We initiate coverage on Baofeng (暴风集团) with an Underperform rating and a TP of RMB25 based on an SOTP valuation, 39% below the current share price. Baofeng aims to build an ecosystem around content, platform and big data technology. It rolled out Baofeng TV in Dec 2015 and VR products in Sep 2014. However, its TV market share remains small at 2%, while its VR remains an entry-level product with unappealing user experience and content.
   
We value Baofeng’s video business based on 5x 2018 P/S at a premium to Youku’s acquisition valuation of 2x and higher than our target multiple of 4x for A-share peer Leshi Video due to Baofeng’s more stable cash flow. The valuation of both advertising and membership from video is RMB5.7bn, or RMB20 per share. We value Baofeng’s TV arm Baofeng Tongshuai based on 0.7x 2018 P/S, in line with the A-share TV maker Hisense. We value Baofeng’s 30% stake in Baofeng Tongshuai at RMB602mn (30% of RMB2bn), or RMB2 per share.
   
Baofeng TV’s share remains insignificant. Since Baofeng TV debuted in Dec 2015, shipments have not been picking up meaningfully, as the value proposition of its membership remains limited and its spec/pricing are not distinctive from peers, in our view. We forecast Baofeng’s TV shipments to grow from 1mn in 2016 to 1.7mn, or 3% market share in 2017. Baofeng’s TV business accounted for 58/69% of total revenue in 2016/17.
   
First mover in VR but user experience not enticing. Baofeng Mojing is clearly one of the leading VR players in China. It debuted the first VR headset in Sep 2014 with consistent upgrades. Its cumulative shipments have surpassed 1mn units by 2015, and 2mn by Oct 2016. Over the years, Baofeng Mojing has been expanding the content offering and the social aspect of its VR ecosystem with 25k+ movies, TV dramas, panorama clips, and VR-based games. However, the user experience is not particularly enticing. Its headsets are similar to Google Cardboard as an entry-level product. Its viewing experience, e.g. resolution and viewing angle as well as game content, are acknowledged as behind the international peers. The listco owns 18.85% of Baofeng Mojing. We value its stake at RMB528mn or RMB2 per share.
   
Video risks being a marginal player. Baofeng Video ranked seventh by mobile monthly active users (MAU) in Nov 2016 according to Analysys, and ninth by PC MAU according to iResearch in Nov 2016. As Baofeng falls behind competitors in terms of user metrics and lack of high-dollar popular content, we are concerned it may lose out during industry consolidation at the top. Baofeng is working on membership subscription and Baofeng Pictures on content production, but with limited progress thus far. As such, we model a modest 20% advertising revenue CAGR between 2015 and 2018.
   
Upside risks. Faster than expected TV shipments along with membership subscriptions, breakthroughs in content production e.g. in original content, a favourable customer preference for VR products, higher than expected valuation for its businesses e.g. Baofeng Mojing and Baofeng Tongshuai in private financing round.