SM Entertainment ( KQ)

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Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including the U.S. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT.

SM Entertainment

(041510 KQ)

China growth story to begin in 2014

3Q and 4Q earnings to be in line; Strong momentum anticipated in 4Q

Despite a sluggish 1H, we expect SM Entertainment’s 2013 revenue to grow 16.5% YoY to W281.5bn, and operating profit to remain broadly flat YoY at W60.7bn under consolidated K-IFRS.

The 1H earnings weakness was attributable to: 1) sharp yen depreciation, 2) overseas concert royalty income being geared towards 2H (only 500,000 concertgoers were reflected in 1H out of 2.32mn concertgoers in 2013F), and 3) a significant fall in album royalties from Japan (direct exports of Korean language albums, which had been a major earnings contributor in 2012).

We see strong earnings momentum in 4Q, as the company should recognize revenue from several directly operated concerts (which are more profitable), including the Korea-China-Japan SM Town tour. We estimate non-consolidated operating profit at W12bn in 3Q and over W18bn in 4Q.

2014 earnings catalysts: China, Exo, and additional revenue streams

China should become a major market for SM in 2014. The entertainment firm is looking into joint ventures with local Chinese firms to establish a broad presence in the country across broadcasting, commercials, TV dramas, and films. The company is purportedly in discussions with major Chinese entertainment and media firms over potential alliances. The boy band Exo is scheduled to hold its first concert (as a headline act) in December and has been added to SM Entertainment’s 2014 concert lineup. Exo’s album is on track to break the 1mn sales mark, which would make it the first domestic album to do so in 13 years. The boy group, which includes four Chinese members, is gaining widespread popularity in China and Southeast Asia.

The company’s subsidiary SM C&C (048550 KQ) should display sharp earnings growth in 2014, driven by: 1) earnings contributions from Woollim Entertainment (which represents the popular group Infinite) beginning in October 2013, and 2) secondary revenue streams, including broadcast productions, fan meet-and-greet tours and merchandise stores. We estimate SM C&C’s 2014 revenue and operating profit at W111.2bn and W11.1bn, respectively.

Maintain Buy and Lift TP to W60,000

While major artists TVXQ, Super Junior, and Girls’ Generation continue to enjoy worldwide popularity, SM has expanded its lineup with the additions of Exo and Infinite. On top of traditional album and concert sales, the company is introducing more profit models, like fan package tours and merchandise stores.

We maintain Buy and lift our target price to W60,000 (from W46,000) after revising up our 2014F earnings and changing our valuation base year and P/E target comparison. We expect two straight quarters of solid earnings in 2H, which should help restore investor confidence. In addition to the nine-day SM Town Week concert in December, the growing visibility of SM’s Chinese joint venture could also trigger upside to the stock.

Entertainment

Company Update

November 14, 2013

(Maintain)

Buy

Target Price (12M, W)

60,000

Share Price (11/13/13, W)

38,400

Expected Return

56%

OP (13F, Wbn) 61 Consensus OP (13F, Wbn) 60 EPS Growth (13F, %) 27.3

Market EPS Growth (13F, %) 15.0

P/E (13F, x) 15.1 Market P/E (13F, x) 11.0 KOSDAQ 505.60 Market Cap (Wbn) 793 Shares Outstanding (mn) 21 Free Float (%) 78.3 Foreign Ownership (%) 10.3 Beta (12M) 1.09 52-Week Low (W) 29,100 52-Week High (W) 69,500 (%) 1M 6M 12M Absolute 3.6 -1.9 -44.5 Relative 6.7 -2.7 -48.4 30 50 70 90 110 130 11/12 3/13 7/13 11/13 Share price KOSDAQ

Daewoo Securities Co., Ltd.

Internet/Game/Entertainment Chang-kwean Kim +822-768-4321 [email protected] FY (Dec.) 12/10 12/11 12/12 12/13F 12/14F 12/15F Revenue (Wbn) 97 143 241 281 357 393 OP (Wbn) 20 26 61 61 77 90 OP margin (%) 20.9 17.9 25.1 21.6 21.4 22.9 NP (Wbn) 17 23 40 52 64 76 EPS (W) 942 1,235 1,994 2,539 3,114 3,675 ROE (%) 22.9 23.1 24.7 22.0 21.8 20.8 P/E (x) 16.0 33.0 22.8 15.1 12.3 10.5 P/B (x) 3.6 7.4 5.5 3.6 2.7 2.1

Notes: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, KDB Daewoo Securities Research estimates

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2

KDB Daewoo Securities Research

Investment points

Gaining Chinese market share on the back of competitive content

China’s service and entertainment markets are growing at a rapid pace <Figures 1-6>. Huayi Brothers Media, a Chinese film studio and record label, is being traded on the Shenzhen Stock Exchange at respective 2013F and 2014F P/Es of 43x and 37x (market cap of at least W5tr). The Beijing SM Town concert held in October drew over 70,000 fans. This resounding success is evidence of the massive popularity of Korean pop culture (especially SM artists) in China. Thanks to the rapid spread of mobile internet, there is almost no time lag between the production of music content in Korea, and consumption in China. SM has an excellent track record of developing globally popular pop groups (from H.O.T. in 1995 to Exo in 2013). Its global presence has been felt mainly in Japan over the past decade, but China will likely take center stage in the company’s overseas growth for the next 10 years.

We maintain our Buy call on SM and raise our target price from W46,000 to W60,000. As the end of the year is approaching, we have changed the base year of valuation from 2013 to 2014. And in deriving our target price for SM, we applied Cheil Industries’ 2014F P/E of 19.7x (the highest level among Korean entertainment and media firms). 2014F peer average P/E levels are 23.0x for global firms and 15.8x for domestic firms.

Figure 1. Foreign investments in China are shifting away from manufacturing to consumption and service sectors

Note: Cumulative Jan.- Aug. 2013 data Source: CEIC, KDB Daewoo Securities Research

Figure 2. Earnings and share price of Huayi Brothers Media

Source: Bloomberg, KDB Daewoo Securities Research (%) -20 0 20 40 60

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aceuticLodgin_alsgEquipm_entManuf_acturingCompu_tersTextilesMining

FDI (3-year average growth) % of all FDI

Increased FDI in consumption-/environment-/finance-related industries

Reduced FDI in traditional manufacturing/light industries -20 0 20 40 60 80 100 120 140 1/10 7/10 1/11 7/11 1/12 7/12 1/13 7/13 0 1000 2000 3000 4000 5000 6000 7000 8000 Revenue (L) Operating profit (L) Share price (R) (US$bn) (RMB)

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Figure 3. Relationship between Korea’s per-capita GDP & growth of culture/arts & service sectors

Note: Real GDP (base year of 2000)

Source: World Bank, BOK, KDB Daewoo Securities Research

Figure 4. Gov’t expenditure on culture/arts & service in China Figure 5. Employment in culture/arts & service in China

Source: National Bureau of Statistics of China, KDB Daewoo Securities Research Source: National Bureau of Statistics of China, KDB Daewoo Securities Research

Figure 6. Service industry as a % of GDP

Source: Bloomberg, KDB Daewoo Securities Research 0 5,000 10,000 15,000 20,000 25,000 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 -10 0 10 20 30 40 50 60 70 Real GDP per capita (L)

Culture/arts & service - YoY growth (R)

(US$) (%)

Culture/arts and service boomed as per-capita income increased from US$4,000

to $10,000 0 1 2 3 4 5 1/07 7/07 1/08 7/08 1/09 7/09 1/10 7/10 1/11 7/11 1/12 7/12 1/13 7/13 (US$mn) CAGR of 23.7% between 2007 and 2013 14 15 16 17 18 9/05 3/06 9/06 3/07 9/07 3/08 9/08 3/09 9/09 3/10 9/10 3/11 9/11 3/12 9/12 3/13 (mn persons)

CAGR of 3.1% between 2009 and 2013

US Germany France Great Britain Italy Spain Taiwan Japan China Malaysia Indonesia India Thailand Brazil Mexico Russia Turkey _Poland 30 40 50 60 70 80 0 10 20 30 40 50 60 (US$'000) (% of GDP) K orea Czech

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Table 1. Earnings forecasts for global media/entertainment companies (US$mn, %)

Revenue Operating profit OP margin Net profit Net margin EPS

Market _cap. 12 13F 14F 12 13F 14F 12 13F 14F 12 13F 14F 12 13F 14F 12 13F 14F SM Entertainment 739 214 269 342 54 56 71 25.1 21.0 20.7 35 43 48 16.5 15.9 14.1 1.8 2.1 2.3 YG Entertainment 476 95 121 147 19 24 35 20.1 19.9 23.8 17 21 29 17.6 16.9 19.8 1.6 2.1 2.8 CJ CGV 962 692 901 1,076 49 67 90 7.1 7.4 8.4 48 40 65 6.9 4.4 6.1 2.3 2.0 3.1 Cheil Worldwide 2,684 2,101 2,594 3,075 112 139 169 5.3 5.3 5.5 83 104 128 4.0 4.0 4.2 0.8 1.0 1.2 CJ E&M 1,102 1,239 1,551 1,719 34 64 98 2.8 4.1 5.7 33 42 74 2.7 2.7 4.3 0.0 1.1 2.0 KT Skylife 1,184 503 584 631 58 94 103 11.6 16.2 16.3 50 82 91 9.9 14.0 14.5 1.0 1.7 1.9 Walt Disney 121,986 45,041 47,823 50,945 9,450 11,276 12,396 21.0 23.6 24.3 6,136 6,933 7,625 13.6 14.5 15.0 3.4 3.9 4.5 Time Warner 60,426 28,729 29,603 30,607 6,214 6,670 7,131 21.6 22.5 23.3 3,019 3,643 3,877 10.5 12.3 12.7 3.4 3.8 4.3 CBS 35,239 14,089 15,216 15,461 3,013 3,326 3,611 21.4 21.9 23.4 1,574 1,894 2,062 11.2 12.4 13.3 2.5 3.0 3.5 Discovery Holdings 30,041 4,487 5,553 6,207 1,861 2,075 2,415 41.5 37.4 38.9 943 1,119 1,371 21.0 20.1 22.1 2.5 3.1 4.0 Viacom 39,823 13,887 13,745 14,427 3,901 3,925 4,266 28.1 28.6 29.6 1,981 2,278 2,422 14.3 16.6 16.8 4.2 4.6 5.4 Liberty Interactive 14,037 10,054 10,261 10,738 1,200 1,175 1,306 11.9 11.4 12.2 1,530 501 617 15.2 4.9 5.7 -0.8 1.0 1.4 E.W. Scripps 999 903 817 920 90 23 93 9.9 2.8 10.2 40 - - 4.4 0.9 0.0 0.9 News Corp. 9,995 8,891 8,790 8,850 140 150 246 1.6 1.7 2.8 506 169 248 5.7 1.9 2.8 0.4 0.4 Clear Channel 569 6,247 6,197 6,345 1,108 - - 17.7 -424 - - -6.8 -3.2 -3.7 -3.0 RealNetworks 257 259 - - -42 - - -16.3 45 - - 17.3 -0.6 - -Pandora 5,426 427 649 898 -38 -30 18 -8.8 -4.6 2.0 -38 -36 14 -8.9 -5.5 1.6 -0.2 0.0 0.2 Avex 1,068 1,679 1,639 1,885 170 158 215 10.1 9.7 11.4 89 97 100 5.3 5.9 5.3 2.1 2.3 2.3 Amuse 174 373 320 332 50 37 39 13.3 11.5 11.6 30 23 24 8.0 7.1 7.1 3.4 2.6 2.7

Huayi Brothers Media 4,664 213 317 413 41 131 160 19.2 41.2 38.7 39 103 122 18.1 32.5 29.7 0.0 0.1 0.1

Average 12.9 14.1 15.9 8.9 9.3 10.3

Notes: Bloomberg consensus; Based on November 13th closing prices; EPS is based on US$. Source: Bloomberg, KDB Daewoo Securities Research

Table 2. Valuation comparison of global media/entertainment companies (US$mn, %)

P/E P/B P/S EV/EBITDA ROE ROA

Market _cap. 12 13F 14F 12 13F 14F 12 13F 14F 12 13F 14F 12 13F 14F 12 13F 14F SM Entertainment 739 22.8 17.3 16.0 4.4 3.4 2.7 3.8 2.8 2.2 11.7 9.2 7.6 24.7 19.6 19.8 16.3 12.8 13.8 YG Entertainment 476 33.3 22.6 16.6 6.5 4.4 3.6 5.9 4.0 3.3 23.2 14.4 10.5 21.6 21.2 23.6 18.0 17.2 18.9 CJ CGV 962 12.2 22.8 14.6 1.9 2.6 2.3 0.9 1.1 0.9 7.3 11.2 8.8 16.6 11.7 16.3 5.6 4.5 6.4 Cheil Worldwide 2,684 24.9 24.5 19.7 3.3 3.7 3.1 1.0 1.0 0.9 12.1 15.4 12.6 13.5 15.5 17.1 4.9 5.7 6.1 CJ E&M 1,102 646.3 26.7 14.9 0.8 1.0 0.9 0.7 0.7 0.6 2.9 3.2 3.0 3.0 3.4 6.1 1.8 1.9 3.4 KT Skylife 1,184 28.5 14.6 13.1 4.6 3.1 2.6 2.8 2.0 1.9 12.1 8.0 7.5 17.7 22.9 21.3 9.5 13.1 12.8 Walt Disney 121,986 19.2 17.2 15.0 2.6 2.8 2.3 2.6 2.6 2.4 11.2 10.1 9.2 14.4 15.6 16.7 7.9 8.6 9.1 Time Warner 60,426 14.2 17.7 15.7 1.5 1.8 1.7 1.6 2.0 2.0 8.7 10.3 9.7 10.1 11.8 12.7 4.4 6.1 6.5 CBS 35,239 14.9 19.3 16.8 2.3 3.5 3.1 1.7 ]2.3 2.3 8.4 10.9 10.2 15.6 18.6 20.6 6.0 7.5 8.1 Discovery Holdings 30,041 25.2 27.4 21.3 3.1 4.9 4.8 5.3 5.4 4.8 11.8 15.0 13.2 14.7 18.0 22.4 7.6 8.9 10.0 Viacom 39,823 12.7 17.8 15.1 3.6 6.6 7.7 2.0 2.9 2.8 8.4 11.4 10.5 24.6 34.6 47.4 8.8 11.8 12.7 Liberty Interactive 14,037 - 26.9 20.3 1.4 2.2 2.1 1.1 1.4 1.3 10.3 12.1 11.3 21.8 7.3 8.9 7.0 4.2 4.8 E.W. Scripps 999 12.1 - 19.0 1.1 - - 0.7 1.2 1.1 4.0 15.9 6.8 7.3 0.0 8.9 4.0 0.0 4.7 News Corp. 9,995 - 48.6 40.7 - 0.9 0.9 - 1.1 1.1 9.6 10.7 9.4 4.7 - - 3.5 - -Clear Channel 569 - - - - - - 0.0 0.1 0.1 11.0 11.6 10.8 - - - -2.6 - -Real Networks 257 - - - 0.8 - - 1.0 - - - 14.2 - - 10.8 - -Pandora 5,426 - - 115.7 20.1 52.3 35.7 4.5 8.4 6.0 - 370.1 85.9 -37.5 3.7 30.8 -19.2 1.7 15.4 Avex 1,068 15.1 10.4 10.4 2.4 2.1 1.9 0.8 0.7 0.6 7.0 5.6 4.2 18.2 19.0 18.9 7.0 8.2 9.1 Amuse 174 6.8 7.4 7.1 1.1 1.0 0.9 0.5 0.5 0.5 1.5 1.8 1.7 17.5 13.8 13.2 11.1 -

-Huayi Brothers Media 4,664 36 43 37 4 8 7 6.4 14.7 11.3 30 37 33 12.8 21.8 21.0 7.4 15.3 15.1

Average 63.4 83.1 23.0 3.6 6.0 4.8 2.1 2.2 1.9 9.5 30.4 12.9 12.4 14.8 19.0 5.9 7.5 9.5

Notes: Bloomberg consensus; Based on November 13th_{closing prices.}

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Music market outlook

Asian music markets, especially China, to grow rapidly

China has become the second–largest movie market in the world, following the US, on the back of: 1) the easing of restrictions on movie imports by President Xi Jinping’s administration, 2) a bump in the quality of domestic releases, and 3) improved infrastructure (e.g., an increase in multiplexes).

By contrast, the nation’s music market accounts for only a small fraction of the global total (1.4% based on 2013F data), according to PricewaterhouseCoopers. While concert ticket sales and CD sales are the respective drivers of the US and Japanese markets, digital music sales are the engine of the Chinese music market (as in Korea). Currently, digital music sales—mainly distributed by telecom operators—make up 72% of the nation’s music market. And it should be noted that revenue from these sales tends to barely cover related payment service and commission fees. Looking once more at the movie industry, we find that theater expansion in China accelerated market changes so rapidly that, now, high-end movie ticket sales (e.g., 3D, IMAX) represent more than 70% of the market. In our view, the proliferation of mobile internet could serve as a similar catalyst for change in the music space. Indeed, mobile internet is providing fans with greater access to music videos and other content, which is sparking a surge in fandom for idol bands. Considering Chinese-language copies accounted for half of the sales of Exo’s latest album (close to 1mn copies total), we believe that the Chinese music market has already begun to evolve. Figure 7. Music market growth over the next five years by country; Growth is stronger in developing countries

Note: Total music market, including concerts, festivals, digital music, and CD albums.

Source: PwC, Recording Industry Association of America, Bundesverband Musikindustrie, Informa Telecoms & Media Figure 8. Breakdown of global music market by country

Note: 2013F total music market, including concerts, festivals, digital music, and CD albums.

Source: PwC, Recording Industry Association of America, Bundesverband Musikindustrie, Informa Telecoms & Media -2 0 2 4 6 8 10 12

China Thailand Vietnam Indonesia Singapore Korea Japan US Euope (%) Five-country avg.: 7.7% Four-country avg.: 1.1% Other 16.9% Europe 37.0% US 30.0% Korea 1.6% _Japan 13.1% China 1.4%

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Figure 9. Chinese music market Figure 10. Chinese music market growth

Source: PwC, Recording Industry Association of America, Bundesverband Musikindustrie, Informa Telecoms & Media

Figure 11. Chinese concert market per capita Figure 12. Chinese digital music market per capita

Source: National Bureau of Statistics of China, PwC, Recording Industry Association of America, Bundesverband Musikindustrie, Informa Telecoms & Media

Figure 13. Chinese CD album market per capita Figure 14. Chinese music market per capita

Source: National Bureau of Statistics of China, PwC, Recording Industry Association of America, Bundesverband Musikindustrie, Informa Telecoms & Media

Source: National Bureau of Statistics of China, PwC, Recording Industry Association of America, Bundesverband Musikindustrie, Informa Telecoms & Media 0 300 600 900 1,200 2012 2013F 2014F 2015F 2016F 2017F Concerts/festivals Digital CD (US$mn) -20 -15 -10 -5 0 5 10 15 2012 2013F 2014F 2015F 2016F 2017F Concerts/festivals Digital CD (%) 0.115 0.12 0.125 0.13 0.135 0.14 0.145 0.15 2012 2013F 2014F 2015F 2016F 2017F

Concert market size per capita (US$) 0 0.1 0.2 0.3 0.4 0.5 0.6 2012 2013F 2014F 2015F 2016F 2017F

Digital market size per capita (US$) 0 0.002 0.004 0.006 0.008 0.01 0.012 0.014 0.016 0.018 0.02 2012 2013F 2014F 2015F 2016F 2017F

CD market size per capita (US$) 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 2012 2013F 2014F 2015F 2016F 2017F

Overall music market size per capita (US$)

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Table 3. Korean music market breakdown and 2013-17 CAGR forecast (US$mn) 2008 2009 2010 2011 2012 2013F 2014F 2015F 2016F 2017F 2013-17 CAGR Concerts/festivals 357 371 376 394 415 432 449 468 484 498 3.6 Digital 139 169 194 238 253 261 268 276 282 287 2.4 Physical albums 114 105 112 118 123 123 123 123 122 120 -0.6 Total 610 645 682 750 791 816 840 867 888 905 2.6 YoY Concerts/festivals 3.9 1.3 4.8 5.3 4.1 3.9 4.2 3.4 2.9 Digital 21.6 14.8 22.7 6.3 3.2 2.7 3.0 2.2 1.8 Physical albums -7.9 6.7 5.4 4.2 0.0 0.0 0.0 -0.8 -1.6 Total 5.7 5.7 10.0 5.5 3.2 2.9 3.2 2.4 1.9

Source: PwC, Recording Industry Association of America, Bundesverband Musikindustrie, Informa Telecoms & Media, KDB Daewoo Securities Research

Table 4. Chinese music market breakdown and 2013-17 CAGR forecast (US$mn)

2008 2009 2010 2011 2012 2013F 2014F 2015F 2016F 2017F 2013-17 CAGR Concerts/festivals 131 143 152 160 172 178 183 188 194 200 3.0 Digital 369 397 419 438 457 516 570 627 688 747 9.7 Physical albums 59 46 36 29 24 22 19 17 15 13 -12.3 Total 559 586 607 627 653 716 772 832 897 960 7.6 YoY Concerts/festivals 9.2 6.3 5.3 7.5 3.5 2.8 2.7 3.2 3.1 Digital 7.6 5.5 4.5 4.3 12.9 10.5 10.0 9.7 8.6 Physical albums -22.0 -21.7 -19.4 -17.2 -8.3 -13.6 -10.5 -11.8 -13.3 Total 4.8 3.6 3.3 4.1 9.6 7.8 7.8 7.8 7.0

Table 5. Japanese music market breakdown and 2013-17 CAGR forecast (US$mn)

2008 2009 2010 2011 2012 2013F 2014F 2015F 2016F 2017F 2013-17 CAGR Concerts/festivals 1,511 1,534 1,564 1,547 1,557 1,574 1,592 1,610 1,625 1,641 1.0 Digital 1,288 1,225 1,141 998 840 813 803 795 785 774 -1.2 Physical albums 5,993 4,784 4,403 4,288 4,265 4,204 4,174 4,130 4,075 4,021 -1.1 Total 8,792 7,543 7,108 6,833 6,662 6,591 6,569 6,535 6,485 6,436 -0.6 YoY Concerts/festivals 1.5 2.0 -1.1 0.6 1.1 1.1 1.1 0.9 1.0 Digital -4.9 -6.9 -12.5 -15.8 -3.2 -1.2 -1.0 -1.3 -1.4 Physical albums -20.2 -8.0 -2.6 -0.5 -1.4 -0.7 -1.1 -1.3 -1.3 Total -14.2 -5.8 -3.9 -2.5 -1.1 -0.3 -0.5 -0.8 -0.8

Table 6. US music market breakdown and 2013-17 CAGR forecast (US$mn)

2008 2009 2010 2011 2012 2013F 2014F 2015F 2016F 2017F 2013-17 CAGR Concerts/festivals 8,150 8,631 8,039 8,441 8,611 8,905 9,216 9,442 9,695 9,984 2.9 Digital 2,910 2,873 2,893 3,264 3,591 3,846 4,065 4,256 4,439 4,598 4.6 Physical albums 5,767 4,602 3,664 3,381 2,822 2,375 2,062 1,795 1,578 1,403 -12.3 Total 16,827 16,106 14,596 15,086 15,024 15,126 15,343 15,493 15,712 15,985 1.4 YoY Concerts/festivals 5.9 -6.9 5.0 2.0 3.4 3.5 2.5 2.7 3.0 Digital -1.3 0.7 12.8 10.0 7.1 5.7 4.7 4.3 3.6 Physical albums -20.2 -20.4 -7.7 -16.5 -15.8 -13.2 -12.9 -12.1 -11.1 Total -4.3 -9.4 3.4 -0.4 0.7 1.4 1.0 1.4 1.7

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8 Earnings outlook

More upside to earnings momentum to emerge in 2014

We expect SM Entertainment’s consolidated earnings to grow only marginally YoY this year, despite an improvement in indicators for earnings and qualitative growth, due to: 1) sharp yen depreciation and 2) a plunge in album royalties from overseas markets. An increased revenue contribution from SM C&C, for which profits and margins are not yet fully on track, is also partially responsible for the projected dip in OP margin.

In 2013, the company’s domestic CD sales are projected to grow 58.8% YoY to 1.68mn copies. CD sales in Japan, which stood at 1.7mn in October, are projected to come in at 2.4mn at end-2013, similar to the 2.45mn copies recorded last year. Meanwhile, the company is expected to attract a total audience of 1.72mn to its concerts in Japan this year, up 81.8% YoY. So far, concerts held in ex-Japan, ex-China markets have recorded a total attendance of 306,000, fewer than the 459,000 figure for full-year 2012. However, an SM Town concert (with a target audience of 100,000) is scheduled to be held in December in Korea, which should sharply push up the company’s ex-Japan concert sales.

For 2013, we estimate SM Entertainment’s revenue and operating profit at W281.2bn and W60.7bn, respectively, under consolidated K-IFRS. In 2014, consolidated revenue and operating profit are anticipated to improve to W357.4bn and W76.5bn, respectively. Of note, the company is expected to see its consolidated subsidiaries generate W10bn in operating profit in 2014.

Figure 15. Quarterly CD sales in Korea Figure 16. Annual CD sales in Korea

Source: Company data, Gaon, Hanteo Information System, KDB Daewoo Securities Research

Figure 17. Quarterly CD sales in Japan Figure 18. Annual CD sales in Japan

Source: Company data, Oricon, Wikipedia, KDB Daewoo Securities Research Source: Company data, Oricon, Wikipedia, KDB Daewoo Securities Research 154 282 425 200 326 389 470 500 0 100 200 300 400 500 600 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13F

Quarterly domestic sales ('000 copies) 0.2 0.6 0.5 0.8 1.1 1.7 0.0 0.3 0.6 0.9 1.2 1.5 1.8 2008 2009 2010 2011 2012 2013F

Annual domestic sales (mn copies) 194 541 765 477 689 390 610 720 0 100 200 300 400 500 600 700 800 900 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13F

Quarterly Japanese sales ('000 copies) 2.9 2.5 _2.4 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 2011 2012 2013F

Annual Japanese sales (mn copies)

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Figure 19. Concert ticket sales in Japan Figure 20. Ex-Japan concert ticket sales

Source: Company data, Wikipedia, KDB Daewoo Securities Research Source: Company data, Wikipedia, KDB Daewoo Securities Research

Figure 21. Concerts in Japan: Large-venue (Dome) concerts vs. other

Source: Company data, Wikipedia, KDB Daewoo Securities Research Figure 22. Cumulative sales of major artists in Korea

Note: Figures are estimates, not official data

Source: Wikipedia, Hanteo Information System, KDB Daewoo Securities Research 0.0 0.4 0.8 1.2 1.6 2.0 2011 2012 2013F

Concert ticket sales in Japan (mn tickets) 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2 2011 2012 2013F

No. of other concertgoers No of Dome concertgoers (mn persons) 0 500 1000 1500 2000 2500 2000 - Jo S ungmo 2000 - g.o. d. 2000 - Coo l 2000 - DJ DOC 2000 - Tu rbo 2001 - Va rious artist s 2001 - Wax 2001 - Lim Cha ng-jun g 2002 - BoA 2002 - Brow n Eyes 2002 - Co yote 2002 - Lee Sooy oung 2002 - Jung Nara 2008 - TVX Q 2013 - Ex o ('000 copies) Fewer than 500,000 copies sold (recession of the CD market) 0 100 200 300 400 500 2011 2012 Oct. 2013

Concert ticket sales ex-China Chinese concert ticket sales ('000 tickets)

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Table 7. SM Entertainment’s annual earnings (Wbn, %)

2008 2009 2010 2011 2012 2013F 2014F Revenue 40.1 61.8 86.4 143.0 241.3 281.2 357.4 CD 10.8 14.6 14.9 19.7 22.3 30.0 37.0 Digital 4.8 9.5 8.5 6.3 6.4 12.6 19.2 Overseas 8.6 15.8 36.8 81.1 128.7 127.5 143.1 Management 16.0 21.9 26.2 35.9 36.3 51.7 61.8 Other - - - - 47.7 59.5 96.4 Revenue breakdown CD 26.9 23.7 17.3 13.8 9.3 10.7 10.3 Digital 11.9 15.3 9.8 4.4 2.6 4.5 5.4 Overseas 21.4 25.5 42.6 56.7 53.3 45.3 40.0 Management 39.8 35.5 30.3 25.1 15.0 18.4 17.3 Other 0.0 0.0 0.0 0.0 19.8 21.1 27.0 Operating profit -1.9 9.3 20.2 25.6 60.5 60.7 76.5 OP margin -4.7 15.1 23.4 17.9 25.1 21.6 21.4 Net profit 4.3 4.5 15.9 21.8 37.3 52.3 64.1 Net margin 10.7 7.3 18.4 15.2 15.5 18.6 17.9 YoY growth Revenue 27.9 54.1 39.9 65.6 68.7 16.5 27.1 CD 21.3 35.7 2.1 32.0 13.3 34.3 23.2 Digital 8.9 98.1 -10.2 -26.2 1.2 97.6 52.6 Overseas 52.0 84.1 133.1 120.6 58.6 -0.9 12.2 Management 28.4 37.3 19.6 37.2 0.9 42.6 19.6 Other - - - 24.6 62.2 Operating profit RR TTB 117.2 26.7 136.3 0.3 26.0 Net profit TTB 4.7 253.3 37.1 71.1 40.2 22.6

Notes: Figures are based on K-GAAP through 2010; From 2011, figures are based on consolidated K-IFRS; TTB stands for “turn to black,” and RR stands for “remain red.” Source: Company data, KDB Daewoo Securities Research estimates

Table 8. Earnings forecast revisions (Wbn, W, %, %p)

Previous Revised % chg. 2013F 2014F 2013F 2014F 2013F 2014F Revenue 281 335 281 357 0.1 6.8 Operating profit 62 74 61 77 -1.3 3.9 Pretax profit 75 88 69 85 -7.9 -3.9 Net profit 51 61 52 63 1.6 3.8 EPS(W) 2,500 3,003 2,539 3,114 1.6 3.7 OP margin 21.9 22.0 21.6 21.4 -0.3 -0.6 Net margin 18.1 18.3 18.3 17.7 0.3 -0.5

Notes: All figures are based on consolidated K-IFRS; Net profit refers to net profit attributable to controlling interests Source: KDB Daewoo Securities Research

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Table 9. SM Entertainment’s quarterly revenue breakdown (Wbn, %)

1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 Notes

Revenue 38.5 32.4 51.5 46.2 33.2 33.5

CD 3.0 3.7 8.7 6.9 4.8 6.4 Cost-to-revenue ratio: Approx. 80%

Digital 1.6 1.4 1.7 1.7 1.1 1.5 Cost-to-revenue ratio: Approx. 20-30%

Royalties 0.0 0.2 0.2 6.2 3.0 2.2 Cost-to-revenue ratio of merchandise, etc.:

Approx. 20-30%

Management 7.1 7.4 9.0 6.1 7.2 7.7 Cost-to-revenue ratio: Approx. 80%

Domestic

Subtotal 11.8 12.8 19.6 20.8 16.2 17.6

CD 0.2 0.1 0.4 0.2 4.5 3.1 Direct exports of CDs produced in Korea

Digital 0.3 1.6 0.7 1.5 0.4 0.4 Cost-to-revenue ratio: Approx. 20-30%

5.9 9.1 3.1 4.4 6.6 4.4

Royalties mostly consist of income received from the sales of DVDs and recorded music produced overseas Royalties

Cost-to-revenue ratio: Approx. 20-30%

20.3 8.8 27.7 19.2 5.5 8.0 Cost-to-revenue ratio of management

services: 80%

Cost-to-revenue ratio of concerts (tickets + merchandise): 50-60%

Revenue of W250-400mn (smaller venues), and W400-800mn (Domes) per 10,000 Japanese concertgoers Overseas

Management

Concert-related income: W12bn; Balance is from other services (e.g., commercials)

Concert-related income: W20bn; Balance is from other services (e.g., commercials)

Revenue of W1-3bn per SM Town concert in Southeast Asia and China

Subtotal 26.7 19.6 31.9 25.4 17.1 15.9 Revenue breakdown CD 7.8 11.4 16.9 14.9 14.5 19.0 Digital 4.2 4.3 3.3 3.7 3.3 4.3 Royalties - 0.6 0.4 13.4 9.1 6.4 Domestic Management 18.4 22.8 17.5 13.2 21.5 22.9 CD 0.5 0.3 0.8 0.4 13.6 9.2 Digital 0.8 4.9 1.4 3.2 1.2 1.2 Royalties 15.3 28.1 6.0 9.5 20.0 13.2 Overseas Management 52.7 27.2 53.8 41.6 16.5 23.8 Operating profit 11.7 10.3 11.7 14.1 7.7 2.2 OP margin 30.4 31.8 22.7 30.5 23.1 6.6 Net profit 9.4 9.7 8.7 9.3 6.4 2.0 Net margin 24.4 29.9 16.9 20.1 19.2 6.0

Notes: K-IFRS non-consolidated basis; Figures are estimates, not official data Source: Company data, KDB Daewoo Securities Research

Table 10. SM C&C’s annual earnings (Wbn)

2008 2009 2010 2011 2012 2013F 2014F 2015F 2016F

Revenue 9.5 11.2 12.5 12.4 19.6 52.8 111.2 120.6 138.1

Operating profit -2.0 2.5 2.4 2.0 -2.6 1.0 11.1 13.3 16.6

Profit from continuing

operations -14.1 -0.5 1.6 0.4 -12.9 1.0 11.1 13.3 16.6 Net profit -13.1 -0.5 1.9 0.8 -12.8 1.0 8.7 10.3 12.9 Revenue breakdown Tourism 9.5 11.2 12.5 12.4 12.4 12.4 14.9 14.9 14.9 TV dramas 8.5 17.0 42.5 51.0 68.0 Domestic broadcasting rights 5.0 10.0 25.0 30.0 40.0 Product placement 1.0 2.0 5.0 6.0 8.0 Overseas broadcasting rights 2.5 5.0 12.5 15.0 20.0 Number of productions 1 2 5 6 8

Variety show programs 24 28 32 32

Revenue per program 0.06 0.07 0.08 0.08

Number of productions 2 3 4 6

Other including Woolim. 1 21 51 52 52

Notes: K-IFRS non-consolidated basis; Figures are estimates, not official data Source: Company data, KDB Daewoo Securities Research

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12 SM Entertainment (041510 KQ/Buy/TP: W60,000)

Comprehensive Income Statement (Summarized) Statement of Financial Condition (Summarized)

(Wbn) 12/12 12/13F 12/14F 12/15F (Wbn) 12/12 12/13F 12/14F 12/15F

Revenue 241 281 357 393 Current Assets 198 234 317 398

Cost of Sales 132 163 209 224 Cash and Cash Equivalents 100 136 202 275

Gross Profit 110 119 149 170 AR & Other Receivables 23 27 35 38

SG&A Expenses 49 58 72 80 Inventories 6 7 8 9

Operating Profit (Adj) 61 61 77 90 Other Current Assets 25 30 38 41

Operating Profit 61 61 77 90 Non-Current Assets 125 151 154 158

Non-Operating Profit -4 9 8 10 Investments in Associates 2 7 7 7

Net Financial Income -2 -2 -3 -5 Property, Plant and Equipment 39 48 47 46

Net Gain from Inv in Associates 4 0 0 0 Intangible Assets 43 45 37 34

Pretax Profit 57 69 85 100 Total Assets 323 385 471 556

Income Tax 20 18 21 25 Current Liabilities 74 86 109 120

Profit from Continuing Operations 37 52 63 75 AP & Other Payables 45 53 67 74

Profit from Discontinued Operations 0 0 0 0 Short-Term Financial Liabilities 3 3 3 3

Net Profit 37 52 63 75 Other Current Liabilities 27 31 39 43

Controlling Interests 40 52 64 76 Non-Current Liabilities 10 8 8 8

Non-Controlling Interests -3 -1 -1 -1 Long-Term Financial Liabilities 8 6 6 6

Total Comprehensive Profit 34 51 63 75 Other Non-Current Liabilities 1 1 1 1

Controlling Interests 37 52 64 75 Total Liabilities 84 94 117 128

Non-Controlling Interests -3 -1 -1 -1 Controlling Interests 213 262 325 401

EBITDA 70 80 105 113 Capital Stock 10 10 10 10

FCF (Free Cash Flow) 2 38 65 70 Capital Surplus 119 121 121 121

EBITDA Margin (%) 29.0 28.3 29.5 28.7 Retained Earnings 84 136 200 276

Operating Profit Margin (%) 25.1 21.6 21.4 22.9 Non-Controlling Interests 26 29 29 28

Net Profit Margin (%) 16.5 18.6 17.9 19.2 Stockholders' Equity 239 291 354 429

Cash Flows (Summarized) Forecasts/Valuations (Summarized)

(Wbn) 12/12 12/13F 12/14F 12/15F 12/12 12/13F 12/14F 12/15F

Cash Flows from Op Activities 46 63 82 87 P/E (x) 22.8 15.1 12.3 10.5

Net Profit 37 52 63 75 P/CF (x) 18.4 11.1 8.5 8.0

Non-Cash Income and Expense 34 29 42 38 P/B (x) 5.5 3.6 2.7 2.1

Depreciation 2 1 1 1 EV/EBITDA (x) 11.8 8.3 5.7 4.6

Amortization 7 18 28 22 EPS (W) 1,994 2,539 3,114 3,675

Others -6 8 3 3 CFPS (W) 2,471 3,453 4,515 4,790

Chg in Working Capital -4 -3 -3 -1 BPS (W) 8,305 10,729 14,233 18,014

Chg in AR & Other Receivables -6 -4 -7 -4 DPS (W) 0 0 0 0

Chg in Inventories -3 -1 -2 -1 Payout ratio (%) 0.0 0.0 0.0 0.0

Chg in AP & Other Payables 15 6 14 7 Dividend Yield (%) 0.0 0.0 0.0 0.0

Income Tax Paid -21 -16 -21 -25 Revenue Growth (%) 68.8 16.5 27.1 10.0

Cash Flows from Inv Activities -48 -19 -14 -12 EBITDA Growth (%) 116.7 13.5 32.4 7.3

Chg in PP&E -23 -9 0 0 Operating Profit Growth (%) 136.4 0.3 25.9 17.7

Chg in Intangible Assets -19 -19 -19 -19 EPS Growth (%) 61.5 27.3 22.6 18.0

Chg in Financial Assets -5 9 0 0 Accounts Receivable Turnover (x) 14.1 12.2 12.7 11.9

Others -2 0 5 7 Inventory Turnover (x) 58.3 45.6 47.4 44.4

Cash Flows from Fin Activities 75 -6 -1 -1 Accounts Payable Turnover (x) 7.7 6.6 6.8 6.4

Chg in Financial Liabilities 0 0 0 0 ROA (%) 15.2 14.6 14.8 14.6

Chg in Equity 65 -4 0 0 ROE (%) 24.7 22.0 21.8 20.8

Dividends Paid 0 0 0 0 ROIC (%) 65.3 48.9 57.8 71.6

Others 9 -2 -1 -1 Liability to Equity Ratio (%) 35.1 32.4 33.0 29.8

Increase (Decrease) in Cash 66 36 66 73 Current Ratio (%) 266.4 270.9 290.9 332.7

Beginning Balance 34 100 136 202 Net Debt to Equity Ratio (%) -55.8 -55.7 -64.4 -70.2

Ending Balance 100 136 202 275 Interest Coverage Ratio (x) 51.3 35.5 54.3 63.9

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APPENDIX 1

Important Disclosures & Disclaimers

Stock Ratings Industry Ratings

Buy Relative performance of 20% or greater Overweight Fundamentals are favorable or improving

Trading Buy Relative performance of 10% or greater, but with volatility Neutral Fundamentals are steady without any material changes Hold Relative performance of -10% and 10% Underweight Fundamentals are unfavorable or worsening

Sell Relative performance of -10%

* Ratings and Target Price History (Share price (----), Target price (----), Not covered (■), Buy (▲), Trading Buy (■), Hold (●), Sell (◆)) * Our investment rating is a guide to the relative return of the stock versus the market over the next 12 months.

* Although it is not part of the official ratings at Daewoo Securities, we may call a trading opportunity in case there is a technical or short-term material development.

* The target price was determined by the research analyst through valuation methods discussed in this report, in part based on the analyst’s estimate of future earnings.

The achievement of the target price may be impeded by risks related to the subject securities and companies, as well as general market and economic conditions.

Analyst Certification

The research analysts who prepared this report (the “Analysts”) are registered with the Korea Financial Investment Association and are subject to Korean securities regulations. They are neither registered as research analysts in any other jurisdiction nor subject to the laws and regulations thereof. Opinions expressed in this publication about the subject securities and companies accurately reflect the personal views of the Analysts primarily responsible for this report. Daewoo Securities Co., Ltd. policy prohibits its Analysts and members of their households from owning securities of any company in the Analyst’s area of coverage, and the Analysts do not serve as an officer, director or advisory board member of the subject companies. Except as otherwise specified herein, the Analysts have not received any compensation or any other benefits from the subject companies in the past 12 months and have not been promised the same in connection with this report. No part of the compensation of the Analysts was, is, or will be directly or indirectly related to the specific recommendations or views contained in this report but, like all employees of Daewoo Securities, the Analysts receive compensation that is impacted by overall firm profitability, which includes revenues from, among other business units, the institutional equities, investment banking, proprietary trading and private client division. At the time of publication of this report, the Analysts do not know or have reason to know of any actual, material conflict of interest of the Analyst or Daewoo Securities Co., Ltd. except as otherwise stated herein.

Disclaimers

This report is published by Daewoo Securities Co., Ltd. (“Daewoo”), a broker-dealer registered in the Republic of Korea and a member of the Korea Exchange. Information and opinions contained herein have been compiled from sources believed to be reliable and in good faith, but such information has not been independently verified and Daewoo makes no guarantee, representation or warranty, express or implied, as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein or of any translation into English from the Korean language. If this report is an English translation of a report prepared in the Korean language, the original Korean language report may have been made available to investors in advance of this report. Daewoo, its affiliates and their directors, officers, employees and agents do not accept any liability for any loss arising from the use hereof. This report is for general information purposes only and it is not and should not be construed as an offer or a solicitation of an offer to effect transactions in any securities or other financial instruments. The intended recipients of this report are sophisticated institutional investors who have substantial knowledge of the local business environment, its common practices, laws and accounting principles and no person whose receipt or use of this report would violate any laws and regulations or subject Daewoo and its affiliates to registration or licensing requirements in any jurisdiction should receive or make any use hereof. Information and opinions contained herein are subject to change without notice and no part of this document may be copied or reproduced in any manner or form or redistributed or published, in whole or in part, without the prior written consent of Daewoo. Daewoo, its affiliates and their directors, officers, employees and agents may have long or short positions in any of the subject securities at any time and may make a purchase or sale, or offer to make a purchase or sale, of any such securities or other financial instruments from time to time in the open market or otherwise, in each case either as principals or agents. Daewoo and its affiliates may have had, or may be expecting to enter into, business relationships with the subject companies to provide investment banking, market-making or other financial services as are permitted under applicable laws and regulations. The price and value of the investments referred to in this report and the income from them may go down as well as up, and investors may realize losses on any investments. Past performance is not a guide to future performance. Future returns are not guaranteed, and a loss of original capital may occur.

Disclosures

As of the publication date, Daewoo Securities Co., Ltd. has been acting as a financial advisor to SM Entertainment for its treasury stock trust, and other than this, Daewoo Securities has no other special interests in the companies covered in this report.

SM Entertainment 0 20,000 40,000 60,000 80,000 100,000 11/11 5/12 11/12 5/13 11/13 (W)

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14

Distribution

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United States: This report is distributed in the U.S. by Daewoo Securities (America) Inc., a member of FINRA/SIPC, and is only intended for major institutional investors as defined in Rule 15a-6(b)(4) under the U.S. Securities Exchange Act of 1934. All U.S. persons that receive this document by their acceptance thereof represent and warrant that they are a major institutional investor and have not received this report under any express or implied understanding that they will direct commission income to Daewoo or its affiliates. Any U.S. recipient of this document wishing to effect a transaction in any securities discussed herein should contact and place orders with Daewoo Securities (America) Inc., which accepts responsibility for the contents of this report in the U.S. The securities described in this report may not have been registered under the U.S. Securities Act of 1933, as amended, and, in such case, may not be offered or sold in the U.S. or to U.S. persons absent registration or an applicable exemption from the registration requirements.

Hong Kong: This document has been approved for distribution in Hong Kong by Daewoo Securities (Hong Kong) Ltd., which is regulated by the Hong Kong Securities and Futures Commission. The contents of this report have not been reviewed by any regulatory authority in Hong Kong. This report is for distribution only to professional investors within the meaning of Part I of Schedule 1 to the Securities and Futures Ordinance of Hong Kong (Cap. 571, Laws of Hong Kong) and any rules made thereunder and may not be redistributed in whole or in part in Hong Kong to any person.

All Other Jurisdictions: Customers in all other countries who wish to effect a transaction in any securities referenced in this report should contact Daewoo or its affiliates only if distribution to or use by such customer of this report would not violate applicable laws and regulations and not subject Daewoo and its affiliates to any registration or licensing requirement within such jurisdiction.

KDB Daewoo Securities International Network

Daewoo Securities Co. Ltd. (Seoul) Daewoo Securities (Hong Kong) Ltd. Daewoo Securities (America) Inc. Head Office

34-3 Yeouido-dong, Yeongdeungpo-gu Seoul 150-716

Korea

Two International Finance Centre Suites 2005-2012

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Tel: 44-20-7982-8016 Tel: 65-6671-9845 Tel: 81-3- 3211-5511

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Centec Tower

72-74 Nguyen Thi Minh Khai Street Ward 6, District 3, Ho Chi Minh City Vietnam