China Literature took a big step towards its ambition of becoming a full-fledged media and entertainment company on Tuesday as it agreed to acquire privately-held production house New Classic Media for Rmb15.5 billion ($2.3 billion).
The Hong Kong-listed company, best known as the operator of Tencent’s electronic book platform QQ Reading, is betting on production of movies and TV series as its next growth driver.
But the deal, along with a slowdown in the growth of e-book revenue, sent investors rushing to the exit on Tuesday. China Literature’s shares plunged 17%, its biggest daily decline since its initial public offering in October last year. The company had also reported that e-book revenue grew just 13.3% in the first half, down from 125.9% in the same period a year earlier.
The slowdown was a predictable plot twist; after all, China Literature already owned more than 10 million publications from 7.3 million authors as of the end of June, and has gobbled up more than 70% of China’s digital literature market, limiting scope for further growth.
As such, the company's aspiration of converting into a full-scale film production studio makes sense. It hopes to monetise its vast trove of intellectual property from its library of online literature by turning some of its hugely popular online novels into movies and television dramas, as well as conducting commercial entertainment events around these publications.
The question for investors is whether China Literature is paying too much for an asset that was worth less than 80% of the $2.3 billion acquisition price as little as five months ago. In March, Tencent acquired a 27.64% stake in New Classic Media for $480 million, valuing the firm at around $1.75 billion.
Still, the acquisition is earnings-accretive. China Literature is buying at around 41 times New Classic Media’s post-tax profit of $55 million last year, while its own shares are trading at 56 times price-to-earnings.
The scale of the purchase is clear from the fact that China Literature can't pay the full price even with its huge cash reserves of $1.25 billion – most of which was generated from its $1.1 billion IPO last year. It is paying roughly $800 million in cash to settle about one-third of the payment, while the bulk of the consideration will be settled by issuing new shares.
China Literature will issue 153.9 million shares – about 14.5% of its enlarged share capital – to its parent Tencent and the controlling shareholders of New Classic Media at HK$80 per share, representing a premium of 19.4% over its HK$67 Monday closing price.
Founded in 2007, New Classic Media possesses a highly visible pipeline of television series, web series and films under production, covering everything from costume drama and war films to fantasy and comedy.
One of the company's best known movies is Wu Kong, which was based on an online novel featuring the main character of Journey to the West, one of the four classic novels of China literature.
It is worth noting that New Classic Media applied to list on the mainland stock market three times in 2012, 2015 and 2017 respectively. Its listing application last year is still under review by the China Securities Regulatory Commission, but it is unlikely to pursue the plan after becoming a subsidiary of Hong Kong-listed China Literature.
Bank of America Merrill Lynch advises China Literature on the acquisition.
