How the Netflix Model May Look at FAB Universal (FU:NYSE)

How the Netflix Model May Look at FAB Universal

On September 24, 2013 FAB entered into an agreement with Future TV Co. Ltd. to distribute its copyright-protected media content through pay TV terminals used in the home by Future TV’s subscribers.

The Deal: Under the terms of the agreement, FAB will provide copyright protected content including high-definition video, music lessons, children's programs, and other educational and related programming. Future TV will integrate the content provided by FAB Universal with its operational platform and manage subscriber payments.

The Players: Future TV is a subsidiary of China Network Television (CNTV), the online division of China Central Television (CCTV), which is the national public broadcaster in China. It operates a national Internet TV platform, China Internet TV, the first such platform authorized by China's State Administration of Radio, Film and Television. Future TV reaches 20 million families in China, provides over 1.3 million hours of quality video-on-demand programming.

The Takeaway: How will this deal look for the company in 2014? First we assume it will take the remainder of the year to set up the deal and therefore our estimates for 2013 remain the same. Let’s assume a conservative pick up of Future TV customers.

So we start with the 20 million customers at Future TV. Let’s conservatively say that there are three mutually exclusive scenarios where the company can expect to get 2%, 5% and 7% of Future TV’s clientele into a monthly pay content model. Our models only consider the Future TV deal.

Should the firm prosper with Future TV and begin to sign other deals there is a large growing base of internet users in China. According to China Internet Network Information Center (CNNIC), China’s Internet penetration increased by two percentage points recently to 44 percent or 591 million users.

Netflix and Fab have a similar story in that both began with the physical distribution of media and have gradually been moving into an online distribution model. Netflix does not do business in China currently.

According to company reports and the associated press Netflix's subscribers outside the US grew by 605,000 as of June 30, 2013.

Broken down by Streaming the numbers look like this:

Ø 29.8 million in U.S., gain of 633,000 during the second quarter

Ø 7.75 million outside the U.S., gain of 605,000

Ø 37.6 million total, gain of 1.2 million

Beyond Future TV

Chris Spencer, CEO of FAB Universal recently laid out the company’s objectives with regard to pay content.

“Going forward, our ambition is to become a leading pay-TV content operator in China. Our plans include entering digital TV, through distribution agreements with cable network operators, and IPTV and over-the-top TV (with the set top box already installed in the television), through distribution agreements with telecom and content aggregation licensing providers. Expanding our distribution platform to encompass subscription TV will position FAB Universal at the forefront of the trend toward greater Internet usage and rising Internet penetration rates in China.”

According to Airoha Technology, IPTV home users in China numbered 8 million in 2010, and grew to 13.5 million users in 2011, and 23 million in 2012. IPTV users are estimated to reach 56.3 million in 2013 and break the 100 million-mark in 2015. Total cable TV users in China were approximately 220 million in the first quarter of 2013. However, digital cable TV is growing more rapidly as the Chinese Government is focused on its development. The users for digital cable TV amounted to over 120 million in 2012, representing a digitalization rate (the percentage of cable TV users switching to digital cable TV) of 64.2%, and grew to nearly 130 million users in the first quarter of 2013, representing a digitalization rate of 67.2%.



Valuation

Our net income estimate for 2013 remains at $19.6 million which is the mid-point of the company's guidance it provided. If we use the fully diluted shares to do a quick forward PE ratio calculation we get an estimated EPS of $0.40. (closer to $0.48 if you take the shares outstanding as of 12/31/2013) We initiated at $3.50 of so that's a P/E of about 8.8x earnings. At $6.00 that translates to 15x earnings. At $10.00 it translates to 25x earnings. The industry average according to Zacks Data is about 22x earnings for its peer group.

So the question you have to is.....Is the firm worth paying a premium for? We see earnings growing at a 30% clip next year so we think it is. Cash generation is a big story here. At the beginning of 2013 FAB started off with $19.6 million in cash and in just two quarters has grown that cash to $27.6 million with $9 million in accounts receivable. The past three quarters operating cash flow has been $25 million. We feel investors should take our most conservative estimates in the above tables and work them in to the 2014 numbers. If there is proof of more success and new deals perhaps work some of the more aggressive numbers into the mix.