NYSE candidate banks on digital TV growth in China

China Digital TV, which provides smart cards and access systems to the digital TV industry, aims to raise $156 million from its IPO.
Once upon a time, it was the television set that was at the top of the wish list for ChinaÆs newly rich, but those days are long gone. As the wealth has spread and the countryÆs middle class has grown bigger, that list has expanded to include even more expensive items and the must-have this year is probably more likely to be a piece of property û or why not a portfolio of stocks in ShanghaiÆs surging A-share market.

But TVs arenÆt entirely out of fashion, only these days it is the digital version that is capturing peopleÆs imagination. Or at least that is what the latest Chinese listing candidate to the New York Stock Exchange hopes.

China Digital TV Holdings, which is looking to raise up to $156 million, is a provider of conditional access systems aimed at ChinaÆs digital TV market û a market that, not surprisingly, is growing faster than its counterparts in other regions of the world. The growth is coming from a low base but the potential is huge, if one is to believe the domestic research firms quoted in China DigitalÆs prospectus.

As of the end of last year, about 362 million Chinese households had a TV and, of those, 139 million were subscribers to cable TV. However, of the cable viewers, only about 13 million were digital subscribers, which is equal to 3.5% of all TV owners û the lowest penetration rate in the world.

To help these numbers along, the Chinese government has set a target that all TV broadcasts be made in digital format by 2010. By the end of that year, the number of households linked to cable television networks is expected to reach 176 million households and the number of digital TV subscribers will stand at 111 million, according to Analysys International. The government initially also said that all analogue transmissions have to be switched off by 2015, but in February this year, it amended this order to say operators will have to continue to provide at least six analogue channels after 2015 to cater to those who do not wish to subscribe to the digital services.

Still, such strong government support for digitalisation is helping the cable TV industry to make quantum leaps forward in terms of changing the standards.

China Digital TV is involved in this market throughout the transmission chain. It develops the software that is used by the operators to encrypt the audio and video signals that are to be transmitted; it provides software for set-top boxes in the home that allows the digital TV network operators to control the distribution of content and the value-added services and also gives them the ability to block unauthorised access to their networks; and it sells the smart cards that are inserted into the set-top boxes to decrypt the signals.

ôConditional access systems sounds complicated, but all this business does is ensure that content gets from one end to the other and capture the fact that there is a lot of value to be had on both ends,ö says a source close to China Digital TVÆs offering. ôAnd these guys (China Digital TV) are more active than anyone else by a multiple of market share.ö

The company is offering 12 million American depositary shares (ADS), or 21.6% of its existing share capital, at a price between $11 and $13 apiece. All the shares are new and each ADS accounts for one common share. There is a 15% greenshoe that could boost the total deal size to as much as $179.4 million.

Credit Suisse and Morgan Stanley are the joint bookrunners for the IPO, which kicked off the roadshow on Monday this week. The final price is to be determined after the New York close on October 4 and the shares are scheduled to start trading on October 5.

As of June 30, the company had installed CA systems at 130 digital TV network operators in 26 of ChinaÆs 32 provinces and autonomous regions. However, its core business is the smart card sales, which accounted for about 88% of its revenues in the six months to June this year, and here it has a 44% market share.

The key selling points of this deal is without doubt the companyÆs growth profile, which has been impressive to say the least in the three years since the company was founded in 2004. And if one is to believe the analysts following the sector, it isnÆt likely to slow down any time soon.

What is clear is that China Digital TV offers significantly higher earnings growth than its peers in Europe and the US where the markets are mature leading to lower selling prices and lower margins. What is less clear is how the ChinaÆs strict regulations with regard to the broadcasting industry may impact on the companyÆs business. The state controls everything from the broadcasting content, the content and amount of advertising and the price of pay-TV subscriptions to the role of private sector and foreign investment into the industry

For instance, the governmentÆs support for the transition from analogue to digital transmissions could change or cable TV licenses of some of the companyÆs key customers may be withdrawn, making it impossible for them to continue operating. However, many investors may argue that this is all part of the risk of investing in Chinese companies and as long as the returns are in line with those risks they are okay with it.

Looking at the historical numbers, China Digital TVÆs revenues have grown at a compound annual growth rate (CAGR) of 188% between 2004 and 2006 and its gross and net margins last year stood at 61% and 43% respectively.

As the base increases, the growth will slow somewhat, but according to sources the company is still expected to deliver revenue CAGR of 47% and net income CAGR of 70% in 2006-2008. For 2007, they anticipating a gross margin of about 60% and a net margin of 57%.

ôThis is the only way to play the China digital cable growth, and you will have great margin growth - gross and net - versus the comps,ö one observer says.

It is not entirely true that it is the only way to play this theme, as Hong Kong-listed DVN Holdings is also active in the same industry, although on the hardware side. According to sources close to the deal, this makes it less valuable as a comparable to China Digital TV.

Better comps in terms of the business model, they say, are US-listed NDS or Swiss exchange-listed Kudelski Group, which both trade at about 17-18 times their projected 2008 earnings. At the top end, China Digital TVÆs IPO range pitches it at a premium to that, at about 20 times, but based on its higher growth profile this is warranted, sources say.

The low end of the price range valued the listing candidate at 16.9 times its 2008 earnings, based on consensus syndicate estimates.

A pre-IPO round of funding brought in Softbank and the Indus hedge fund as shareholders of the company. After the IPO they will hold 17.1% and 3.2% of the company respectively.
¬ Haymarket Media Limited. All rights reserved.
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