Reader Question about China Mass Media

$CMM

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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China Trip: China Mass Media

By Eric Jackson
RealMoney Contributor
4/19/2010 3:30 PM EDT
Click here for more stories by Eric Jackson

Three weeks ago in Beijing, I met with the management of China Mass Media (CMM - commentary - Trade Now), one of the few U.S.-listed Chinese advertising agencies. Despite some challenges in the past year, it's trading at an attractive valuation and is worth a closer look.

I met with CEO and Founder Wang Shengcheng and CFO Eric Cheung. Mr. Wang launched China Mass Media in 2003 and has always had a special relationship with CCTV -- China's largest domestic broadcaster. As a former producer, he enjoys a relationship with a range of CCTV's senior ranks, which helped early on. CMM has traditionally made its money bidding or brokering for ad slots on CCTV.

The Chinese ad industry is still growing by leaps and bounds. During my recent trip, I was amazed by how bombarded consumers are with TV, outdoor, and print ads. You can't ride public buses without seeing ads playing on a couple of screens inside. Of all these ad mediums, TV is the biggest, accounting for $5.9 billion, or 40%, of the total ad market in China as of 2007. Since then, the TV ad market has been growing an estimated 14% yearly.

State-owned CCTV is the dominant player. It's like a combined version of the Big Three U.S. networks, though, like the BBC, it has multiple versions of itself. The niche cable and satellite specialty channels continue to grow, buy CCTV still holds the bulk of national Chinese viewers.

In addition to being a broker for key programs on CCTV, CMM has enjoyed substantial profit margins for years as the exclusive ad agent for CCTV's broadcast of the Chinese New Year Gala. Imagine an ad agency with a lock on selling Superbowl slots in the U.S. and you'll get the picture.

At the moment, some of the changing industry dynamics have rocked CMM. First, CCTV recently announced that CMM would no longer be its exclusive agent for New Year Gala slots. At the same time, the ad business has been so red hot in the past couple of years that last fall's CCTV auction for media underwriters yielded record results.

....

[This post is an excerpt of the full article, available by clicking here to go to RealMoney.com. Note: subscription required.]

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Ask Your Questions for Chinese Growth Companies

I am going to be in China for 2 weeks at the end of this month to meet with management of several Chinese companies. I'm now working to confirm the final list of meetings, but it appears likely as though I'll meet with the majority of the following companies:

- Origin Agritech SEED

- China Agritech CAGC

- China Mass Media CMM

- China Wind Systems CWS

- Puda Coal PUDA

- FUQI FUQI

- Universal Travel UTA

- Shengkai Innovations SHE

If you have any specific questions, please send them along. If I ask, and they answer, I will post the responses once I get back.

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