Integrating AI Like DeepSeek-R1 Will Improve Content Creation And Expand Global Reach

Key Takeaways

• Integration of AI in content creation boosts user engagement and content quality, driving future online reading revenue growth.
  
• Global market expansion and IP commercialization strategies diversify revenue and enhance margins through new markets and merchandise.
  
• Declining profitability, revenue decreases, and user retention issues, alongside goodwill impairment, pose challenges to China Literature's financial health and investor confidence.

Catalysts

An investment holding company, operates an online literature platform in the People’s Republic of China.

• The integration of AI technology, such as the DeepSeek-R1 model, into content creation tools has led to increased daily active users and enhanced capabilities for writers. This advancement is expected to drive future growth in online reading revenue by improving the quality and efficiency of content generation.
  
• The company's focus on IP commercialization, with successful ventures like Ne Zha 2 and collaboration with other IP studios, aims at expanding merchandise reach and diversifying revenue streams. This strategic move is anticipated to boost overall revenue and improve net margins by tapping into the expansive merchandise market.
  
• Expansion in the global market through AI translation has significantly increased non-English work revenues by 350%. This globalization strategy is expected to enhance revenue growth by broadening the audience base and reaching new language markets.
  
• The acquisition and integration of Tencent Animation and Comics provide enhanced synergies, expanding China Literature’s capabilities in content production and distribution. This development is projected to positively impact revenue and earnings by leveraging a unified content creation and distribution strategy.
  
• The emphasis on high-quality short dramas and the development of a robust short drama ecosystem is expected to yield quick returns and further monetize China Literature’s IPs. By capturing the growing short drama market, the company aims to enhance revenue and profit streams.

China Literature Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming China Literature's revenue will grow by 4.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from -2.6% today to 14.8% in 3 years time.
• Analysts expect earnings to reach CN¥1.4 billion (and earnings per share of CN¥1.4) by about April 2028, up from CN¥-209.2 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting CN¥1.6 billion in earnings, and the most bearish expecting CN¥1.2 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 25.9x on those 2028 earnings, up from -119.5x today. This future PE is greater than the current PE for the HK Media industry at 8.1x.
• Analysts expect the number of shares outstanding to decline by 1.34% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.84%, as per the Simply Wall St company report.

China Literature Future Earnings Per Share Growth

Risks

• There was a significant decrease in net profitability, with China Literature reporting a net loss to shareholders of RMB 209 million in 2024 compared to a net profit of RMB 805 million in 2023 which could adversely affect investor confidence and overall earnings.
  
• New Classics Media, a subsidiary, experienced less-than-expected profit performance due to certain project delays and failure to develop some scripts, impacting the company's overall revenue from IP operations.
  
• Revenue from self-operated channels on Tencent's products decreased significantly by 28.2%, largely due to a decrease in advertising revenues, which could continue to impact revenue growth if the trend persists.
  
• The reporting of an impairment loss of goodwill for New Classics Media amounted to RMB 1.1 billion, which impacts net margins and highlights challenges in asset valuation.
  
• The average monthly active users (MAUs) on self-operated channels on Tencent products decreased by 37.7%, indicating potential issues with user retention which could impact future subscription revenues.

Valuation

• The analysts have a consensus price target of HK$31.684 for China Literature based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of HK$37.08, and the most bearish reporting a price target of just HK$22.98.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be CN¥9.2 billion, earnings will come to CN¥1.4 billion, and it would be trading on a PE ratio of 25.9x, assuming you use a discount rate of 6.8%.
• Given the current share price of HK$26.4, the analyst price target of HK$31.68 is 16.7% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.