Merilll Lynch(Target price:10.5)

DMG acquisition offers a full subway solution
VisionChina’s acquisition of DMG, which operates subway LCD ads in 9 cities including Shanghai, should offer advertisers a united national LCD ad platform in subways from 2010, covering all of the Big 4 cites. We expect synergies to start
come through in 2H10 after some material dilution in 1H10. We cut 2010 EPS by 27% on higher location costs, particularly related to the Shanghai subways, but
model FCF growth to increase to 23% from 15% in 2011-15 as pricing power gradually emerges. Hence, our DCF-based PO was raised to US$10.5 (discount rate of 10%; 23% FCF CAGR in 2011-15; terminal growth of 0%). Long-term positive but near-term dilutive given loss-making nature of DMG
We estimate DMG could incur US$8m location costs per quarter, with the majority related to Shanghai subways. VisionChina indicated DMG’s revenue was only about
RMB40m (~US$6m) in 3Q09, albeit growing fast. Absorbing a loss-making entity would be dilutive for VisionChina, at least in 2010. We expect total location costs to
rise to US$95m in 2010 from US$56m previously expected and US$49m in 2009. TV price hikes to help pricing, but no major shift in budgets TV prices in 2010 could go up by 30%+ due to recent regulation to reduce ad time on TV during peak hours. Less supply of premium TV inventory implies higher
pricing. This will support price hikes of most other media especially LCD ad platforms like VisionChina, Focus Media and Airmedia. However, we like to point out that there is not likely a big shift of budgets from TV to other media. Different media exhibit some different characteristics and are not completely substitutable. Client acquisitions and location investment affect nearterm margins
VisionChina had lower ASP in 3Q09 and would see soft ASP in 4Q09 as it gives discounts to lock up clients ahead of the new year. Location costs would also go up in 4Q09 by US$600K from new contracts and step-up arrangements.
Company, however, stands by its 09 revenue guidance (US$121-124m).