Notable Calls

Youku.com (NASDAQ:YOKU) and other Chinese online-video stocks could be on fire today after news the State Administration of Radio, Film and Television (SARFT) is planning to request that all advertisements aired during TV dramas should be removed nationwide in 2012. The losses caused by this new policy could be in excess of Rmb20bn.

We have couple of firms out with comments:

- Mirae Asset, a HK based brokerage sees this as a major positive to online video companies, including YOKU, TUDO, SOHU and Baidu Qiyi. The firm estimates at least 15-20% of the lost Rmb20bn advertisement fees will flow to online video, with the remaining flowing to outdoor media.

According to iResearch, online video advertisements had a revenue run rate of Rmb1.3bn in 3Q11. In particular:

- While SARFT did not specifically ask to remove advertisements before and after the TV drama (pre-roll and postroll), these advertisements are not as effective as the ones during (mid-roll) the drama. Also, adding pre-roll or postroll inventory would dilute the existing advertisers’ right and reduce their effectiveness. Assistant director of Jiangsu Satellite TV has already confirmed that the mid-roll will not be shifted to pre-roll and post-roll.They believe other TV stations will follow Jiangsu;

- Coupled with SARFT’s earlier regulation for major satellite TV stations to limit the amount of entertainment programming that can be shown in 2012, the cancelled advertisements could find it difficult to shift to other
programs

- Online video is the closest alternative to TV, while outdoor media could also benefit;

- Advertisers are currently planning their budgets for next year. The law came at the right time.


YOKU will be the major beneficiary because its market share has gained
Mirae estimates YOKU to get 40-50% of the incremental advertising spending in online video because YOKU’s has enough inventories to digest the advertisers’ demands. Baidu Qiyi has already added mid-roll advertising but YOKU hasn’t, which means it can now sell for a higher price.

YOKU’s aggressive investment strategy will pay off. In October, YOKU’s time spent market share within the top 15 (P2P and web combined) rose 2.3ppt to 17.3%, the fastest gainer in the month, while SOHU Video, TUDO and Baidu Qiyi lost ground. If only counting web, YOKU’s time market share increased to 34% in October from 29% in September.

In 2012, YOKU has secured 22 exclusive TV dramas. With YOKU’s overall utilization still in the mid 20%’s, the chance for it to further increase revenue growth is high.

YOKU is Mirae's #3 top pick in China’s Internet sector with a TP of US$31.5.


- Goldman Sachs' Catherine Leung views these proposed regulations as materially positive for online video in general and Youku (YOKU) in particular.

The proposed regulations coincide with mass adoption of online video, with Youku leading in user traffic and time spent.

The regulations would follow recent SARFT rules issued in late October limiting entertainment content (e.g. variety shows) and imposing some ad controls. For example, Xinhua has reported possible new regulations to further restrict the amount of prime-time entertainment content among satellite TV stations.

Leung reiterates Conviction Buy rating on YOKU.

Notablecalls: If Mirae estimates prove to be correct, the new SARFT rules could more than double China's online-video opportunity. With YOKU among the top-tier players, this could prove to be very beneficial for them.

Do note however that analyst consensus revenue #'s for 2012 already foresee a 100% growth rate. Nonetheless a material positive, as GSCO notes.

I'm thinking $17.50+, that's a 10%+ move.

Quick note: Long term Focus Media (NASDAQ:FMCN) bull Juan Lin from Wedge Partners is out with some thoughtful comments on the name. . I've been on FMCN's case past 24 hrs so I'm posting for the sake of objectivity. Worth a read guys.

The Waters are Clear

Yesterday research firm Muddy Waters posted a report on Focus Media (FMCN) recommending a ‘strong sell’ on the stock based on an accusation of fraudulently reporting operating numbers and historical write-downs. We believe that most of the comments are based on historic events, misunderstandings of the business and has insufficient support to lead to the conclusion.

MW: FMCN has been fraudulently overstating the number of screens in its LCD network by approximately 50% – particularly in Tier I cities. FMCN claims to operate 178,382 screens, but the actual number in FMCN’s media kit is less than 120,000. This is similar to China MediaExpress Holdings, Inc. (OTC: CCME), which we reported is a fraud on February 3, 2011. We therefore question whether FMCN’s core LCD business is viable.

The LCD commercial network includes LCD TV screens and LCD digital poster frames. MW only counted LCD TV screens to accuse the company of fraudulently overstating the number of screens. The company sells to advertisers with detailed lists of buildings and numbers of screens in the building, who understand the difference.

FMCN also plans to ask a well-known global third party survey company to investigate the number of screens. The company will hopefully deliver the report in 2-3 weeks.

MW: Like Olympus, FMCN is significantly and deliberately overpaying for acquisitions, writing down $1.1 billion out of $1.6 billion in acquisitions since 2005. These write-downs are equivalent to one-third of FMCN’s present enterprise value. FMCN’s overpayments include fraudulently booking at least six mobile handset advertising acquisitions that it never made. Olympus’s situation may explain why FMCN overpays for acquisitions. Olympus management has stated that Olympus deliberately overpaid for acquisitions in order to disguise losses on investments. Questions remain about whether individuals associated with these transactions also pocketed the money, and / or whether the acquisitions were really used to cover losses in Olympus’s seemingly robust core business.

We went through the time periods when Chinese outdoors media companies were having severe competition in expanding market share. In order to demonstrate consistent strong growth, Focus Media decided to make massive acquisitions through earn-out terms. The company had to sometimes pay a very high premium in order to stop competitors from issuing IPOs. Target Media, Frame Media and CGEN were the primary cases. We have talked to people in this industry and understand the acquisition of these entities were NOT fraudulent, although the acquisition of CGEN was a failure.

MW: FMCN has written at least 21 acquisitions down to zero and then given them away for no consideration. We show that many of these write-downs are not justified. There are several possible nefarious reasons FMCN gives acquisitions away, including doing so may put FMCN’s problems beyond the reach of auditors.

The company used to have a bad strategy of expanding through acquisitions. Some of the acquisitions were unwise and not well assessed. The company learned from that lesson and has not made any further acquisitions in the last three years. The company disposed of all of the subsidiaries from 2009 to 2011 since Jason Jiang returned to the company in 2009. The focus on core business development has been proven to be successful. The company does not intend to make major acquisitions in the foreseeable future either.

The company indeed used to overpay for some of the acquisitions and decided to stop paying for the second and third payments due to the tough advertising environment in 2009 in order to maintain cash. The impairment of acquired companies is mainly due to such situations and also the write down the company had to take after the stock price dropped from $60 to $6. Other examples like Allyes and some media companies do not have a lot of assets apart from people, so the large impairment is also understandable once the operation is not going well and talent left the company.

Another reason for some impairment is due to the Shanghai Expo during which the Shanghai government prohibited outdoor advertising in certain ways in 2010.

MW: Sales of FMCN shares by insiders have netted them at least $1.7 billion since FMCN went public in 2005.

The shareholders mainly include early investors including Softbank, IDG, Goldman Sachs, and management of Target Media and Frame Media. More importantly, CEO Jason Jiang has not sold any shares since 2006; but, instead, increased his share of the company over time.

On its conference call this morning with investors, FMCN stated that it is talking to its law firm in deciding whether to file a lawsuit in responding to Muddy Waters’ ‘misleading report’. The company maintains its outlook for 25% top line growth for 2012, of which 20% is organic growth and 5% from the new interactive screen business, and has not yet seen any abnormal spending pattern from advertisers. Advertisers have also provided positive feedback to FMCN’s new interactive screen business. Additionally, the company plans to accelerate share its buyback plan due to the share price drop caused by the MW report.

While remaining concerned about the potential growth slowdown of next year’s advertising market due to the macroeconomic environment, we have learned that the digital out-of-home market has been evolving from 2008, and has become a strong substitute for TV advertising. Advertisers have been driven away from the TV platform by the price hike (over 30% annually) and have gradually dropped some low quality, local TV stations. Advertisers are shifting budget to outdoor digital platforms and online especially online video platforms. For outdoor platforms, those who can reach to end consumers, including Focus Media’s networks, in-store screen networks, in-cinema advertising networks, bus-stop posters and ad networks on transportation tools should see healthy growth.

Furthermore, the possibility of advertisers suddenly ceasing spending like what happened in late 2008 will unlikely happen either in 2011 or next year. We have seen the normal year-end advertising budget flush into various media platforms, and the current feedback from advertisers on outdoors advertising platform still indicates normal growth for next year.

Compared to Focus Media’s platform, which can provide sales campaign themed ads, we are more concerned about traditional billboard and brand advertising platforms such as AirMedia’s platform.

Notablecalls: The problem with FMCN doesn't seem to be related to their core business but rather related party transactions.

As some of you may have noticed, I haven't been that active in posting over the past couple of months. This can partly be explained by lack of substantive calls and the overall tough trading environment but Twitter does have a major part to play.

http://twitter.com/#/thenotablecalls

It's just that cramming my thoughts into 140 character pings via Twitter has been so much more time effective than writing & editing long blog postings.

Oh, and I get to change my mind there!

Let me give you an example:


- Nov 17: Salesforce.com (NYSE:CRM) issued worse than expected results, causing the stock to drop as low as $112 (prev. close $126.09) in after hours trading. The stock rebounded to $118 after management gave it their best shot to explain away the deferred revenue & billings miss on the conference call.

- Nov 18: After shifting through the overnight analyst commentary on Salesforce.com (NYSE:CRM) I posted the following comments around 07:00 AM ET. The stock was trading at around $117.

$CRM - Every Tier-1 firm out defending Salesforce.com (CRM) this AM following #'s. Sell side lovefest. It's down 9pts from close. Bounce?

$CRM - DBAB's Tom Ernst PT now $205, new Street high. 'Contracting optics obscure accelerating momentum' he says.

Bio-Reference Labs (NASDAQ:BRLI) a lab testing company currently under siege from short-sellers at Streetsweeper.org appears to be losing Sell side analyst support this morning after Jefferies & Co decides to put their rating Under Review (prev. Hold).


- Jefferies analyst Arthur Henderson notes they expect BRLI shares to see increased pressure after a second short report, published on Thursday afternoon, criticized the company's business practices and the background of certain employees. While they have no reason to believe the company has done or is doing anything inappropriate or unethical, the firm believes the news will not be well received and could elicit scrutiny from regulators. Rating under review (from Hold).


The details:

The Street Sweeper strikes again. On Thursday afternoon, The Street Sweeper, an online research organization whose goal is "to uncover the dirty little secrets that investors need to know," released the second part of its investigation into BRLI's business practices. The report digs deeper into BRLI and discusses the alleged sordid background of a few current and former employees. As a reminder, the first report was issued on November 1st and raised concerns about the viability and sustainability of BRLI's earnings growth, which has been fueled in part by increased utilization of the company's GenPap test -- a sophisticated test allowing OB/GYNs to better screen and detect a wide range of organisms such as chlamydia, gonorrhea, syphilis, etc. That report also articulated concerns about the company's billing practices, its weak cash flows, and salesforce tactics.

A new overhang emerges for BRLI. The Street Sweeper report is definitely an eyeopener and could spook investors as well as draw the attention of regulators. While we have no reason or evidence to conclude that the company or its employees have done anything unethical or inappropriate, the allegations are poignant and could provide a meaningful overhang on BRLI shares.

Notablecalls: Well this is alarming. I expected a garden variety Sells side defense but not this.

With Henderson calling the Sweeper report an 'eyeopener with potential to draw regulatory attention' I would not be surprised to see the stock in free fall.

Note there's 28% short interest in the name.


Here are the reports:

Is Bio-Reference Laboratories as Healthy as It Seems?

Bio-Reference (BRLI): Loads of Dirty Laundry

Geen Mountain Coffee (NASDAQ:GMCR) trading down 30%+ following results and guidance reported last night.

- Most analysts are defending the name.

- Canaccord analyst Scott Van Winkle highlights something I would like to share with you:

'...A bear would argue that our (positive) opinion is shaded by our rose colored glasses. Well, we heard people saying the exact same thing in the exact same situation in Hansen Natural (HANS : NASDAQ : $90.09 | HOLD) in May 2010. We remember this so clearly because the HANS correction last May was the greatest buying opportunity we have ever seem on a timing issue around a price increase and the greatest miss we have ever had as a sell-side analyst. HANS instituted a price increase in January 2010 that led to massive buying by distributors ahead of the increase and even though the company knew there was a channel load, it didn’t realize how significant the buy-ahead was. Sound familiar? The result was that HANS crushed Q4/2009 results and then missed the subsequent Q1/2010 estimates by an even wider margin than GMCR’s relatively modest miss last night. HANS shares plummeted from near $45 to as low as $25 intraday.

The stock plummeted on an apparent slowing. Yet, third-party data from the likes of Nielsen and IRI continued to show robust growth at point of sale. Sound familiar? GMCR just put up a figure that will lead some investors to think business is slowing. It isn’t, in our view, because the third-party data from the likes of Nielsen and IRI, but more importantly NPD on brewers, show continued growth and even accelerated growth of brewers. For those who follow consumer staples, we don’t need to remind you what happened next with HANS. It is obvious in hindsight. Growth continued, shipments caught back up to the sell-through data in the next quarter, and HANS went on an extended rally to close yesterday at $90.09 ($97.31 is the recent high). If you dumped HANS on the miss, you missed a triple. This may not sound familiar yet for GMCR, but we expect it will....'

Notablecalls: Just draw your own conclusions. Calling it Actionable Call Alert!


"History doesn't repeat itself, but it does rhyme."

-- Mark Twain

Janney's Tony Wible is dealing a potential death blow to Dreamworks Animation SKG (NYSE:DWA) downgrading the name to Sell from Hold while lowering his price target to Street low of $12.

According to Wible they are increasingly concerned about the decay in franchise film performance, the possible cannibalization from the NFLX deal, the weak open on Puss in Boots, and their diminished outlook on new IP films. These concerns are exacerbated by the steep decline in DWA's DVD sales, but is partly tempered by better international performance, the near term boost from NFLX catalog sales, strong non-film performance, and the potential for self distribution savings in 2013. On balance, Janney believes estimates will need to move lower and sees the risk/reward on the stock in favor of a Sell rating.

KEY POINTS:

Downgrade on Spike and Optimism - We are downgrading DWA to Sell from Neutral, as we believe the street is too optimistic about the rebound prospects on Puss In Boots, which we believe is now trending towards a $135 million USBO ultimate (below our reduced expectations). The under performance leads us to question the prospects on DWA's future slate of new IP films. We are reducing our fair value to $12 based on the reduction in our estimates.

Lower Generic Expectations - We believe the generic $200 million USBO film will trend down to $175 million. While foreign performance has helped worldwide numbers, the high rental rates offset much of the benefit. Our reduction of Puss In Boots numbers and the reduction in new IP film estimates (Guardians, Croods, Turbo, Shadow) lead us to reduce our 2012 and 2013 EPS to $1.07 and $0.95 from $1.41 and $1.50, respectively.

Franchise Fatigue - The core of DWA's business has been under pressure as established franchises are decaying faster than expected while new IP films have yet to create new franchises. The company is still producing some of the highest grossing animated films but the relative weakness and the string of disappointments will likely cast more doubt over future releases. Mounting competition also stands to commoditize the value of DWA's IP.

DVD Doubts - The entire industry has seen weakness in disc sales. However, DWA's compression in DVD to Box office ratios have been higher than its peers, which we ascribe to its support of cheap rental services. While the new NFLX deal will provide incremental catalog revenue near term, this deal has the potential to cannibalize new release and catalog disc sales as the output deal launches in 2013.

Foreign Exchange - The recent strength in the USD could be another headwind for DWA, as it produces its films in USD but sees more than half its revenue from international markets. The high USD would essentially deprive DWA of high margin revenue. While P&A spend is a hedge, each DWA film is expected to be profitable so the hit to revenue will be greater than the expense offset. We would note there has been recent weakness in key Latin American currencies that are now trending between a 4% to 8% YOY headwind.

One Last Hurrah - Puss will likely rule the USBO for one final weekend and may gross between $25 to $35 million, which could fuel more bullish optimism. However, Puss's run is coming to a close as Happy Feet 2 launches next week.

Notablecalls: So who is Tony Wible from Janney you ask? The guy who nailed (or killed) Netflix.

- April 26, 2011: Headwinds Trump Momentum – Downgrading To SELL

- Oct 10, 2011: Upgrade to Hold

- Oct 25, 2011: Downgrade to SELL with $51 PT


And now it appears he is going after DWA with similar vigor, cutting PT and estimates way below Street.

This alone should send tremors down the holders' spines.

DWA should get hit after open and then drift down in the n-t, possibly below $18 level.



PS: I'm posting this around open.

Career Education Corp. (NASDAQ:CECO) literally shit the bed last night as the co issued a slew of announcements this evening, including 1) the resignation of CEO Gary McCullough, 2) an update on its internal investigation into placement rates, and 3) its third-quarter results (a week earlier than expected). Board chairman Steven Lesnick has been named CEO while the board conducts a search for a permanent replacement.

CECO revealed that 36 of its 49 ACICS-accredited Health Ed and Art & Design schools failed to meet minimum accreditation standards for its placement rates in 2010-2011.

I've seen 3 downgrades so far but I'm quite sure more will follow after the 8:30 AM ET conference call concludes:


- William Blair is lowering CECO to Underperform saying that given 1) the likelihood that estimates will come down a lot for 2012 and 2013, 2) the chance of a material fine/settlement could occur, and 3) visibility on a recovery in starts for every franchise but the international business, it is difficult to value (in other words where would the stock be a buy) the enterprise with traditional metrics. On a rough sum-of-the-parts basis, (no value for Health or A&D, $50 million to $150 million in legal liabilities or fines, and $300 million in teachout cash flow losses over 2 years at Health and A&D) they believe the stock is worth probably $10 and $12, but a lot of that value depends on what 2012 profits in the University segment are; hopefully they will get a better feel for that on Wednesday’s call.

- First Analysis cuts CECO to Underweight noting they believe the independent counsel has not yet completed its investigation into the company's other segments, suggesting additional issues may still be uncovered. AIU and CTU are regionally accredited and thus don't have to report placement-rate data to their accrediting body (the Higher Learning Commission), though they believe they have provided placement data to prospective students, potentially exposing them to other legal and regulatory risks if the data proves to have been inaccurate.

Firm expects Career Education's stock will trade down meaningfully today. However, given the difficult-to-quantify and potentially substantial nature of the issues noted above, they find it difficult to recommend even investors with a deep value focus take a meaningful position in the stock at present.

They believe other names in the sector may trade down as well as investors ask whether others could have similar issues. Firm reminds investors that many of the companies in their coverage universe are regionally accredited and don't purport to offer placement services, much less report placement rates to their accrediting bodies. (These include Apollo, American Public Education, Capella, Strayer, and institutions at non-covered companies Bridgepoint and Grand Canyon. DeVry University is also regionally accredited, and while it does provide graduate employment data to students, First Analysis is confident in DeVry's internal controls.) They also believe nationally accredited schools that have grown organically, such as ITT and UTI, have operational controls in place to prevent such issues. Finally, they note that while Career Education's announcement may provide another arrow for Senator Harkin's quiver in his campaign to further clamp down on the sector, the placement-rate question isn't a new one, and a hearing he held in September 2010 was on precisely this topic.


- Stifel cuts to Hold from Buy noting that while an earnings and enrollment miss in this very challenging environment is not shocking, their original Buy thesis was predicated on the sum of the parts being greater than the enterprise value, improving academic quality, and progress being made by a relative newer management team. While progress was made on several fronts, the board’s decision to accept the CEO’s resignation in light of recent allegations of inflated placement rates in the health care division suggest lacking integrity in disclosed metrics. As such the firm believes the stock will be in the state of limbo for the foreseeable future. They therefore feel compelled to move to the sidelines until the management situation is clarified/resolved.

- CSFB says they expect shares to face significant pressure this morning.

- Baird says they expect CECO to trade down today.

- Morgan Stanley notes they expect shares of CECO to decline sharply as investors come to terms with the CEO’s sudden departure, findings by outside counsel of improper placement practices, and pre-reported weak Q3 results. CECO has a history of accreditation issues and in the current environment, in which accrediting bodies have been under pressure to better police the industry, they do not expect this to be handled with leniency. Firm notes though that this issue appears to be CECO specific and while the whole group is likely to trade off, they would view this as a buying opportunity for companies with better records of regulatory compliance.

Notablecalls: Reading the PR, all I could think was 'is this going to single digits now?'

Utter clusterf*ck and this could get worse as the independent counsel completes its investigation. Note the 49 colleges investigated represent around 40% of CECO revenues. So there could be more to come.

CECO has 6 bucks of cash per share on the balance sheet, which should limit the downside to $9-10 level.

This could hurt the entire sector. It's unlikely CECO is alone in this with its placement issues.