From all appearances, Xinhua Finance Media (Nasdaq: XFML) seems like the ideal opportunity for small-cap investors looking to profit from China’s lucrative media industry. However, with its string of recent management troubles and unclear acquisition strategy, investors might be wise to look elsewhere.

For sure, China’s media industry would be a great sector to get into. The television, print and Internet segment is definitely booming as firms rake in the cash from advertising revenues. The country’s 2006 total advertising revenue in radio, film and television reached US$14.43 billion, a growth of US$2.63 billion, or 33%, from 2005, according to a recent report by China’s State Administration of Radio, Film and Television. iResearch Consulting Group, an Internet research firm based in Shanghai, estimated Chinese online advertising sales for last year to be around US$555 million, a jump of US$150 million or a 48% increase from 2005. Meanwhile, annual revenues from print-media are at least US$6 billion, with a growth rate of around 6%. 

This growth is fueled by the explosive Chinese economy as advertisers try to tap into the country’s growing middle class, which is now estimated to be at 80 million, an increase of 14.5 million, or 22%, since January 2005. With the prospects of millions in ad revenues, entrepreneurs see enormous business opportunities and have been investing heavily in Chinese media groups for the past few years. Two of the biggest media groups include the Southern Daily Group, based in the southern city of Guangzhou, and the Shanghai Media Group.

So where does that put Xinhua Finance Media? Based simply on its name, it would seem the firm is in a prime position to seize the bounties. As a spin-off from the Chinese government’s official media mouthpiece Xinhua, the company could ideally leverage this unique relationship to navigate through China's archaic bureaucratic hurdles and government controls on the media to seize on emerging opportunities.  For example, it could quickly get government approvals for the opening of new print magazines and acquisitions of media companies, which often take years of waiting, with the application often rejected. There is also definitely a demand for English and Chinese financial news, particularly among the growing hordes of Chinese investors trying to cash in on the current Chinese stock market boom. According to the China Securities Depository and Clearing Corp, the number of individual trading accounts has soared by 30% over the past year, to 95 million.

Xinhua Finance Media describes itself on its website as “China’s leading diversified financial and entertainment media company.”  It is these advantages that make analysts such as WR Hambrecht and CIBC World Markets bullish on the firm (not to mention the fact that the two firms were involved in the underwriting of Xinhua Finance Media’s March 12th IPO).

However, is Xinhua Finance Media fully developing its real advantages as a financial news service provider that has close ties to the government? Indeed, the firm has been actively making moves, such as acquiring Beijing Mobile Interactive, a cell phone service provider on June 4, and the Singshine Advertising agency on June 11, as well as winning a contract to re-brand the Hebei Movie & Drama TV Channel on June 18. However, these actions are not focused on maximizing the company’s core advantages - developing its brand as a preeminent Chinese financial media services company. 

To be competitive in China’s financial media, such services, like anywhere else in the world, have to provide insightful and in-depth analysis of the market, not just official press statements and statistics. China already has a vibrant financial media sector with cutting edge publications led by Caijing Magazine and the 21st Century Business Herald as well as online portals, such as Baidu (Nasdaq: BIDU) and Sina (Nasdaq: SINA).  Xinhua Finance Media’s print holdings, such as Economic Observer and Money Journal, Funds Observer and China Venture, while decent enough, are not the top-of-the-line publications that are religiously read by the Chinese investment community. In addition, its wire service faces fierce competition not only from Chinese companies, but from traditional English services such as Reuters Group Plc (Nasdaq: RTRSY), Bloomberg and Dow Jones & Co. Inc. (NYSE: DJ), all of which have set up shop in China. Thus, this is not the most opportune niche to be in. 

Moreover, the company’s unique relationship with the Chinese government is apparently over. The official Xinhua news agency announced in April that its ties with Xinhua Finance Media have ended and that the listed company must adhere to Chinese regulations in its relations with the government agency. This means that the firm can no longer quickly get government approvals for its acquisitions. The worst case scenario is that the officials could cancel its past transactions. In fact, the firm has admitted in its IPO prospectus that certain of its operating companies and partners had "previously engaged, or may currently engage, in activities without appropriate licenses or approvals."

The company's management has also been embroiled in controversy. In its July 2 edition, Forbes reported that Xinhua’s American CEO Loretta Fredy Bush recently settled long-running litigation with the U.S. government by acknowledging she had filed personal tax returns understating her liability. Weeks earlier, Barron’s said that the company’s former chief financial officer also headed a U.S.-based securities firm sanctioned by U.S. regulators last year and had helped underwrite fraudulent stocks. The executive is no longer with the firm. This has resulted in a string of legal troubles. On May 25, Federman & Sherwood filed a class action lawsuit on the behalf of investors accusing the company of issuing a false and misleading registration statement for its IPO. Xinhua Finance has responded by saying the accusations are without merit.

Despite its troubles, the firm financially claims to be doing OK. According to its first-quarter press release, Xinhua Finance Media said its revenues were US$16.7 million, a growth of US$9.6 million from $7.1 million for the first quarter of 2006 ended March 31, with its operating margins at 4.35%. The stock price is currently hovering around US$9, a 30% drop since its IPO price of $13 on March 12. Based on these numbers, small-cap investors could take a chance on the idea that the firm’s troubles have discounted the stock price.

Another option is to look at China Finance (Nasdaq: JRJC), which provides online financial and listed company data and information in China through subscriptions. For the first quarter ended March 31, the company said revenues were US$4 million, compared with US$1.41 million the same period last year. The company’s current operating margin is 9.35%. Its stock price is also around $9 per share, just below its 52-week high of $10 per share. As important, management has not been embroiled in any public scandals. Moreover, its revenues are generated from its core competency – increased subscriptions. China Finance said its registered users grew to 6.57 million, an increase of 9% from the previous quarter, while its fee-based individual subscribers grew to 31,700, an increase of 12% from the previous quarter.