Thoughts on ETO

8th Dec '15 by DJLJ23

32 comments 19136 reads

Clearly the market has taken a serious dislike to the annoucement that it was raising debt. But i have to admit that i'm struggling to understand the reasons behind such an extreme reaction.
They claim the portfolio has been valued at $1Billion which at the current price ($1000M/333M)
is about $3 per share.
so if that was a realistic valuation, the shares are significantly under valued (eod 8 dec 15) and one would have thought it would now be in play as a take over target.

The interims stated "The Group continues to explore debt financing options to support its growth strategy" so it was not news that it was planning to do something about its debt.

Overall pretty confused, if anybody can help to clarify, it would be appreciated.

thanks David

Should remember don't catch a falling knife. i did s so currently have a small holding in ETO.

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Ramridge

8th Dec '15

Hi David -
I looked at ETO this afternoon with a view to buying if I thought the fall of 20% was overdone. In the end I didn't. Here are the reasons.
The key problem is debt. Before the issue of the loan notes, the Net Debt/ EBITDA ratio stood at 4.5, and Net Debt / OP stood at 5.6. These are ratios which exceed acceptable upper limits. Net finance charges are eating into profits in a big way (around 36% at the interim stage)
With the addition of the new £285m secured loan, the position just gets worse. To what extent I can't calculate because part of the loan will be used to repay existing credit facilities.
That wouldn't be too bad if there was confidence that the company will grow revenues and profits and cash flow , but analysts have doubts. One analyst predicts that free cash flow will be negative for at least 3 years.
My understanding is that this combination of increased debt at a dangerous level and lack of confidence about future profitability spooked the market in marking the shares down around 20%.

All IMO and please DYOR

janebolacha

David,

There are extracts from the two notes, from Peel Hunt and from Investec, in today's "FT Alphaville Live", (together with the usual smartass chat from their journalists):

http://ftalphaville.ft.com/marketslive/2015-12-08/

It's at 11.28am, about halfway through the session.

Then there's the Moodys rating report of December !:

https://www.moodys.com/research/Moodys-assigns-Ba3-corporate-family-rating-to-eOne-outlook-stable--PR_305465

The value of the content is reportedly quite some way over the $1bn figure since that figure does not include the value of the ADB content. This is from the interim results RNS of November 17:

"The value of the Group's content library, as at 31 March 2015, had increased to over US$1 billion with further upside to come following the ABD transaction"

You'll see that Peel Hunt and Investec come to very different conclusions. The Moodys ratings report included this phrase, "London, 01 December 2015 -- Moody's Investors Service has today assigned a Ba3 corporate family rating (CFR) and a Ba3-PD Probability of default rating (PDR) to Entertainment One Ltd ('eOne' or the 'company'), a leading independent global film distributor and a TV programming producer. " Moodys do later state this:

" LIQUIDITY PROFILE

Moody's regards eOne's liquidity position as adequate over the next 12-18 months. The proposed re-financing will improve eOne's capital structure and its debt maturity profile. At the end of September 2015, the company had GBP40.9 million of cash and cash equivalents (excluding interim production cash of GBP27.9 million) on its balance sheet. After the debt re-financing, eOne will have cash of GBP84 million (excluding interim production cash) on its balance sheet and will also have access to a GBP100 million revolving credit facility (this revolver could be upsized to GBP125 million), which together with internally generated cash flows should be sufficient to cover eOne's operational cash requirements. The RCF incorporates certain maintenance financial covenants under which we would expect eOne to maintain comfortable headroom at all times. There is no material debt maturity before the RCF maturity in December 2020."

Exactly why there is a PDR (Probability of Default Rating), tbh, I don't understand in view of the later statements in the liquidity profile but the slide in the share price seems to have started with the Moodys report and then accelerated with the Peel Hunt downgrading.

My impression is that the market is churning through all of this and not knowing what to make of it and then selling with the slide then feeding on itself. The rate on the bond seems high but Investec seem to be implying in their note that it is actually a reasonable rate for a company like ETO.

At 140p, the company is valued at about 470m pounds which seems to be a PER of about 7 or perhaps a little more. The increase in the financing charge after this bond issue has been estimated as equating to only 9% of profit but the market has been hit successively by the discounted placing, the bond issue, the Moodys rerating and the Peel Hunt downgrade so perhaps one can understand the brutal market reaction.

That said, there does not seem to be any immediate liquidity problem and, from what I've read, ETO is okay for at least 12-18 months, time a-plenty to get their longer-term financing profile in order.

I had been thinking that with one blow after another, this was some kind of masochistic rehearsal by ETO for the television series of "Rocky" that I know they are now programming. Whatever, to me the share price of 140p seems to be a punch too far. I picked up a few at just over 140p.

All IMHO, DYOR.

Jane.

PS: Takeover? Well, content is the no. 1 theme in television. ETO has plenty of it and has been mentioned before as a takeover target. So, who knows?

DJLJ23

9th Dec '15

Jane, Ramridge
Many thanks for posting and helping to clarify.
Lets hope that Peppa has a good xmas, i read some where its in the Royal Mail top requests to santa.
Happy and proftible xmas new year to all
David

Nice bounce this morning....

roque22x

11th Dec '15

The excessive drop an overreaction to say the least. The drop is more to do with human psychology of panic than logic. Maybe a representation of Benjamin Graham's view of " the market" been likened to a manic depressive.

ACounsell

4th Feb '16

Entertainment One (LON:ETO) continues to perform abysmally without any specific reason. Does anyone have any idea why - is it still a hangover from the refinancing? I am considering selling at a significant loss but suspect that a bidder may come along for some or all of their content at some point. However, perhaps the debt levels are discouraging any potential bidder. Any thoughts appreciated

bsharman

I would like to find out what is driving the share price decline at the moment. I'm thinking about buying some more but am concerned that it may go lower still.

It all depends whether you see the share price as reflective of the company. I think a PE of 7.29 is incredibly low and there is a favourable risk reward. I think the nervous reaction of the share in the past has set a precedence of a herd mentality in any falls. I believe that the share on positive news will jump very quickly. Usually the bigger the fall , the bigger the opposite reaction. This could be a classic case of contrarianism. Shares prices do not make sense in many cases and precisely because of that you can make or lose money. The market offers the price but the investor decides the value.

16th Aug '16

The value in Entertainment One (LON:ETO) now seems to be well and truly recognised, at last - and, one could perhaps say, despite its management's best (or worst?) efforts.

It has been obvious for years that the real value in the company is in the Peppa Pig franchise, 85% owned by ETO. It has been frustrating to see resources and effort and ambition invested into the film production side, the results of which are dependent on market caprice and which can be hit - or, more often, miss.

At least one major shareholder, Livermore Partners, holding about 10% of ETO, has for some time been calling for the Board of Directors to be shaken up:

http://www.reuters.com/article/us-ent-one-livermore-idUSKCN0Y82MK

Perhaps it needed the little porker to demonstrate that she could clean up in the US just as she has done elsewhere. This article from (yes!) The Guardian shows how succcessful Peppa is on the other side of the pond:

"While the UK remains Peppa’s biggest market, the US saw 400% growth in royalty revenues and 275% growth in retail sales, with particularly strong sales in Toys R Us."

"We are really only just starting in the US, which is far and away the biggest market for licensing and merchandising in the order of 50% of the total [globally]. Momentum is really building there and there are opportunities opening in markets like France and China.”

https://www.theguardian.com/media/2016/may/24/peppa-pig-on-track-to-be-2bn-brand-after-making-splash-in-uk-and-asia

(It's worth remembering that only 5% of revenues come from the tv broadcasting itself. It is the merchandising that brings in the bacon).

KKR is reported to be mulling a bid for ETO. That ought not to come as a surprise, really. KKR owns Toys R'Us and will have seen the way the Peppa Pig merchandise flies off the shelves. They may also have realised the theme park potential in the US. Almost certainly, KKR would sell on the film and music divisions and realise, with resources that would not be available to ETO, the full potential of the Peppa Pig franchise.

KKR have reportedly already been in talks with the Canadian Pension Plan, who own 19% of ETO. Again, this ought not to be a surprise since KKR and CPP have a long-standing relationship in other business areas:

http://media.kkr.com/media/media_releasedetail.cfm?ReleaseID=410159

http://dealbook.nytimes.com/2013/01/17/canadian-pension-plan-to-join-k-k-r-merchant-banking-venture/?_r=0

http://media.kkr.com/media/media_releasedetail.cfm?ReleaseID=734030

Where the involvement of CPP becomes interesting is in the price they paid for their shares in ETO. This was 269p, now about 260p following the later rights issue. Given the CAD/GDP exchange rate movement since September 2015, the time they became shareholders, CPP would need a price of about 290p to break even on their investment. Presumably they would want to make a profit so would perhaps be looking at 300p or more.

Analysts are quoted as expecting ITV (LON:ITV) to up its bid to about 280p compared to the 236p on the table already. At today's price of 255p, ETO is on a PER of only 12.6 so 280p would still be a PER of only about 14. Imo, that would be still very cheap for the tremendous potential in the Peppa Pig franchise.

The management of ETO have been quoted as saying the group is worth a price of 350p-400p. That might be stretching it a bit (besides raising the question of why the present management is seemingly so poorly rated by the market?) but, imo, a price north of 300p would be getting on to realistic ground.

Other possible suitors have been mentioned but KKR might well have an inside track.

A story to follow.........avidly!

Carey Blunt

17th Aug '16

I don't mind saying that I need 278 to break even so glad my interests are aligned with the large share holders!

Hi Jane - interesting note and well researched as ever.
ITV's share price has been moving sideways since it announced its offer for ETO.
My view is that if they have to up the offer (300 or above) then their share price will slide south, but if KKR (or others with deep pockets) come on the table with a much better offer, then ITV will have to withdraw in which case their SP will head north.
Plausible or nonsense?

Hi Ramridge,

There could be something in that, perhaps at least initially, should ITV over-pay. I wouldn't see that happening, tbh, since I'd be pretty sure that ITV would be aware that in buying ETO, they would be buying something not wholly compatible with their existing business and overpaying could, as you say, send the share price lower but in doing so then increase the immediate vulnerability of ITV itself. Yes, the Peppa Pig franchise would add content but it would come with the cinema film production division and the music division which ITV would then presumably want to sell on. Should they get to that point, then actually ITV, boosted by Peppa and its potential, would perhaps also become an even more attractive target for takeover. That's why any share price move south could well be limited, imo. ITV does, imo, have some tricky thinking to do.

The forces against an ITV bid succeeding are perhaps quite formidable. I'd expect CPP (holding 19%) to be lining up with KKR, that is providing there is an offer price of 300p or thereabouts. Livermore Partners (holding 10%) could well join that group since they have been very, very critical of the management of ETO. So there we have close to 30%, perhaps in one bloc. It would not be easy for ITV to overcome that, imo, particularly since they would not have the more obvious synergies that KKR could muster, particularly in respect of the merchandising of Peppa products (with KKR's ownership of Toys 'R Us) and the full and fast development of the Peppa potential, through theme parks, movies and so on.

Imo, ETO is a bit of a mongrel. Whoever buys it will be likely to break it up and thus both realise value from the divisions sold off and then have a strong and focused Peppa division to either develop strongly or to float off independently. There could well be other or additional elements of a value maximisation strategy, including perhaps a double listing, perhaps in the US or in Canada, or both. ETO is already a Canadian-registered company and in this way benefits from the Canadian Government's generous incentives for the film industry. Splitting off the film division to become a free-standing Canadian operation would presumably preserve those incentives. Peppa is 95% merchandise so that could perhaps have a US listing and would have a much higher rating, both intrinsically (once the film and music divisions shed) and because media is much more US-centred and much more highly rated by investors there than is the case in UK, besides opening avenues in the US for such areas as theme parks.

Lots of variables, quite fascinating really, to see where this all goes.

All IMHO, as always DYOR.

Best wishes,
Jane.

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