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研究部 (Research Team)
輝立証券

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For Research Report and Business enquiry

Beneficiary of 3G

Thursday, July 31, 2008

5083

A8 Digital Music Holdings Limited(800)

Recommendation on 31 July 2008
Recommendation	Buy
Price on Recommendation Date	$1.500
Target Price	$1.790

Weekly Special - 2333 Great Wall Motor

Highlight

We rate A8 Digital Music Holdings Limited (0800.HK; A8) as Buy with HK$1.79 target price-----We believe, the company was one of the main beneficiaries of launching 3G mobile technology in the PRC. As the group’s main contributions of revenue came from Music-related services in the past 3 years, while Music accounted for the largest part of mobile entertainment services in telecom market, it is reasonable to expect that when the telecom market and 3G technology becomes more mature in the PRC, the group will be benefited more. Our target price is based on target price-to-earnings, which is equivalent to a 2008E P/E at 10.5x and 2009E P/E at 9.1x, suggests potential 19.3% upside. Recommend Buy.

Overview

A8 is an integrated digital music company, which sources their music content mainly in 2 ways: (1) their own interactive Internet UGC platform, www.a8.com, (2) as well as from other international and domestic record labels. One of the services provided is that they sell the music content in various forms such as ringtones, RBTs and IVR Music to mobile subscribers in the PRC, though the wireless network of mobile operators in the PRC and on the Internet.

There are mainly two broad categories of the music content distributed by the group, namely the original independently produced music content, which is uploaded to the A8’s own interactive Internet UGC platform, www.a8.com, by artists, and other music content, which is licensed from international and domestic record labels.

Besides the music-related services provided, the group also distributes non-music content, which include but not limited to games, wall-papers, entertainment news, jokes and so on.

Business

As the group distributes its products to mobile subscribers through not only the internet but also, mainly, the existing two mobile operators in the PRC, China Mobile (0941.HK; CM) and China Unicom (0762.HK; CU), those 2 mobile operators are the major customers of A8. CM accounted for approximately 86.3% while CU accounted for approximately 13.4%of total revenue in 2007 of A8.

Most of the revenue of A8 is settled through CM and CU by a revenue sharing model, where A8 sets the price of their services for mobile entertainment with the mobile operator partners (CM and CU). For the subscribers whose would like to use the services, they can choose either to pay for single purchase or to subscribe for subscription packages.

Financial Highlight

The financial of the company does not give any surprise in the past few years. All of the growth on revenue, gross profit and net profit of the company would be stable.

Moreover, the compound annual growth rate (CAGR) of the group is not outstanding too. It just manages to reach double digits in the last 3 years.

Although the growth of the group is not surprising, its profitability seems to be sustainable in the past few years. The gross profit margin of A8 indeed keeps dropping in the past years due to the rising pressure of the cost. Nevertheless, the net profit margin, despite fluctuate, rose to 19.3% in 2007 from 14.8% in 2006 and 17.9% in 2005.

However, when we go into more in-depth to analyze the financial statement of the group, we would be able to discover that some of the items should not be included when we access the operation efficiency and profitability of the group.

In the above table, we can see that the “other income and gains, net” proportionally equal to 0.4% of revenue in 2005, and rose to 3.6% of revenue in 2006, and then further rose to 7.1% in 2007.

Those “other revenue” should indeed approximately RMB537,000, RMB3,920,000, RMB10,712,000 in 2005, 2006 and 2007 respectively come from non-recurring items.

So, when we exclude those effects for the company, the net profit margin in 2007 of the group should go down by about 1.6%, and it becomes a normalized net profit margin 17.7%, approximately equal to the one in 2005.

Expect a faster grow after introduction of 3G in the PRC

While the group has a relatively higher reliance on its music-related services provided to the mobile subscribers, we strongly believe that, when the introduction of the 3G technology will come soon after the restructuring of the telecom sector, A8 will certainly be benefited. It is firstly because that, among the mobile entertainment services, music related services account for the largest portion in the global market. We believe there will be similar case in the PRC after it becomes more mature.

Also, it is because with a relatively faster speed by using 3G technology, it is reasonable to expect a higher demand of such services. Also, the market will be more mature with the support of such technology. Furthermore, when the per capita disposable income of both urban and rural households keeps increasing in the PRC under the rapid growth of economy, it is reasonable to expect that mobile subscribers will increase their spending on value-added services. (In fact, there is a trend for the telecom operators to achieve an increasing revenue contribution from such value-added service.)

Statement of risk

We believe the major risks of A8 are as follows: (i) low bargaining power with customers due to limited number of customers available in the market; (ii) high reliance on major customer; (iii) failure to identify music content with potential for popularity.

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