daily on video apps increased 259% to 31 minutes in 2012 from 9 minutes.
4. Transition away from low-margin 2G to higher-margin mobile advertising, video and gaming businesses
Investors who sold FENG after the 3Q 2013 earnings may not have fully considered the factors leading to the weaker than expected sales guidance and the long-term implications. FENG's in-line 3Q sales and 4Q guidance miss was attributable to unexpected weakness in the FENG's 2G business. Since it is FENG's lowest-margin business, the decline had a muted impact on FENG's earnings.
The 2G business consists of SMS and MMS based services such as community chat, messaging, picture download, personal ring tones, etc. to users through various 2G and 2.5G channels. As China's adoption of 3G and 4G LTE accelerates, SMS-based WVAS revenue will continue to decline and will eventually disappear.
This is positive for FENG because low- to no-growth revenue with 5-10% operating margins will be replaced by FENG's higher-growth businesses which are growing an order of magnitude faster and have 2-3x the margins. A key example of such a business is the Company's relatively new Web games business:
FENG launched its web games business last year and will launch its 3G/4G mobile games business in 2014. Both businesses will have much higher margins than its 2G business.
FENG's margins have improved as higher margin advertising, Web games and 3G value-added services revenue replaces the much lower-margin 2G revenue.
Another driver of margin improvement has been the decline in bandwidth costs as a % of sales.
China's Ministry of Industry and Information Technology (MIIT) has a goal to reduce bandwidth costs by 30-35% over the next five years. Note the following quote from the CFO of 21 Vianet ( VNET ), China's dominant independent Internet infrastructure company, during VNET's 3Q 2013 earnings call :
China Telecom and China Unicom, actually, they are making a commitment... to the ministry, MIIT... to reduce bandwidth cost... by 30% over the next 5 years.
(For more about VNET, see our Seeking Alpha report here .)
Our industry contacts and the management teams of several domestically-listed Chinese ISPs have suggested that bandwidth costs have already begun to come down, which will structurally boost FENG's long-term gross margins.
FENG continues to strengthen its position as an iconic media company with the industry's most robust content-driven moat as well as the most diversified multi-channel revenues.
The two factors that matter most to our investment thesis are:
- FENG's ability to strengthen its substantial content-based moat
- Continued success in transitioning its mobile revenue base from FENG's legacy 2G business (feature phone-driven) to its high-growth 3G (smartphone-driven) business.
FENG's 3Q earnings showed progress on both fronts, although the Company's strong progress on the latter was obfuscated by the ongoing transition from legacy to higher-growth mobile business. The long-term bullish implications of this transition are evident in FENG's large increases in margins and profitability, particularly versus expectations.
We continue to believe that FENG provides investors an opportunity to buy a secular winner coming out of a cyclical trough and gain exposure to some of the highest growth trends in global media without paying the nosebleed multiples often associated with such investment opportunities. Due to its compelling differentiated content, FENG continues to take market share from competitors in PC, mobile and online video. Its success in mobile and online video are particularly notable, given their rising importance to both advertisers and investors. The increase in market share further allows FENG to attract more advertisers and continually raise pricing. The virtuous cycle created by growing traffic, market share and increased pricing will allow FENG to continue its fundamental momentum in 2014.
Disclosure: I am long [[FENG]], [[VNET]]. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Refer to additional disclosures here: toroip.com/disclaimer-feng.html
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