VODONE - 3 businesses converge to build lottery franchise

China Everbright Research Limited Please read the analysts and company disclosure and the disclaimer in the last page Equities HK/China Initial Coverage Company Report BUY (Initiated) Share Price Target Price (30 April 2010) HK$2.82
HK$4.10 HS Index 21,108.59 (30 April 2010) Relative Performance Company Data Share issued 2,361.613 m Market cap HKD6,659.75 m Avg daily vol (shrs) 61.78 m 52-week Hi HKD3.26 52-week Lo HKD0.22 Free float 76.9% Company Background Vodone is an Internet video broadcasting company with the rights to produce and broadcast Internet video content. Incorporated in June 2005, VODONE was introduced to the Hong Kong Stock Exchange through backdoor listing in July 2006. Vodone hit a new milestone in 2009 by stepping into lottery and mobile gaming, in order to fully capitalize on its Internet broadcasting platform and explore further business potential. VODONE 82.HK 3 businesses converge to build lottery franchise 3 May 2010  Right industry and right segment in lottery distribution. Holding a generally positive stance on the lottery industry, we particularly favor the downstream distribution segment. Vodone is the only listed lottery service provider with pure focus on downstream operation. Moreover, Vodone has chosen to focus on the higher growth hi-frequency games and sports guessing game (SMG).  Establishing downstream distribution franchise. Vodone intends to leverage on the newly acquired Dragon Joyce mobile game platform to develop a more user-friendly and attractive mobile lottery interface. Our channel checks indicate Vodone is adding around 400k active members per month year to date. Together with the recent entertainment platform embedment agreement forged with MTK, we are buoyant that Vodone will be close to double its mobile subscriber base this year.  45.7% 2-year CAGR in net profit. We expect Vodone to record a 304% surge in net profit in FY10F to HKD425 million, because lottery and mobile gaming will be fully booked in FY10F. On a comparable basis, we forecast Vodone to register 45.7% CAGR from FY10F to FY12F. Our model indicates lottery business shall contribute 80% of growth during the period.  Initiate with BUY and target price at HKD4.10. We adopt a conservative 13% discount rate for the DCF model, in order to price in the risk of insufficient track record. We have reached a DCF-based target price of HKD4.10, representing 22.8X and 14.6X FY10F and FY11F PER. The target PER represents Vodone as an Internet entertainment company with strong distribution franchise. Valuation Table Y/E: Dec 31 2009 2010F 2011F 2012F Net profit (HKD m) 105 425 665 904 % Change N.A. 304.0 56.2 36.0 EPS (HKD) 0.05 0.18 0.28 0.38 % Change N.A. 232.8 55.7 36.0 DPS (HKD) 0.006 0.03 0.06 0.10 P/E (x) 52.1 15.7 10.1 7.4 Dividend yield (%) 0.21 1.0 2.0 3.4 P/B (x) 4.6 4.3 3.2 2.4 Net debt / equity (%) Net Cash Net Cash Net Cash Net Cash ROE (%) 11.8% 31.0% 36.5% 37.3% Source: The Company, CER Estimates Kevin Tam CFA CE No.: AGO269 Tel: (852) 25308394 E-mail: kevin.tam@everbright165.com China Everbright Research Limited Please read the analysts and company disclosure and the disclaimer in the last page 2 COMPANY BACKGROUND Vodone is an Internet media company owning a full set of Internet video qualifications and licenses. Vodone is among the few Internet media companies that own the rights to produce and broadcast Internet video content. With an aggregate page view of 150 million per day, its BUS is one of the largest Internet video advertising platforms in China. Incorporated in June 2005, VODONE was introduced to the Hong Kong Stock Exchange through backdoor listing in July 2006. Dr. Zhang Lijun, founder, Chairman and CEO, was the former Chairman of Sino-Interest Worldwide Economic Group, under the National Development and Reform Commission and Economic Restructuring Office of the State Council. Vodone hit a new milestone in 2009 by stepping into lottery and mobile gaming, in order to fully capitalize on its Internet broadcasting platform and explore further business potential. Snapshot of Vodone’s business model Lottery Mobile gaming Internet broadcasting Business model Acts as a mobile and Internet distribution and marketing channel for lottery tickets issued by CWLC and CSLAC Develops mobile game embedded into mass market domestic handset Operates BUS (Broadcasting Union System), which enables advertisers to choose their advertising location over 3 million allied websites Revenue model Shares 8-10% of lottery revenue - Adopts free-to-play and item-based model - Shares 35 - 50% of gaming revenue - Arrangement of revenu