Description

Apologies, this is not a new idea but just a follow-up post to Chalkbaggery’s original write-up on HIM International Music from 19 October 2017 (thanks!). We defer to many things in the original posting, including the potential for streaming-led growth, but would like to add that one key aspect of the company has changed for the better as far as HIM shareholders are concerned:

High-margin music royalties (primarily for HIM’s ~2,000 song catalog of recorded music as opposed to their separate, smaller publishing catalog) from streaming services a) now contribute nearly all of the profit (OP margins have leapt from <20% to >40% in the last 12 months), and b) are now primarily pre-paid thanks to a lucrative 3-year guaranteed deal signed with Netease Cloud Music for mainland China. Hence, earnings growth and visibility for the next two years, at least from the licensing segment, are “in the bag.”

The Netease deal, which was structured as a three-year exclusive licensing contract for the period 1 March 2018 to 1 March 2021, is basically upfront guaranteed money for HIM to secure their exclusivity (to keep the catalog away from Tencent Music) and does not require that Netease’s streaming customers actually listen to HIM’s music.  The payment consideration for each year of the contract arrives in HIM’s bank account in Taiwan by the first day of March each year (HIM doesn’t even have a mainland Chinese subsidiary as Netease can just wire the foreign currency from one of their offshore accounts straight to Taiwan without restriction).

Moreover, the consideration revenue recognition is structured to grow 8% per year over 2018-2021, so this provides HIM’s P&L with a huge amount of stability and visibility for at least the next two years.        

HIM has remained coy about the exact size of this Netease deal but we can infer from a few different sources. Page 75 of the 2018 consolidated financial statements shows an unnamed “customer D” that contributed TWD 502.21 million of revenue for the year 2018 (30% of total revenue). Customer D is almost certainly Netease Cloud Music, and this amount was only for 10 months of contribution since the deal only began on 1 March 2019.

Because of the pre-paid nature of HIM’s licensing deal with Netease, which runs from March to March, you can get a preview of revenue growth potential for the year by looking at the 1^st quarter 2019 balance sheet on the liabilities side. There on page 42 of the 1^st quarter 2019 statements you will see a footnote showing prepaid deferred revenue from streaming has now reached TWD 847.15 million, up from TWD 508.614 million a year ago.

On the same page there is also a chart breaking down the licensing revenue contribution by the type of revenue recognition method employed. The two types of revenue recognition methods are  於某一時點認列之收入or point-of-sale driven revenue recognition (i.e. non-China, non-prepaid licensing revenue from sources like Apple Music or Spotify in Taiwan/elsewhere) and 隨時間逐步認列之收入 or revenue recognized over a period (i.e. the prepaid Netease licensing revenue). What this breakdown shows is that licensing revenue from both China and non-China (mostly Taiwan) have grown significantly year on year through March 31^st 2019.

Thanks to the above, trailing twelve-month EBIT through June 2019 has reached TWD 600.88 million versus TWD 511 million in FY2018 and TWD 293 million in FY2017. In other words, if you give credit to the value of HIM’s passive-income investment property (an unrelated office building that is actually not even fully leased out) valued at TWD 1.1 billion by their appraisers, then this company is still selling for an EV/EBIT multiple of less than 10x despite above-average earnings growth visibility.  And this does not even account for the fact that LINE Music is now launching their streaming platform in Taiwan https://www.digitalmusicnews.com/2019/07/12/line-music-now-available-in-taiwan/.  Should LINE succeed to create a new streaming music subscriber base without cannibalizing from Spotify/Apple Music then it should be a nice source of revenue growth for HIM.

Telecom companies everywhere seem to be willing to subsidize users for a certain period to sign up to one or more streaming services so that should also be beneficial to music catalog owners like HIM if enough users stay on the streaming platforms once their subsidy expires. https://www.smartone.com/en/services_and_apps/fun_and_entertainment/apple_music/service.jsp?_sveee=E219C1A33F5AF819F866E7EF01604629

Not surprisingly, there was a significant amount of insider shareholder purchases in HIM stock in the 4^th quarter of 2018 by management and directors. This insider buying wave came in addition to the smartly timed repurchase the company itself conducted over the same period.

Catalyst

Further growth from streaming music licensing which leads to further growth in profits/dividends