Thursday, April 22, 2010

Reader Question about China Mass Media


I've written about China Mass Media (CMM) before and said that I have a long position in the company.

Earlier this week, a reader asked me:

"How is it possible that CMM's operating cash flow exceeds its revenues? I'm looking at its financials from Yahoo! Finance."

I posed this question to Eric Cheung, CMM's CFO, with whom I met last month in Beijing. Here's his response:

Here is the reason for our operating cash flow is greater than our revenue for the years ended 2005, 2006, 2007 and 2008.

One simple sentence answer:

We were able to manage payments of media cost liabilities to be settled at a much slower pace than we collected revenue from the advertisers or their agency firms.

A full story version of the answer:

During this four year period, the overall Chinese economy is rapidly propelling and advertising industry was one of the industries receiving such benefit. Being a huge earner of the Chinese advertising budget cake each year, CCTV also enjoyed a steady and significant growth in terms of revenue.

Due to high quality of CCTV's air time resources, CCTV requires prepayments from advertisers for their advertisements to be broadcasted on its network. We leverage on this bargaining power and be able to request prepayments from our customers in most of the case. So, our revenue collection is very timely.

Due to our advertising air time contracts structured with CCTV, for most of CMM's products, we were obliged to pay CCTV after the advertisements have been broadcasted as we adopted "revenue sharing" type of business model with CCTV. We paid CCTV when they billed us. And CCTV did not demand for significant payments of media fees during this period of time. Hence, we had accumulated significant amounts of accounts payable on the balance sheet during this period as well.

A little extension to the answer:

However, such situation was reversed in 2009, when the global economic crisis finally hit China starting from late 2008. CCTV started to collect our payables to them starting from mid 2009. Hence, you can see from my balance sheet, the balance of accounts payable has been significantly reduced in 2009 and the company have a negative operating cash flow in 2009.

Following the change of the Station Chief of CCTV in 2009, the new officer had installed many new mechanisms when dealing with advertising agency firms. Now CCTV increasingly used underwriting model rather than commission model to deal with its advertising agency firms if they want to secure some exclusive ad resources. Personally, I see the significant negative operating cash flow in 2009 was an one-off event and everything should be "reset" to the normal level starting from 2010 and we should not have significant accounts payable accumulation anymore in the future. Generally, my expectation is 1-3 months creditor turnover days.

I hope I had made a clear explanation and thank you once again for your interest in our company.

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