Phoenix New Media: Special Dividend, Strong Asset Value, Strong Brand, Weak Profitability

• Phoenix New Media (6/6 closing price = $3.45) is selling a majority of its strategic investment in Yidian Zixun for estimated net cash proceeds of US$409mm ($5.62/ADS).
• The company expects to pay a special dividend of 15-25% of proceeds ($0.84-$1.40/ADS)
• The company will retain net cash + ST/LT investments after the dividend of $552-$593mm ($7.56-8.12/ADS)
• Phoenix’ news business is a well-regarded market leader, but profitability has been pressured by intense competition and weak consumer spending
• Phoenix will invest retained proceeds from the Yidian sale to extend its news brand into related areas with improved revenue potential

Phoenix New Media (FENG) invested $92mm between 2014-2016 to acquire a 37.6% stake in Yidian Zixun (一点资讯), a news aggregation site. FENG agreed in March 2019 to sell a majority of its holding for gross cash proceeds of $448mm (estimated $409mm after transaction costs) and will retain a 5.63% stake with an implied value of $79mm. The share price (net of the the dividend described by management during the 1Q19 conference call) will be a bargain relative to remaining asset value. The company’s strong media market presence provides potential for future growth in profitability, but there is a risk that Yidian proceeds will be deployed into new initiatives that are not successful.

If shares trade at a conservative 50% discount to post-transaction asset value then current buyers may receive a near term return of 63% ($4 fair value/$2.45 basis). A substantially larger gain is possible over a 2-3 year period as investors gain confidence in the company’s operating business.

Important risks are

1. The Yidian sale transaction could fail to close
2. The company could choose to pay a different dividend amount or no dividend at all.
3. Asset value could decline and profitability could fail to improve

Topics:

• Company Background
• Industry Challenges
• Phoenix New Business Initiatives
• Valuation
• Changyou Dividend Comparison

COMPANY BACKGROUND

Phoenix New Media was spun off by Hong-Kong listed Phoenix Media Investment (Phoenix TV or PTV) through a 2011 IPO at $11/ADS.

The shareholding structure carries the risk that decisions about FENG will be made for the benefit of Phoenix TV rather than public shareholders. The structure also provides some protection through Phoenix TV’s strong independent investors (China Mobile, TPG, and Bank of China) plus regulation and disclosure obligations as a HKEX-listed company. The intended return of a portion of the Yidian sale proceeds to all FENG shareholders through a special dividend is a very positive signal about the group’s corporate governance.

Phoenix TV operates 6 cable/satellite channels and has 13 news bureaus in major cities worldwide. A 2018 survey showed its audience has higher average income and professional status than major competitors. Phoenix New Media’s internet business has a foundation of the strong brand image, news, and other editorial content (including video) from Phoenix TV. The ifeng.com website was 7^th most popular in China in March 2019 with over 280mm unique visitors (source: iresearchchina)

Additional information about FENG is available from the company’s IR website, SEC filings, conference calls, and investor presentation. Information about Phoenix TV is available from its Annual Report and other HKEX filings.

INDUSTRY CHALLENGES

Phoenix New Media has a strong position in a market suffering from intense competition while customer advertising spending has been depressed by weakness in many consumer end markets.

Advertising revenues have been pressured from lower spending on luxury goods due to the anti-corruption campaign, weak auto sales, and regulatory crackdown on non-bank financial businesses.

Share price returns have been terrible and most media companies have underperformed the Kraneshares China Internet ETF which has been supported by returns from ecommerce holdings.

Competition increased with the explosive growth of new algorithm driven content distributors including:

• Jinri Toutiao (今日头条 ), controlled by Bytedance Technology which has a reported private market valuation of US$75Bn.
• Qutoutiao (趣头条) which came public in September 2018 and has a current market cap of US$1.3Bn. Qutoutiao has a bias towards lighter news, entertainment, and topics popular in Tier3/Tier4 cities. QTT’s 20-F showed its installed use base grew from 74mm at 12/31/17 to 335mm at 12/31/18 and Daily average users grew from 10mm to 31mm.
• Yidian Zixun (一点资讯) which has an implied value of US$1.4Bn based on FENG’s sale of 32%.

These “content aggregators” have no editorial function and recommend stories based on patterns of user behavior (see SCMP: China’s king of titillating content Jinri Toutiao issues apology for providing what the people want)

Investors have attributed high valuations to the aggregators despite substantial operating losses. FENG was fortunate to recognize the opportunity to participate in this trend through Yidian, but FENG’s share price has not fairly reflect the value of that investment, most of which will soon be realized in cash. FENG will retain a modest stake which could appreciate if Yidian becomes listed in Shanghai or Shenzhen.

PHOENIX NEW BUSINESS INITIATIVES

FENG’s operating profit has been OK relative to other traditional media companies, but their market values are aided by profitable subsidiaries, Netease (NTES), Sohu(SOHU), and Tencent (TCEHY) have games while Sina (SINA) and Tencent have social media. FENG plans to invest its Yidian proceeds in new areas that could benefit from affiliation with the strong Phoenix brand name and ifeng traffic.

• Original Content. FENG is developing intellectual properties which can be used across its platform through video, books, films, and games. The company has incurred substantial costs to develop and launch new series which are not yet covered by advertising revenues, however strong viewership data should lead to licensing revenues from third-party distributors such as Iqiyi, Youku, and Tencent. Recent hits have been:

1. 1. Fireless Power (火力无限 ) is built around use of advanced technologies to perform rescues
   2. Super Tongue (最强辩手) is a debate competition show which has been a big hit on several platforms with combined views over one billion
   3. A journey Through literature (一路书香) features celebrities traveling to locations around China and exploring the meaning and context of famous books

• “we-media” accounts supply editorial content from public intellectuals, commentators, scholars, key opinion leaders, or KOLs and professors. These users are not FENG employees, but share in advertising revenue related to views of content they supply. These business model has some similarities to Seeking Alpha.
• Housing subsection of ifeng.com features editorial content about Chinese and international real estate supported by advertisements for home sales/rentals. FENG claims revenues in this business have grown at a 74% CAGR for the past 5 years (about 16X cumulative increase) and is optimistic about the potential from expanded services. FENG owns 50% of this business and a contractual change will enable FENG to consolidate its operating results from April 2019 providing improved visibility to investors.
• Online Reading combines the content of FENG’s existing Fread with Tadu which FENG acquired 51% of in recent months for US$42mm. The “online reading” business in China has discovered many talented authors who were not previously published or well-known. Anybody can submit content to Fread or Tadu which receives editorial review and promotion if selected for distribution. Readers can pay for content by subscription plan, purchase of individual titles, or by viewing ads . Online reading titles and series that become popular can be used as a basis for games, TV series and films. Tadu averaged over 1mm daily average users at the time of purchase and the acquisition agreement included these performance targets:

1. 1. Daily average users to exceed 1.4mm by December 2020
   2. Original literature titles for which Tadu has exclusive distribution rights to exceed 5315 and exclusive IP adaptation rights to exceed 5950
   3. Annual revenue of at least 180mm RMB in 2019 and 235mm RMB in 2020
   4. Net profit of at least 12mm RMB in 2019 and 18mm RMB in 2020

If successful then Tadu’s high growth and profitability could make a meaningful difference to market perceptions of the value of FENG. If Tadu fails to meet the performance targets then 59% of the acquisition price will be refunded. FENG acquired its 51% stake from Tianyin Communication which retained 49% ownership. FENG management believed Tadu had strong technology, but would benefit from improved access to content, exposure, and adaptation capability as part of the Phoenix Media group.

• Games. FENG hired a well-known game designer in 2015 with a long-term goal of developing new intellectual property. His hit novel Adventure in Skies (九霄奔云传) was published in 2017 and a game adaption should be released around the end of 2019. This preview video released in March.

• New Investments. FENG provided some conference call comments about investment of proceeds from the Yidian sale:

“We remain prudent in selecting strategic investment opportunities. We are only willing to consider those investment targets closely aligned with our funding principles, business philosophies, brand image

 Our initiatives include expanding our own IP production to cultivate a full IP ecosystem, strengthen on our original content production, and enlarging our content library by investing on We-media.

…while the Yidian transaction has provided a handsome return, it also meant that we relinquished an integral piece of our newsfeed and algorithm development strategy. As a result, we’ll need to explore additional investment opportunities that are capable of contributing to organic business growth.

The key areas that we can focus on includes enhancing our AI capabilities, expanding our content library, accelerating our user base expansion, improving the monetization capabilities of our apps, strengthening our brand influence and exploring more investment opportunities in new markets. In fact, we already have identified a few key targets and we will keep our investors posted on our progress. And given our proven record in investment in the last four years, we invested in the Yidian and we achieved very handsome returns. So, we’re confident going forward, we’ll replicate this legacy. But definitely, we have definitely identified several targets. We are in the process of due diligence and negotiations, but it’s still not the time to disclose too much details.”

VALUATION

FENG’s 3/31 financial statements showed net cash and liquid investments of $124mm (US$1.70/share). Details of the Yidian sale transaction are in the sale contract and the Phoenix TV Extraordinary General Meeting Notice. Key closing conditions remaining to be satisfied were approval by Phoenix TV shareholder vote (received on 5/31) and final approval by Phoenix TV Board of Directors. Notification should be sent to the buyer within 15 days and the closing should occur in late June.

FENG management suggested in the 1Q19 conference call that 15-25% of the Yidian proceeds would be distributed as a special dividend, but no final decision has been made.

“we have preliminary planned to use the proceeds as follows; 15% to 25% for potential special dividend payment; 25% to 35% for investment in content verticals, accelerating our organic growth and the general working capital; and 40% to 60% for strategic investments. “

FENG will retain a large cash balance immediately after the closing of the Yidian sale, however a majority of these funds will be invested in new intellectual property and strategic investments. 1Q19 results showed advertising revenues -11% yoy while cost of advertising revenues +31% yoy due to spending on new IP initiatives. The company has not provided earnings guidance, but suggested that a transformation and investment period could require two years. That implies weak operating profits or more likely losses. FENG shares will probably trade at a substantial discount to asset value and may not reflect any value for the core business until the new business initiatives demonstrate high growth and/or profits.

The strong market presence of ifeng/PTV and record of success with Yidian suggest that the company could be successful over a 2-3 year horizon. As evidence of the company’s future direction becomes clearer the discount should narrow, shares could appreciate to Asset Value, and investors could once again attribute value to the core business. If profitability remains weak and new initiatives are unsuccessful then asset value could decline to meet the share price.

CHANGYOU DIVIDEND COMPARISON

The performance of Changyou (CYOU) shares around its recent special dividend provide an example of the benefit to shareholders of a large cash distribution. Changyou’s dividend enabled investors to realize a portion of the full value of the company’s assets which were being valued in the market at a discount.

DISCLOSURES

The author is a shareholder of Phoenix New Media.  The author does not make any recommendation regarding any investment in any company mentioned in this article.  Investors are encouraged to check all of the key facts cited here from SEC and other sources prior to making any investment decisions.