Inestment Highlights:

A player transforming into a pan entertainment conglomerate.

Before being renamed as Zhongnan Red Culture Group in May 2016,the Company was Zhongnan Heay Industries, which was incorporatedin Dec 2008 and mainly engaged in processing pipe fittings, flange andpipe prefabrication made from arious materials. It started transformingits core business actiely in 2014, enturing into the culture and mediasector. It has make presence in IP, artist brokerage, moie/TV content,gaming etc. to build a pan-entertainment eco-system eer since. During1-3Q2016, it registered reenue of Rmb810mn （+30.38% YoY） and netprofit of Rmb128mn （+60.66% YoY）。

The year of 2016 saw China’s box office reenue growth slow downbut game deelopers’ sticking to coming up with premium works.

Despite the slowdown in China’s box office reenue growth in 2016, webeliee that there is still upside for the growth in the long run, expectingthe box office reenue to exceed Rmb100bn in 2020E and grow by 20%YoY in 2017. Thanks to diersification and deelopment of new mediachannels, out of all TV dramas aired during 1H2016 across China, 9dramas registered 5bn online iews respectiely. The size of China’smobile game market amounted to Rmb81.92bn in 2016 （+59.2% YoY）。

We beliee that game deelopers boasting strong R&D capabilities andsticking to coming up with premium works will excel amid consolidationsacross the game segment.

With quality IP and artists, the Company is expected to enjoy themost premium from content. The Company has built a three-tieredcultural eco-system （core resources, a matrix of monetization channelsand strategic partnership & inestment）。 Its core resources include 1）top notch IPs （with IP projects such as Lost In Kunlun etc.）， 2）well-known writers （ZHANG Muye and YAN Geling）， for whom theCompany acts their copy right agent, 3） an abundance of artists, 4） amusic JV, which is expected to become an incubating platform foricons/stars, 5） art school that it opened in cooperation with NanjingAcademy of Art. IP and artists are the two scarcest elements for contentproduction, with which the Company will make the best from the trend ofrising prices for contents.

Expanding the pan entertainment eco-system ia inestment intopremium moie and game companies and strategic cooperationwith Mango Media. The company has also built a matrix ofmonetization channels ia a string of acquisitions or strategicinestment/cooperation. It acquired Datang Brilliant Media and set up itsfilm arm, Zhongnan Film, to foray into the moie field. Zhongnan Filmreleased in May 2016 its list of moies under progress. Of which, threemoies, in which the Company is major inestor and leading producingparty, are promising to hae an integratedregime of moie and game businesses, between which it will generate synergies. In terms of inestmentand strategic cooperation, the Company set up a fund with Mango Media to inest into the cultureindustry, thus matching capital and business deelopment closely. In addition, it has inested into a fewcompanies

Potential risks: disappointing asset consolidation, fierce competition and policy headwind and drainageof talents.

Earnings forecast, aluation and inestment rating. We forecast the Company’s 2016-18E pro formaEPS to be Rmb0.49/0.62/0.74 considering consolidation of www.jggame.net into the Company’sstatement. Its current price of Rmb15.80 implies 3-year PE of 32/26/21x, whilst its comparables from thepan-entertainment segment are trading at P/E ranging from 30x to 78x, or an aerage of 43x. Taking intoaccount: （i） Zhongnan’s growth potential; （ii） premium contents and artists full in the pipeline and; （iii）comprehensie presence in films and gaming fields; （i） close collaboration with Mango Media, etc, wealue the Company at Rmb20.0bn, or 40x 2017E P/E. In addition, we also alue its traditional businessat Rmb1.0bn. Therefore, we arrie at a target price of Rmb24.70/share. Initiate coerage with BUY.