FAB Universal Corporation (FU) is a distributor of global digital media. The Company serves its customers through three segments including: Retail Media, Wholesale Media and Digital Media. Libsyn, which is a subsidiary of Digital Media operates podcast hosting technology. On April 5, 2012 FAB signed an official share exchange agreement with Wizzard Software Corp. The acquisition closed September 26, 2012 and the new company became FAB Universal.
This stock provides the investor a unique blend of several high growth businesses that range from podcasting to Kiosk. FAB is the only company in China that uses Kiosk as a digital content distribution platform. Podcast growth has been very strong and could contribute $1 million to the bottom-line in 2013. The firm should see margin expansion in the coming quarters as the fastest growing segments also have the highest margin contribution.
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Investment Thesis
- FAB's retail division carries the largest selection of copyright protected audio and video products in China, including CDs, VCDs, DVDs, blu-rays, books, magazines and portable electronic devices.
- Currently, FAB is the only company in China that uses a Kiosk as a digital content distribution platform.
- The Company's objective is for the number of kiosk licensees and installed network count to double and membership card holders to jump to 1 million in three years.
- Liberated Syndication (libsyn) pioneered a system to host and monetize podcasting in 2004. By 2012 Libsyn had hosted over 13,000 shows with over 1.6 billion downloads and 28 million audience members. Libsyn hosts several big name podcast producers such as Adam Carolla and Marc Maron as well as small start-ups. The goal is for Libsyn to generate $1 million in profits this year.
Retail Media
Retail business is conducted through its flagship stores. One is located in the Joy City shopping mall and the other is an entertainment superstore in SoShow. Each store is over 20,000 square feet in size and carries one of the largest selections of copyright protected audio and video products in China, including CDs, VCDs, DVDs, blu-rays, books, magazines and portable electronic devices. The flagship stores are recognized by many Chinese consumers as the most trusted place to buy copyright protected products. The corporate goal is to go from 2 flagship stores to 6 stores over three years and perhaps as many as 200 smaller stores.
FAB has regularly used celebrity signing events as a major driver to FAB's retail stores. This is a popular venue for Chinese music and movie stars to meet their fans. Recently stars from outside mainland China, from Hong Kong, Taiwan, Korea and Japan, wishing to enter the Chinese market have chosen FAB as their launching platform. These events not only promote sales of audio-video products but also increase FAB's brand recognition.
What makes this a high growth segment is the growth of the Chinese middle class and their disposable income. China continues to transform much of its population and economy from poverty to a middle class environment. The urban population has doubled from 302 million in 1990 to 622 million in 2009 and is projected to approach one billion by 2025. There were 40 large cities that had more than one million residents in 2000. That number tripled to 122 in 2008. The Economist Intelligence Unit (EIU) forecasts that there will be more than 200 large cities by 2025. Rapid urbanization calls for an integrated modern transportation system, and China's government has responded with intense investment in infrastructure. According to ChinaView.com, China built six new airports in 2009, bringing the total number to 166 as of last December. Naturally the internet has gone through a modernization as well.
The average disposable income of urban Chinese households rose to around $3,000 per capita in 2010, according to an analysis of official government statistics by China Market Research Group. That means a typical family of three earns around $9,000 a year.
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Wholesale
The wholesale business provides audio-video products such as compact discs, video compact discs and digital video discs as well as books and magazines to audio-video product retailers. FAB distributes these media products to over 80 customers. FAB's wholesale business caters to three types of customers: large retail stores, FAB license stores and small wholesale/resellers. Customers place orders by telephone, through the internet or in-person and fulfillment is handled by FAB's vehicle fleet or through direct warehouse access.
It is clear that the content model has changed and I think this piece from Filmmaking.net drives the point home.
The Changing Landscape of Entertainment (source filmmaking.net)
Just as VHS and DVD once looked threatening to the movie industry, the internet threatens to change distribution once again. The industry is seeing P2P/IP TV as the new TV, download-to-own as the new DVD, and worldwide-synchronous online releases as the new cinema. In the past when the industry viewed new technology as a threat, that very threat ended up increasing sales.
The internet does not only represent a threat (piracy) but rather an opportunity to reach bigger audiences with more product, more quickly for far less cost. Think of the cost benefit of taking DVD's out of the supply chain. Several insiders also point to built-in marketing tools like peer-review and recommendations, and brand new methods for taking advantage of old revenue sources such as advertising.
Desire for Cinema and programs have not changed - just how we choose to access it. And we now have plenty of choices. Download services are re-populating our distribution landscape, giving rise to many exciting new opportunities. The early pioneers in content delivery were iTunes, Netflix, Amazon.com, Sony Playstation, and Microsoft Xbox.
Digital Media
Kiosks/Licensing-The company's Intelligent Media Kiosks, based on 61 proprietary intellectual property rights, are ATM style terminals where consumers can download copyright protected music, video games, ringtones, digital books and movies directly to their cell phones, memory sticks or other mobile storage devices. The Kiosks also run video ads on the high-tech LCD screens and accept payments for utility bills, and credit card bills. Currently, FAB is the only company in China that used Kiosk as a digital content distribution platform. Similarly, the company's 5C intelligent media kiosks have now expanded to 40 cities with around 8,400 licensees and an installed network count approaching 12,500 Intelligent Media Kiosks.
Kiosk produces revenues through membership cards, advertising fees, and agent and franchise fees. This segment enjoys the highest margins in the company at approximately 84%. The corporate goal for Kiosk is double the amount of machines from 12,500 today to 25,000 over three years. FAB has more than 350,000 membership cardholders. The company's objective is for the number of licensees and installed network count to double and membership card holders to jump to 1 million in three years.
Podcasting - FAB provides a web based podcast distribution platform for podcast producers wanting to broadcast their audio or video shows to people worldwide, in most cases through RSS distribution. FAB's podcast hosting service accumulates and provides audience statistics as well as advertising sales, ad insertion and App creation and sales to help podcasters generate revenue. Throughout 2012, Libsyn had approximately 50 million total audience members and 1.6 billion download requests for podcast episodes.
Podcast has shown explosive growth. Unique monthly audiences have experienced accelerated growth from 20 million people in the first quarter of 2012 to 28 million people in the first quarter of this year. The 40% increase is a result of the addition of 8 million podcast audience members enjoying podcasts from 240 countries around the world on the Libsyn Network each and every month.
More shows are now being distributed to mobile devices than to traditional PC's. Media distribution to mobile devices such as iPhones and iPads demonstrate a fundamental shift away from the traditional method of downloads via iTunes to the PC. This fundamental catalyst represents a significant opportunity for monetization of podcasts through advertising due to the fact that these mobile downloads can now be tracked in the same manner as streaming video content from a website like YouTube. This type of tracking was not possible before this shift in audience consumption habits.
FAB Universal, the parent company of Libsyn, is looking for Libsyn to generate $1 million of profit this year, a first for the podcast division.
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Margin Expansion
From a margin standpoint the division expected to grow the fastest (Kiosk) has the highest corporate margin ranging from 75-84%. Retail is next with a margin range of 26-27% and Wholesale is the lowest margin business at 18-20%. Looking at expected growth rates margin expansion should be a part of the story.
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Risks
While we like the prospects for the firm there are some risks investors need to understand. Industry position is a major one. The firm competes with several companies that distribute online content. FAB primarily competes with distributors of content over the Internet, including content sites, Web directories, search engines and Internet service providers. These sites compete with FAB for customers and advertising dollars. The Internet market in China is relatively new and rapidly evolving. Competition is intense and expected to increase significantly in the future, given the fact that there are no substantial barriers to entry in the market.
Another risk is dilution. As a component of its growth strategy, FAB intends to actively identify and acquire assets, technologies and businesses that are complementary to its existing businesses. Acquisitions could result in the use of substantial amounts of cash, potentially dilutive issuances of equity securities, or significant impairment losses. They will also gradually issue shares to Digital Entertainment International (DEI) as part of an agreed upon arrangement after a certain time period assuming certain objectives are reached.
FAB remains well positioned to achieve solid revenue growth and operating leverage as, digital media is distributed over a variety of devices given the company's competitive advantage led by innovation.
The firm has four things that separate it from the pack in our opinion.
- Explosive Top-Line growth potential
- Exclusivity in Kiosk and Podcast
- Margin Growth
- Markets where they are in the sweet spot of the statistics, such as
- Internet growth in Asia
- Download Content Worldwide
- Disposable income growth in China
We don't see another stock in the small cap space that exposes the investor to such a rich collection of growing businesses. While the firm has the difficult task of bringing these business units together under one roof, we see it as a solid risk reward opportunity.
Looking at 2012 estimated earnings the stock is trading at a very deep discount. Perhaps the disconnect between the stock price and performance is because the company has not had a full year of earnings since the merger. That will happen in 2013 and after tax net income should be $19.2 million. Cash flow from operations has also been very solid, generating $10.1 million in the first quarter of 2013. This nearly doubled fourth quarter of 2012 cash flow from operations.
Valuation
To value the firm we assume FAB takes a moderate share of the market over the next five years and then grows at the rate of the economy after that. We assumed all future dilutive securities are exercised and outstanding. (Source for background info: Investment Valuation; Aswath Damodaran)
Two Stage Free Cash Flow to Equity Model
FCFE = Net Income - Net Capital Expenditure - Change in Net Working Capital + New Debt - Debt Repayment
Assumptions
- The firm is expected to grow at a higher growth rate in the first period.
- The growth rate will drop at the end of the first period to the stable growth rate.
Rationale for using the Model
As kiosks are doubled and podcast continues its explosive growth we expect the firm to grow at a rate above the growth rate of the industry. As These products and services mature and the firm faces more competition we expect the growth rate to level off.
Weakness of the Model
As you add more layers to the model it is more sensitive to the assumptions you make. The growth may look more "lumpy" than we have it in the model.
Output
We used the following inputs:
- A 5-year period with an earnings growth rate of 15% and a discount rate of 12.75%.
- A continuing period assumed to go on forever, with earnings growing at 4% and a discount rate of 10.50%.
To determine a target price we took an average of the two stage model and a conservative Price to Earnings ratio of 9.5x 2013 estimated EPS. With these inputs we arrive at a target price of $10.00. As the profitable quarters begin to add up one could certainly expect 15-20x earnings.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
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