LON:FFI | FFI – Complexity Obscures A Market Leader Trading On 5x Earnings (34p, £54.5m)

9th Oct '18 by AnonymousUser542644

7 comments 4530 reads

DISCLOSURES: I hold, a large (for me) long position in FFI, having purchased recently at prices ranging from 30.3p to 34.3p. I am therefore talking my own book, though, I believe, backed by primary research (e.g. speaking to an industry veteran). Fact check with the company complete.

“I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.” – Warren Buffett

Link to 2018 Annual Report: http://www.filmfinances.com/ff...

The Shortcut

For a stock with a clear moat, industry leading position, and long heritage, FFI appears critically undervalued. Industry woes in 2017, combined with growing pains as the company acquires leading positions in adjacent niches set back management guidance for the current year (FY19) at the half year stage. The result, is that FFI is trading at an over 75% discount to its 2017 IPO price, not helped by poor liquidity. But looking beyond this, trading at just 5x earnings with a solid balance sheet, I firmly believe on a 6 to 12 month view, the stock offers substantial upside. My price objective is 65p, equal to 10 times FY19 ‘guide low’ earnings. Longer term, successful execution could drive a return to a mid-teens PE valuation, on FY20, implying a price objective closer to 120p, though this outcome should be somewhat discounted until execution improves.

What is FFIs heritage?
Film Finances is a business that is building out a full-service offering for the film industry. The company has been around since 1950 after the upheaval of the British film industry, with its heritage in the UK, though following the rest of the industry over to California as the US became the global film industry’s own HQ. The company’s roots until a couple of years ago were solely in the business of ‘completion contracts’, where it remains the market leader, estimated at 80% share, having been involved in over 5,500 film, TV and streaming productions. Excluding significant growth in streaming (which FFI is increasingly servicing), the film industry is anticipated to grow from $38bn in 2016, to $50bn in 2020.

The business is relatively heavily relationships driven, which is a key barrier to entry. Alongside having a multitude of experienced staff working at FFI for well over a decade, the company has a wide-ranging set of relationships with streaming…

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BrianGeee

9th Oct '18

Eric, thanks very much for the helpful write-up. The story is certainly interesting, but I have some concerns, or at least lack of understanding.

Until recently FFI focused pretty much exclusively on completion contracts. Then just before IPO, they embarked on a very substantial diversification, acquiring a number of businesses involved in the film industry, but have no clear strategic connection with the knowledge-base of FFI employees.

So, what gives you confidence that the substantial increase in earnings, based on some probably uncertain acquisition multiples, will be delivered?

There is little track record for the significant new parts of the business. Business integration is new to these guys and this business, and there's clearly risk in assuming the broker & company estimates are good. Recent central cost overruns increase uncertainty in that regard.

Are these clever strategic acquisitions with more rational that they're suppliers of a variety of products to the same end customer, or is it (uncharitably) simply a 'rag bag'?

Brian.

AnonymousUser542644

Good questions, Brian. I think the first thing is to understand that the client base is pretty close knit, and so while they will have been using FFI for completion contracts, they'll have been using, in all likelihood, a smaller regional private business for the different aspects of their production. The cross sell is both logical and highly desirable from the customer's perspective (a key area of discussion on my industry call). Aside from the simplified logistics, there are also some tax benefits in being able to shift around where you render the services to the end customer - a lot of nations globally support the film industry with some form of grants or tax breaks.

At the same time, there is significant scope to cross sell, and these being genuine, e.g. "As with our other acquisitions, Signature offers FFI strong referral opportunities, not least in completion contracts given that within Signature's book of titles only around 3% are currently bonded by FFI. Signature also provides us with significant non-bonding referral opportunities given that all films require editing, general insurance and a range of other ancillary services which FFI can now offer. Referral opportunities are two-way, with Signature itself offering distribution options for some of our smaller-budget completion contract clients."

There is nothing especially difficult about making a success of the post and pre-production businesses or the distribution businesses. And linked to these, is FFIs strategy to keep the existing management team in place. They're generally businesses that have generated good profitability in the previous financial year and are growing. The more tricky one, and one that is more difficult, is Reel Media, which is the insurance business. This has been the cause of some of the integration issues, and some are self-made (expansion at the same time as integration is pretty difficult). Theyve bought a motorsports insurance book, plus acquired part of the entertainment business of Allianz's North American business (the multinational insurer). Which is a big element of the drag this year, with an expectation to move back into EBIT contribution from FY20, rather than weigh as it currently is.

Separate note; much of the contingent consideration is related to Reel, and so if performance continues to be weaker, you do get the reverse benefit of less of that becoming payable. The performance conditions to unlock the contingent consideration are pretty optimistic to say the least so I'd almost want to discount this. If they hit it, great, the stock will be multiples above where it is now. But hard for me to see at this stage how it is possible. "This fair value estimate is based on an assumed discount rate between 2.1 - 3.2 per cent and assumed EBITDA in Reel Media, LLC of $6,800,000 - $11,700,000 for each of the next five years."

I'd therefore agree with you. Quite a lot of moving parts. My expectation, however, is that they come across as broadly pretty competent (despite what has happened so far!) and quite frankly they need to invest in having better group systems, as they are currently doing. I appreciate that they guide to an earnings corridor and at this valuation, think the current valuation is pessimistic to say the least.

Carcosa

11th Oct '18

CFO resigns today along with "The Board appreciates Tim's contributions and wish him well in his future endeavors."

Never a good sign when a CFO leaves at short notice but earlier profit warnings were probably the cause. With no further comment today regarding a 3rd profit warning then the resignation is probably benign wrt ongoing business. Whether investors see it that way today remains to be seen, I suspect not!

CFO looks to have finally been pushed out of the business today and have promoted internally

Could've timed the release for a different day! In reality, he should've been kicked out at the full year results, but think there was a board meeting post close. He hadn't been at the business for a long time, only joining February last year, so the poor performance is not really an acceptable standard, especially around the second warning relating to overheads.

In reality, at this valuation, it changes little, though obviously a net negative to investor confidence. Personally, I had wanted to see this change happen, but just would have preferred it at a different time to this week!

That said, I do think this is a superb entry point

clouds

17th Dec '18

Hi Eric,

Thanks for the write-up, I think it is probably an attractive opportunity and am long. There is a good write-up here if you are interested: https://www.valueinvestorsclub.com/idea/Film_Finances_Inc_Holdings/5735555636#description
(you might need to sign up for free to see it)

Are you concerned about the David Haring connection? He is involved with the Golden Sun Emerging Fund (c. 30% owner of FFI), seems to have a lot of influence (before CFO resigned 4 out of 6 directors had a past connection to Haring). My big concern is that the COO Antony Mitchell (who has past connections to Haring) was the CEO of Emergent Capital (previously called Imperial Holdings), which has been a disaster, that unfortunately I've lost money on. Haring was also invested in Imperial at some point. I think Antony Mitchell was involved in founding Emergent Capital (Imperial) back in 2006, it IPO'd in 2011 at USD 10.75, and now trades at c. USD 0.1.

I am long, as the opportunity does look very attractive, but I am concerned about the Emergent Capital link and hope I'm not being stupid in buying anyway!

RJLZ

15th Feb '19

It looks like the seller that created the overhang here for the last few weeks is now out.

David Sasso has answered all of my questions promptly in detail and quickly which gives me confidence - I think substantial value will now be delivered over the next 12-18 months from the current SP level of 25p. This is an excellent recovery play in my opinion.

mojomogoz

Do post up a brief summary of answers you have. Thanks

FFI – Complexity obscures a market leader trading on 5x earnings (34p, £54.5m)

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