By analyzing the development background and successful experience of SM Entertainment, a leader in the Korean entertainment industry, we provide reference for the study of the development direction of the domestic entertainment brokerage industry and leading companies.
summary
Industry background: South Korea's entertainment industry is developed, and K-POP (Korean pop music) is its prominent representative. The entertainment industry is a symbol of the country's "soft power", contributing more than 6% to GDP in 2023. We believe that the reasons for its prosperity include strong government support, a continuous improvement in the copyright protection system, and the active participation of the private sector. As a prominent representative of the Korean entertainment industry, K-POP accounted for more than 8% of the scale of the Korean entertainment industry in 2022. At present, the K-POP industry has formed an industrial chain structure with fine division of labor and diversified realization, and has the characteristics of strong physical album consumption culture and rapid development of derivative products. The Matthew effect of the industry pattern is obvious, with the total share of the four leading companies exceeding 30% in 2022, and the leading companies are gradually moving from competition to competition.
Current Situation and Prospects: SM Entertainment has been "evergreen" for more than 20 years, and has opened the 3.0 era based on four major strategies. SM Entertainment is a pioneer in Korea's entertainment brokerage industry and a leader in the global K-pop and K-pop culture. The company has been "evergreen" for more than 20 years, with operating income CAGR of 20.2% and net profit CAGR of 20.0% from 2000 to 2023. Since its establishment, the company has spanned three stages: deep cultivation in Korea and Japan, global expansion and diversified innovation, and has now formed three major business segments: entertainment, new media and life services. Starting the 3.0 era in 2023, the company plans to build an entertainment group with global audiences and shareholders as the core driving strategies of IP production, IP monetization, global market and strategic investment.
Domestic enlightenment: The contribution of China's cultural industry is low and the competition pattern is scattered, and the three "secrets" of SM Entertainment's success may be worth learning. China's cultural industry is growing rapidly, but its contribution to GDP is still lower than that of South Korea (4.5% vs. 6.0%, 2022); The market structure of China's artist management industry is more fragmented than that of South Korea, and the maturity of the industry still needs to be improved. We believe that the industrialized artist training and operation system, the globalization strategy throughout the whole cycle, and the innovative spirit that keeps pace with the times are the three important factors that SM Entertainment has been able to "build an everlasting business" for more than 20 years, which may be worthy of reference by Chinese entertainment brokerage companies.
Finance & Valuation
Operating income in 2023 will be KRW 961.07 billion, +13.0% year-on-year; Operating profit was KRW 113.46 billion, +24.7% year-on-year; Net profit was 82.68 billion won, +0.8% year-on-year. The current share price (2024/5/10) corresponds to 2023 P/E(A) 24x.
risk
changes in management equity and personnel; reputational risk to artists; intensified competition in the industry; Globalization is not progressing as expected.
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Introduction to SM Entertainment
A comprehensive entertainment group rooted in Korea and expanding globally. SM Entertainment was founded in South Korea in 1995 and has continued to expand its footprint through new and acquired subsidiaries since its inception. At present, the business scope includes music, concerts/events, content production, advertising agencies, derivative IP business, etc., and has set up branches or subsidiaries in Japan, Thailand, the United States and China to expand international business.
Chart 1: SM Entertainment's main businesses
Source: Company's official website, CICC Research Department
He is a pioneer in Korea's entertainment brokerage industry and a leader in the global K-pop and K-pop culture. As a pioneer in the Korean entertainment brokerage industry, SM Entertainment took the lead in proposing the "support" culture, the first to propose the concept of creating an all-round idol group, and the first to create the trainee system and squad model, becoming the definer and pioneer of many development models in the Korean entertainment brokerage industry. At the same time, the company actively promotes its globalization strategy, which has led to the development and prosperity of the global "Korean Wave" and K-POP (Korean Pop) trends, and in 2013, Forbes magazine named SM Entertainment the creator of K-POP. As of September 30, 2023, the company has accumulated more than 93.4 billion video views on YouTube, held more than 2,000 concerts and meet-and-greets, has an A&R (Artist and Repertoire) team of more than 3,000 people, and promoted Korean pop music, Korean culture, Korean food, and other traditional Korean culture to the world through the "Made by SM" product, enhancing Korea's international influence.
For more than 20 years, the company has been at the forefront of the Korean entertainment industry in terms of revenue and profit. Since its establishment in 1995, the company has performed steadily and has been at the forefront of the Korean entertainment industry. From 2000 to 2023, the company achieved a CAGR of 20.2% in operating income and a CAGR of 20.0% in net profit. In recent years, due to the success of the boy group "BTS" under the industry rookie HYBE in the global market, SM Entertainment's operating revenue and net profit have gradually been surpassed by HYBE, but it is still at the forefront of the Korean entertainment industry.
Figure 2: Operating income of the four largest entertainment companies in South Korea
Note: JYP Entertainment is adjusted to the caliber of natural year
Source: Company announcements, CICC Research
Figure 3: Net profit of the four largest entertainment companies in South Korea
Note: JYP Entertainment is adjusted to the caliber of natural year
Source: Company announcements, CICC Research
In 2023, the profit margin level will be in the middle and lower reaches of the four major entertainment companies. In 2023, SM Entertainment's gross profit margin will be 35.5%, operating profit margin will be 11.8%, and net profit margin will be 8.6%, which is generally at the middle and lower reaches of the four major entertainment companies. From the perspective of the specific item split of costs and expenses, SM Entertainment's inventory changes (accounting for 1.7% of revenue), service fees (accounting for 11.3% of revenue), freight (accounting for 1.8% of revenue), and other expenses (accounting for 6.8% of revenue) are relatively low compared with the other three companies, which has certain advantages. Depreciation and amortization of intangible assets (6.0% of revenue), labor costs (30.1% of revenue), and outsourcing processing expenses (13.5% of revenue) accounted for a relatively high proportion compared to the other three companies.
The operating cash flow is relatively abundant, and the asset-liability ratio is at a reasonable level. In 2023, the four major entertainment companies in South Korea have achieved relatively abundant net cash flow from operating activities, with a coverage rate of more than 100% for net profit. Among them, SM Entertainment achieved a net cash flow of KRW 113 billion from operating activities, with a net profit coverage ratio of 137%. In 2023, SM Entertainment's debt-to-asset ratio is 41%, which is at a high level among the four major entertainment companies, of which short-term trade payables and other current liabilities account for 20% of total assets, which we believe mainly reflects the company's strong ability to occupy funds.
Korean culture and entertainment industry
Development status: One of the pillar industries of South Korea and a symbol of the country's "soft power".
South Korea's cultural industry is developing rapidly, contributing more than 6% to GDP in 2023. According to the Bank of Korea, we estimate that from 2000 to 2023, the added value of South Korea's cultural industry will rise from 31.3 trillion won to 137.9 trillion won, corresponding to a CAGR of 6.7%, and the proportion of South Korea's GDP will increase from 4.8% to 6.2%.
Figure 4: Added value of Korean cultural industry and its share of GDP from 2000 to 2023
注：韩国文化产业增加值为 GDP构成中 Publishing, broadcasting, motion picture, video and television program production, and information service和 Cultural and other services两个细分项的加总；数据采用非季调现价口径
Source: Bank of Korea, CICC Research
The export value of South Korea's cultural industry has grown rapidly, and the "Korean Wave" has become a symbol of South Korea's national "soft power". From 2016 to 2022, the export value of South Korea's cultural content industry[1] increased from US$6.01 billion to US$13.31 billion, with a CAGR of 14.2%. The large-scale export of Korea's cultural industry has led to the spread of the "Korean Wave" around the world. As of 2021, Hallyu enthusiasts are present in 108 countries and regions around the world, and there are 1,470 Hallyu enthusiast clubs around the world, with a total of 157 million members, with China, the United States, and Thailand having the largest number of members. From 2017 to 2021, the "Hallyu" status index showed an upward trend in most countries, with Japan, the United States and South Africa having the highest growth rates.
The reasons behind it: strong government support, continuous improvement of the copyright protection system, and active participation of the private sector
Reason 1: Following the strategy of "cultural statehood", the government vigorously supports the development of cultural industries. The development of South Korea's entertainment industry is inseparable from political and economic factors. Successive presidents have taken measures in terms of policies and regulations, organizational structure and financial funds to promote the development of South Korea's cultural industry in a planned and purposeful manner.
► Policies and regulations: In the 90s of the 20th century, South Korea successively passed laws and documents such as the Film Promotion Act and the Cultural Vision 2000. In the 21st century, the Korean government enacted the Basic Law on Culture in 2013, the Public Diplomacy Act in 2016, and the Culture Vision 2030 in 2018. In 2023, the South Korean government announced the "Korean Cultural Content Export Strategy", which proposes to make Korean culture a major export industry, and achieve exports of 25 billion US dollars by 2027, becoming one of the world's four major content powers.
► Organizational structure: In order to adapt to the development requirements of different historical periods, the cultural authorities of the Korean government have undergone several adjustments. At present, the Korean government has set up the Ministry of Culture, Sports and Tourism to be responsible for cultural development and exchanges, and has established the Korea Cultural Industry Promotion Agency, the Korea International Cultural Exchange Promotion Agency, the Korea Film Promotion Council, the Korean Intellectual Property Commission, the Korea Tourism Organization and other institutions, and all of these institutions have overseas offices. In addition, through the Department of Cultural Products Trade, Korea is helping Korea's cultural industry to actively explore overseas markets. The Korea Foundation for International Exchange (KF), a subsidiary of the Ministry of Foreign Affairs, also undertakes a lot of public diplomacy and foreign cultural exchange work.
Figure 5: Cultural Policies and Initiatives of Previous Governments of the Republic of Korea (Partial)
Source: Korea Legal Information Center Database, Korea Broadcasting Corporation, Ministry of Culture, Sports and Tourism, Ministry of Culture and Tourism, Korea Tourism Organization, Foreign Trade Development Bureau, Ministry of Commerce of the People's Republic of China, CICC Research Department
► Financial funds: Since 1990, the Korean government has set up special funds such as the Cultural Promotion Fund, the Media Development Fund, and the Film Promotion Fund, which are specially used for the support of cultural and creative enterprises and the cultivation of talents, and provide funding for the development of the cultural industry.
Reason 2: The copyright protection system is strict, and the public's awareness of payment is high. As a country that attaches great importance to the cultural industry, South Korea has continuously improved its copyright protection system and actively responded to the phenomenon of infringement of cultural products. The copyright protection system in Korea is centered on the Ministry of Culture, Sports and Tourism, with the cooperation of the Copyright Police Agency and the Korea Copyright Protection Agency. In 1957, the Copyright Act was enacted to protect works of art and their authors, and to promote the dissemination of culture. Since its promulgation, the Copyright Law has been amended several times, including comprehensive revisions in 1986 and 2006, to actively respond to the advancement of digital technology, changes in the environment in which works are used, and international trends in copyright protection, and to bring digital copyright into the scope of regulation. The strict copyright protection system has created a high sense of payment among Korean users, and mainstream digital music platforms hardly provide free music playback services. In this context, streaming digital music platforms need to rely on content producers, i.e., star artists, to improve user stickiness and payment levels, so artists and brokerage companies have a higher voice in the industry chain.
Reason 3: Private enterprises have responded positively and set up cultural foundations to support the development of the art industry. The extensive participation of the private sector in South Korea is a powerful enabler of the "cultural nation" strategy. Major Korean conglomerates such as Samsung and CJ Group have established cultural foundations to support the development of arts and culture and the dissemination of culture overseas. Among them, the Samsung Group established the Samsung Cultural Foundation in 1965 to operate a wide range of cultural and artistic programs, hold educational and training and overseas exchange activities, and provide financial support for young artists. CJ Group established the CJ Culture Foundation in 2006 with the strategic goal of "spreading Korea's beautiful culture to the world" and has been building a bridge between Korea and the world by providing financial support in the fields of music, performance, and film, and cooperating with UNESCO to carry out international cultural education.
K-pop industry
Industry scale: a prominent representative of South Korea's entertainment industry, accounting for more than 8% in 2022
K-POP is growing rapidly, accounting for about 8.5% of the size of Korea's entertainment industry in 2022. According to Statista, the K-POP market grew from 4.6 trillion won to 11.0 trillion won from 2014 to 2022, corresponding to a CAGR of 11.5%. According to our estimates, the K-POP market will account for 8.5% of South Korea's cultural industry in 2022.
K-POP has become a national "business card" of South Korea. According to the Korea Institute for International Cultural Exchange and Promotion's 2023 Overseas Hallyu Reality Survey, when it comes to the national image of South Korea, respondents have the highest response rate of 14.3%, and K-POP has ranked first for six consecutive years.
Industrial chain structure: fine division of labor, diversified realization
The K-POP industry chain consists of five major links: planning, production, publicity, distribution, and consumption, and is divided into seven sub-links: music planning, music production, music publishing, album distribution, online and offline circulation, public performance, and operation. Korean entertainment agencies led by SM Entertainment collaborate with the world's leading musicians and songwriters to produce unique music products and derivative products, reach consumers through online and offline channels, and collect royalties for music products. In addition, the company's artists and artist groups strengthen the commercial value of music products and artists themselves through advertising, variety shows, concerts, meet-and-greets, etc., bringing diversified benefits.
Figure 6: K-POP industry chain
Source: "Hanyu Economics" (Wang Cong, 2015), Tencent Research Institute, CICC Research Department
Industry characteristics: The physical album consumer culture is strong, and derivative products are developing rapidly
The development of the global physical album market is close to stagnation, but the sales of K-POP physical albums continue to grow. With the development of technology and the transformation of music consumption culture, the product structure of the global music industry has been rapidly reorganized in recent years, and the central position of physical records has gradually been replaced by digital music sources, and the growth of the global physical album market from 2017 to 2023 is close to stagnation. However, contrary to the global trend, the Korean physical album market continues to expand, with domestic K-POP physical album sales increasing from 16.93 million in 2017 to 115.17 million in 2023. According to SM Entertainment statistics, from 2017 to 2022, the cumulative growth rate of K-POP physical albums to Japan, the Americas, Southeast Asia, Europe and the Middle East was 38%/78%/46%/128% respectively.
Exhibit 7: Physical album sales and streaming market size in South Korea
Source: Statista, CICC Research
K-POP's strong physical album consumption culture is the result of the combined action of both supply and demand. We believe that from the demand side, the characteristics of K-POP centered on idol singers make fans have a strong willingness to pay and collect physical albums. From the perspective of the supply side, entertainment companies have met the diversified preferences of fans through innovations in physical album versions and configurations, and effectively driven purchase intentions.
The market for derivatives that combine cultural and emotional elements is growing rapidly. Korean entertainment companies have promoted the principle of OSMU (One Source Multi-Use) and created a window effect, fully amplifying the cultural and emotional value of IP through the licensing and commercialization of artist-related products, and expanding a wide range of derivatives market. According to the HYBE prospectus, the sales volume of K-POP derivatives that combine cultural and emotional elements has doubled in recent years; According to the SM 3.0 plan announced by SM Entertainment, the company expects the proportion of derivative IP industry revenue to increase from 23% in 2022 to 40% in 2025.
Competitive landscape: The Matthew effect is obvious, and the head companies are moving from competition to competition
There are many participants in the domestic market, and the Matthew effect of the industry pattern is obvious. According to Statista, as of 2021, the number of companies engaged in the music industry in South Korea is as high as 34,000, but the Matthew effect of the industry is obvious, and the current pattern of "one super three strong" led by HYBE and followed by SM Entertainment, YG Entertainment and JYP Entertainment has been formed. According to our estimates, in 2022, the total operating income of the four leading companies will account for 30.6% of the K-POP industry. According to the 2023 global K-pop chart released by Circle Chart, an authoritative record chart in South Korea, among the top 200 records, the four leading companies account for 141 albums, accounting for a total of 70.5%.
Figure 8: Market share distribution of the K-POP industry in 2022
Note: This chart uses the proportion of each company's overall revenue to the K-POP market size to measure the market share, which may lead to errors in the data and is for reference only
Source: Company Announcement, Statista, CICC Research
The leading companies have moved from competition to coopetition. In recent years, the four leading companies have moved from competition to competition, and have cooperated through various forms such as business and equity. In August 2020, in response to the impact of the new crown epidemic on offline performances, SM Entertainment and JYP Entertainment jointly established the world's first online concert company, Beyond LIVE Corporation (BLC), which is jointly responsible for the operation of the online live concert brand "Beyond LIVE". In January 2021, Big Hit Entertainment (later renamed HYBE) and its subsidiary beNX acquired a stake in YG PLUS, a subsidiary of YG Entertainment that is responsible for music sources and records, and the two parties agreed to cooperate in various fields such as music live streaming platforms, music product distribution, and derivative products. In August 2021, JYP Entertainment acquired a stake in Dear U, a subsidiary of SM Entertainment, to jointly operate a fan communication platform service.
The current situation and prospects of SM Entertainment
Historical evolution: Deep cultivation of Korea and Japan - global expansion - diversified innovation
Capable founders lay an important foundation for the company's success. Lee so-man was born in Seoul, South Korea in 1952 and graduated from Seoul National University with a bachelor's degree in agricultural machinery. In June 1971, Li Xiuman launched the song "April and May" to enter the entertainment industry, and in 1976 won the "MBC Top Ten Singers Song Festival" New Singer Award, in 1977 released his own album of the same name "Lee so Man", and then went to the University of California to study for a master's degree in computer science. While studying in the United States, Lee so-man was exposed to a large number of American pop music and communication channels, and later founded SM Studio, the predecessor of SM Entertainment, in South Korea in 1989. In 1995, Lee so-man restructured SM Studio into SM Entertainment, and launched idol groups based on the production of music. After the establishment of SM Entertainment, Lee so-man's concept of "Culture Technology" has brought a far-reaching impact on the systematization and industrialization of the Korean entertainment industry. We believe that Lee so-man's vision and ability as an artist, technologist and businessman has laid an important foundation for SM Entertainment's success.
The company's development history is divided into three stages: deep cultivation in Korea and Japan (1995-2007), global expansion (2008-2012) and diversified innovation (2013-present). Among them, in the first stage, the company laid the foundation for the main business of record production and sales under the leadership of the founder Li Xiuman, and deeply cultivated the Korean and Japanese markets, launching H.O.T., S.E.S., TVXQ, BoA, Super Junior and other artists and artist groups; In the second stage, the company's business scope expanded rapidly to the world, setting up branches in the United States, China, Thailand and other places, and launching artist groups such as Girls' Generation, f(x), and EXO to help K-POP become popular all over the world; In the third stage, the company expanded its commercial retail, online performances, entertainment parks, advertising and other businesses through acquisitions or the establishment of subsidiaries, and explored diversified and innovative fields.
Exhibit 9: SM Entertainment's history
Source: Company announcement, official website, Bloomberg, CICC Research
Business segments: from entertainment to new media and life services
The expansion of the company's business territory includes three dimensions: first, the geographical expansion of the existing core entertainment business; the second is to expand the entertainment business to the entire media field; The third is the development of new business fields with the theme of life services. At present, the company's business scope includes three major sectors: entertainment, new media and life services.
The company's entertainment segment includes music content production, album production and sales, artist management, concerts, TV dramas, variety shows and other subdivisions. Specifically:
► Music content production, album production and sales: Based on advanced music production technology, the company creates original music through the established global network of producers and songwriters, leading the development of K-POP. As of November 3, 2023, the company has released 1,145 albums.
► Artist management: The company has achieved a full range of business coverage from basic artist management to planning, marketing, operation, and publicity to meet market demand. Since its establishment, the company has launched a total of 21 artists (groups), which is the first of the four major entertainment companies.
► Concerts: As of November 2023, SM Entertainment has held more than 1,600 offline concert tours. In addition, in 2020, SM Entertainment launched the world's first "Online Customized Paid Concert", which created a superb online stage performance using cutting-edge AR technology and real-time 3D image technology.
► TV dramas and variety shows: The company has launched a number of variety shows on the global platform through SM C&C, a previously acquired variety show production company, and participated in the content investment and production of many TV dramas.
The company's account has gained a large number of followers on global social platforms. The company communicates directly with a global audience through social media to deliver the latest news about its artists. According to the company's official website as of December 6, 2023, the company's SMTOWN and artist pages have a total of about 63.58 million likes on Facebook and about 80.91 million followers on Twitter. The company has more than 100 million subscribers to YouTube-related channels and more than 26.58 million followers on Weibo.
The company has launched a variety of self-developed APPs to deepen the interaction between users and artists. Among them, SMTOWN and KWANGYA CLUB are two apps, which make it easier for followers to obtain artist albums, music videos, photos and various event information; Everysing is an intelligent song practice app that has the functions of recording songs and online interviews. SUPERSTAR SMTOWN is a mobile music game based on the works of the company's artists, through which users can collect various forms of derivative products of artists; Fanbook is a platform for creating fanworks by artists.
The company combines the fashion concept and artist base accumulated in the entertainment business with life services such as catering, shopping, and tourism, providing a fresh and unique user experience, and driving the further popularity of K-POP. Specifically:
► Food & Beverage: The company has opened SMT SEOUL and SMT TOKYO in Seoul and Tokyo respectively to meet the diverse needs of customers with pure foreign cuisine, stylish space design and exquisite service.
► Shopping: The company has opened an online mall, SMTOWN &STORE, which sells artist records, posters, merchandise, as well as beauty, fashion, daily life and other products that have cooperation with artists.
► Tourism: In 2012, the company launched the SM GLOBAL PACKAGE service, which provides one-stop service for domestic and foreign K-pop enthusiasts to watch the company's artist concerts and related itineraries, including tickets, transportation, hotels, tour guides, etc. According to the company's official website, tens of thousands of SM enthusiasts have used the service.
Growth Engine: SM 3.0 Strategy
SM Entertainment has undergone a metamorphosis from SM 1.0 to SM 2.0 and proposed the SM 3.0 strategy in February 2023. In the 3.0 era, SM Entertainment will take IP production, IP monetization, global market and strategic investment as the four core driving strategies to build an entertainment company with global audiences and shareholders as the core.
► IP production: SM Entertainment has reformed its organizational structure, from the original single-line model of vertical management by the chief producer to the multi-line parallel model of "5 physical production centers + 1 virtual production center". Each production center has its own production, brokerage, and marketing systems, and is audited by a unified A&R committee to ensure that the production center maintains the high standards of SM Entertainment while maintaining its autonomy. After the IP incubation is completed in the production center, it can be operated under the company's internal label, and after it is more mature, it can leave the headquarters and become an independent label under the company's wholly-owned subsidiary. In terms of music sources, SM Entertainment plans to establish a wholly-owned music distribution company on the basis of retaining the original songwriters, and cooperate with outstanding songwriters and similar companies around the world to improve the quality of its own music sources and enrich its IP music library. The company expects that relying on the new IP production strategy, the company's artist groups and album creation speed is expected to achieve a leapfrog improvement. According to the company's plan, in the 3.0 phase, 2 or more artist groups will be launched every year, and at least 40 albums will be released every year, which is further accelerated compared with the 2.0 phase.
► IP monetization: SM Entertainment's revenue model can be divided into basic IP industry and derivative IP industry. At present, SM Entertainment's main source of revenue is the basic IP industry, including albums, music sources, concerts and performance planning. In 2022, the contribution of the basic IP industry to the total revenue will be 76%, of which the revenue contribution of albums to the basic IP industry will be 46%. In the SM 3.0 strategy, the company will actively develop derivative IP industries with high profit margins, including IP licensing, video content, fan platforms, etc., and strive to increase the proportion of derivative IP industry revenue to 37% by 2025, and drive the company's overall operating income to exceed 1.2 trillion won and the operating profit margin to reach 35%.
Exhibit 10: SM Entertainment's basic IP industry and derivative IP industry revenue
Note: This figure is the data under the caliber of SM Entertainment, so there is a deviation from the company's financial report; excludes other income (e.g. DREAMMAKER Beijing); 2023E is the forecast released by the Company in early 2023 and may deviate from the actual value
Source: Company's official website, CICC Research Department
► Global market: SM Entertainment has divided its overseas expansion into three phases, the first stage is for the Korean production center and business units to perform all responsibilities and carry out global activities, the second stage is to transfer management and business units to overseas local areas, and the third stage is to establish an overseas localized production center to independently perform IP production rights and revenue rights. According to the SM 3.0 plan, the company strives to achieve a global pattern of "7 domestic production centers + 3 foreign production centers + 2 market entry regions" by 2025, that is, to gradually realize the leap from the first and second stages to the third stage. Under the SM 3.0 strategy, the company will formulate differentiated expansion plans according to the market characteristics and competitive situation of different countries and regions, among which Japan, the United States and Southeast Asian markets will become the focus of the next stage.
Exhibit 11: SM Entertainment aims to achieve a global pattern of "7+3+2" by 2025
Source: Company's official website, CICC Research Department
► Strategic Investment: To maintain long-term growth momentum, SM Entertainment plans to invest KRW 1 trillion for the construction of multiple segments. At the same time, SM Entertainment plans to link management salaries to the company's market capitalization, thus ensuring strong responsible management.
Exhibit 12: SM Entertainment plans to invest KRW 1 trillion in various segments
Source: Company's official website, CICC Research Department
Financial analysis: quick recovery after the epidemic, healthy financial statements
Operating income grew steadily, with the entertainment sector being the most important source of revenue. Since 2019, the company's overall operating income has shown a fluctuating upward trend, and although the revenue declined in 2020 due to the impact of the new crown epidemic, it recovered quickly in 2021. In 2023, the company achieved operating income of 961.07 billion won, a year-on-year increase of 13.0%. In terms of business segments, the entertainment business segment (including music sources/albums, artist management, performance/video content and other subdivisions) is the company's most important business segment. In 2023, benefiting from the rapid growth of artist management and performance/video content businesses, the revenue of the entertainment business segment totaled KRW 867.01 billion, a year-on-year increase of 19.0%, accounting for 90.2% of the revenue, an increase of 4.6 pct year-on-year. In 2023, the revenue of advertising business will be 76.95 billion won, and the proportion of revenue will decrease from 17.3% in 2019 to 8.0% in 2023. The company's other business segments include tourism, life services and other businesses, accounting for a small proportion of total operating income, and the revenue declined more from 2020 to 2021 due to the impact of the new crown epidemic, and began to gradually recover in 2022.
Profits fluctuated greatly during the epidemic and have recovered steadily after the epidemic. In 2020, the company's various profit indicators declined year-on-year, mainly due to the impact of the new crown epidemic, offline performances, album exports and other businesses were blocked. Since 2021, with the easing of the epidemic and the rapid adjustment of the company's development strategy, such as focusing on online channels and overseas diversified regional development, gross profit, operating profit and operating margin have achieved steady recovery. In terms of net profit and net profit margin, there will be a decrease from 2022 to 2023 compared with 2021, mainly due to the adjustment of the scope of consolidation and changes in the operating conditions of associates and joint ventures.
Selling and administrative expenses increased slightly, and rates decreased steadily. From 2019 to 2023, the company's sales and administrative expenses maintained a slight increase, benefiting from the release of the leverage effect brought about by the expansion of revenue scale, and the sales and administrative expense ratio showed a steady downward trend after the epidemic. In terms of the breakdown of sales and administrative expenses, the salary expense ratio in 2023 decreased by 0.3pct year-on-year to 7.3%, the advertising expense rate increased by 1.0pct year-on-year to 3.0%, the service expense rate increased by 0.9pct year-on-year to 4.4%, and the other expense ratio (mainly including transportation expenses and amortization of right-of-use assets, etc.) decreased by 1.8pct to 9.0% year-on-year.
The balance sheet and cash flow statement are relatively healthy. From the perspective of the balance sheet, we believe that the company's asset-liability ratio is in a reasonable range as a whole, with an asset-liability ratio of 41% in 2023, of which short-term trade payables and other current liabilities account for 20% of total assets, which we believe mainly reflects the company's strong ability to occupy funds. In addition, we believe that the company's current ratio is also within a reasonable range and has good short-term solvency. From the perspective of the cash flow statement, the net operating cash flow has been positive since 2019, and all of them can fully cover the net profit of the year, indicating that the company's business model is relatively healthy and the payment collection situation is relatively good. Net cash flow from investments was negative, mainly due to investments made from the expansion of the business.
Enlightenment for China's entertainment industry
Comparison of the current situation of China and South Korea: China's entertainment industry has a low contribution to GDP, and the scale of entertainment brokerage companies is small
China's cultural industry is developing rapidly, but its contribution to GDP is still lower than that of South Korea. According to the National Bureau of Statistics of China, the added value of China's cultural and related industries reached RMB5,378.2 billion in 2022, about eight times that of South Korea. From 2012 to 2022, the average compound growth rate of the added value of China's cultural industry was 11.5%, higher than the compound growth rate of 5.2% in South Korea in the same period. With the rapid development of the cultural industry, the added value of China's cultural and related industries has increased from 3.5% of GDP in 2012 to 4.5% in 2022, but it is still far from the 6.0% level of South Korea in 2022.
Figure 13: The added value of cultural industries in China and South Korea and its year-on-year growth rate
Note: The added value of China's cultural industries adopts the national data of added value of cultural and related industries (before deducting price factors) published by the National Bureau of Statistics of China; The added value of South Korea's cultural industry is converted into RMB according to the central parity of the RMB exchange rate on the last trading day of each year, and the corresponding year-on-year growth rate is calculated according to the original value before conversion
Source: National Bureau of Statistics of China, Bank of Korea, State Administration of Foreign Exchange, CICC Research
Chinese artist management companies are mainly divided into four categories, among which professional artist management companies are stronger. According to Frost & Sullivan, artist management companies in China can be divided into four categories: professional artist management companies, platform-based artist management companies, content-based artist management companies, and artist management studios. According to Frost & Sullivan, in 2021, the top five artist management companies in China are all professional artist management companies in terms of revenue generated by artist management business; The artist management business of platform and content-based artist management companies is mainly used as a supplement to their core business (media platform/content production), so the scale of the artist management business is usually small; Artist management studios, on the other hand, are typically focused on specific artists, and we think they're also smaller.
The market structure of China's artist management industry is more fragmented than that of South Korea, and the maturity of the industry still needs to be improved. According to the Lehua Entertainment prospectus and Frost & Sullivan, as of December 31, 2021, there were more than 1,200 players in China's artist management industry. In 2021, China's top five artist management companies will achieve a total operating income of 3.4 billion yuan, with a total market share of 5.5%, of which Lehua Entertainment ranks first with a share of 1.9%, and the overall concentration of the industry is still low; In contrast, South Korea's entertainment brokerage industry has formed a competitive pattern of "one super and three strong" led by HYBE, followed by SM Entertainment, YG Entertainment, and JYP Entertainment. According to our estimates, the total share of the four leading companies in South Korea will reach 30.6% in 2022, and the market concentration is significantly higher than that of China.
Figure 14: Competitive landscape of China's artist management industry in 2021
Source: Lehua Entertainment Prospectus, Frost & Sullivan, CICC Research
Enlightenment from SM Entertainment's experience: industrialization system, globalization strategy, and innovative spirit
Through the review of SM Entertainment's development history above, we believe that the industrialized artist training and operation system, the globalization strategy throughout the whole cycle, and the innovative spirit that keeps pace with the times are the three important factors for SM Entertainment to be able to "build an everlasting business" for more than 20 years, or it is worthy of reference for Chinese entertainment brokerage companies.
The mature artist training and operation system has created SM Entertainment's industrial output capacity. According to SM statistics, between 2010 and 2022, an average of one artist group was launched every 3.5 years, and an average of 31 music albums were produced per year. We believe that SM Entertainment's ability to continuously innovate stems from its mature artist training and operation system. In 1997, the founder, Li Xiuman, proposed the operation concept of Culture Technology, which includes three stages: Culture Creation, Culture Development and Culture Expansion. After nearly 30 years of development, the company has established an industrialized artist training system with four major links: Casting, Training, Producing, and Management. In the artist creation stage, SM Entertainment discovers potential trainees through three ways: high-frequency daily selection (weekly/monthly), global selection and talent scouting. After that, SM Entertainment will train the trainees according to their personality and strengths, and then select a certain number of trainees to enter the debut preparatory group and finally form a group debut through fierce competition and strict assessment. According to SM's management disclosure[2], on average, more than 300,000 applicants from all over the world participate in SM's auditions every year, which is equivalent to the company's cumulative number of auditions since its establishment has reached 10 million, while the company's current operating artist groups are only 21, with an average of 10 people per group, which means that the proportion of debuts to the number of auditions is only about 2/100,000. In addition, according to A Day Magazine[3], SM's regular audition event every Saturday (attended by about hundreds to thousands of people each time) has only a 1 in 1 million chance of passing (being selected as a trainee) since its launch in the 90s, and only 8 artists including Kim Hee-cheol have successfully debuted. After the artist's debut, SM Entertainment implemented its operational philosophy through a well-established organizational structure and refined staffing, assigning each artist/artist group a dedicated producer and 4 managers who were responsible for production, publicity, marketing, and administration.
SM Entertainment attaches great importance to overseas market expansion, and currently accounts for more than 30% of its revenue in overseas markets. SM Entertainment's overseas operating revenue grew from KRW 160 million in 1998 to KRW 302.44 billion in 2023, with a compound annual growth rate of 35%. The company's globalization strategy started in Japan in 2001, and from 2002 to 2003, it successfully opened the Japanese market through the successful sales of two albums of BoA. Since then, the company has set up branches or subsidiaries in China, the United States and Thailand from 2005 to 2012 to accelerate its global layout. In 2010, thanks to the construction of overseas infrastructure, the company's overseas copyright sales increased by 140% year-on-year, driving the company's overseas revenue to increase by 123% year-on-year, accounting for 49% of the total revenue. In 2012, the company's groups TVXQ and Super Junior launched global performances, Girls' Generation appeared on the popular American talk show "The David Letterman Show" to increase the popularity of K-POP in the United States, and EXO debuted simultaneously in China and South Korea, driving the company's overseas revenue to increase by 116% year-on-year, accounting for 43% of total revenue. Since then, from 2013 to 2019, due to the impact of international relations and fierce competition in the Korean artist market, the growth rate of overseas revenue has slowed down; In 2020, due to the impact of the new crown epidemic, overseas performing arts activities were restricted, and overseas income declined; From 2021 to 2023, benefiting from the normalization of offline activities after the epidemic and the company's active layout in the field of online new media, overseas business recovered rapidly, and overseas revenue in 2023 increased by 25% year-on-year, an increase of 70% compared with 2019, accounting for 31% of total revenue. According to the company's announcement, from 2018 to 2023, the proportion of Japan's revenue in the company's overseas revenue decreased from 69% to 43%, and the proportion of the company's total revenue decreased from 27% to 14%.
Exhibit 15: SM Entertainment's overseas market operating revenue, growth rate and proportion
Source: Company announcement, company official website, CCTV, CICC Research Department
SM Entertainment's globalization strategy runs through the entire industry cycle, from artist selection to content production and operation. SM Entertainment's globalization strategy is not only to sell music and entertainment content overseas, but also to run through the entire cycle from artist selection to content production and operation, and thus actually feed back into the business development of the domestic market. For example, in terms of artist selection, SM Entertainment conducts global auditions through the "SM Global Audition" program, and organizes local auditions in overseas countries such as Japan and Thailand. In addition, the company will set up scouts at various art competitions and on the streets around the world. In terms of content production and operation, SM Entertainment has built long-term relationships with more than 500 outstanding producers, lyricists, and composers around the world, and has connected with more musicians through these songwriters, so as to build the company's unique music library and music style, and connect with the global market. For example, The Underdogs, a European and American creative team, has participated in the production of SM Entertainment's popular artist albums more than 10 times since 2012.
SM Entertainment has been able to innovate in planning and operation in line with the development of the times, leading the new model of the K-POP industry. In 1996, SM Entertainment put forward the concept of "support" when launching the H.O.T. group, setting white as the group's support color, and customizing white raincoats and white balloons as support during performances, and the K-POP support culture was born. At the beginning of the 21st century, when Japanese music and European and American R&B were popular, SM Entertainment took the lead in proposing the concept of all-round idol groups and created a trainee system. When the industry followed SM Entertainment's example to form idol groups, SM Entertainment realized that the competition in the Korean domestic market was becoming more and more fierce, and took the lead in seizing the Japanese and Chinese markets with artists and artist groups such as BoA and TVXQ. When the industry is competing to create a small group of 3-6 people, SM Entertainment took the lead in launching Super Junior with 13 members, making the performance forms of songs and stages more diverse; While other companies began to follow the example of large groups, SM Entertainment took the lead in launching Super Junior-KRY's squad mode in multiplayer groups; In 2020, in response to the rise of the metaverse concept, SM Entertainment launched the virtual girl group aespa, which is different from the general virtual idol group, aespa combines virtual members and real operations, once again creating a new model of the K-POP industry.
Risk Warning
Changes in management equity and personnel may affect the stability of the company's operation and development; reputational risk of the company's artists; Intensified competition in the domestic entertainment industry in South Korea has led to a decline in the company's market share; Global expansion is not progressing as expected.
[1] Note: According to the 2022 Hallyu White Paper, the cultural content industry includes 11 fields, including games, publishing, music, comics, advertising, and movies.
[2]https://finance.huanqiu.com/article/9CaKrnJKJmh
[3]https://www.adaymag.com/2021/07/15/sm-saturday-casting-idol.html
Article source:
This article is excerpted from: "CICC Looks at Overseas Companies" published on May 11, 2024 SM Entertainment: A leader in the Korean entertainment industry and a global leader in the "Korean Wave"
杨秋硕 分析员 SAC 执证编号：S0080521050012 SFC CE Ref：BTO983
张雪晴，CFA 分析员 SAC 执证编号：S0080517090001 SFC CE Ref：BNC281
焦杉 分析员 SAC 执证编号：S0080521070012 SFC CE Ref：BRQ187
杨鑫，CFA 分析员 SAC 执证编号：S0080511080003 SFC CE Ref：APY553
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