Is It Time to Short China's Media and Entertainment Companies?

Fueled by liquidity, leverage, and rampant speculation, China's stock markets have reached fever pitch levels and look ripe for a correction.

If you missed out on the recent Chinese market boom and you're looking for a way to make make up for it, you might consider taking advantage of the recent Shanghai and Shenzhen stock market rule changes that now allow investors to short equities.

Don't just take my word for it—PIMCO co-founder and current head of Janus Capital's Janus Global Unconstrained Bond Fund Bill Gross calls the Shenzhen Stock Exchange the next “short of a lifetime.” With an average trailing P/E ratio of 69, the Shenzhen exchange has more than tripled in the past 12 months and is now at the most expensive levels of any exchange worldwide.

On a projected P/E basis, Shenzhen is trading at double the level of stocks on the NASDAQ, and nearly triple the level of the MSCI world index.

Now here's the thing: the media and entertainment stocks that trade on China’s exchanges make non-media companies look positively cheap in comparison. Major Chinese film and TV operations listed on the Shenzhen and Shanghai exchanges are trading at average trailing 12 month P/E ratios of 138. Some are much higher: Beijing Englight, a movie production and distribution company, trades at 151 times earnings. Beijing Hualu Baina Film and TV is at 188 times earnings. China Television Media is at 297 times. Alibaba Pictures has seen its valuation increase 7-fold in the past 12 months to nearly $10 billion without having released a single movie.

Huge fortunes have been made by speculators riding the cresting wave.

Are these media companies’ earnings really worth 3 or 4 or 5 times more than those of the rest of China’s already overvalued stocks? There doesn’t appear to be any fundamental basis for their sky-high prices. There have been no earth-shattering news announcements portending major new developments. No accelerations in growth or earnings to fuel the exponential increases in value. In fact, the Chinese economy’s growth has been slowing over the past year, and if anything media company earnings look vulnerable.

The only factor that seems to matter for these stocks is that they’re in the right place at the right time. China’s investors, with no apparent memory of the Shanghai exchange’s 70 percent crash in 2007, have piled in from the busted real estate sector to snap up sexier looking entertainment and media stocks and drive them to stratospheric heights.

A telling sign of overvaluation is that the Chinese media companies listed on U.S. exchanges like the NYSE and NASDAQ have remained relatively earthbound, even though they operate in the same industry and are subject to the same economic conditions as their Shanghai and Shenzhen listed counterparts. U.S. listed media stocks like Shanda Games, Sina and Perfect World are all trading at between 1o and 20 times earnings. Only NASDAQ listed Bona Film Group is trading at anywhere near the Chinese multiples, at a trailing P/E of 130.

It’s always risky betting against the trend, and fads in China have a way of maintaining strength and momentum without any apparent logic. But the signs of a bubble are right there in plain sight, and bubbles always burst. The only question is when.

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