That's because shares in film distributor and producer Entertainment One (ETO: 220p) obtained a full listing on the London Stock Exchange in July. That was after the June meeting of the FTSE International Committee and so came too late for the company to be promoted. But given that the company now has a market value of £618m, it's an odds on certainty to enter the FTSE 250 index at this week's review.
Currently, the four largest companies in the FTSE SmallCap index are food producer Greencore (GNC: 151p - market value of £604m), cinema operator Cineworld (CINE: 393p - market value of £594m), engineer Hellermanntyton (HTY: 266p - market value of £570m) and support service group Brammer (BRAM: 478p - market value of £562m). So not only is Entertainment One in the number one spot for promotion, it would also rank as the 214th largest company in the FTSE 250 by market capitalisation and the 314th largest company in the FTSE 350.
That's an important point to note because under the FTSE International Committee rules, a company is automatically promoted to the FTSE 250 index at the quarterly review if it ranks 325 or higher in the FTSE 350 index. Currently, that position is held by Polar Capital Technology Trust (PCT: 442p) with a market value of £569m. In other words, even if Entertainment One's share price fell by 8 per cent in the next two trading days, it would still enter both the FTSE 250 and FTSE 350 indices automatically. Click here for a summary of the FTSE International rules for index changes.
Index change rules
Interestingly, a company automatically drops out of the FTSE 250 and into the FTSE Small Cap index at the FTSE International Quarterly Index Review if its market value has fallen below the 376th largest company in the FTSE All-Share index. This index is made up of 586 companies in the FTSE 100, FTSE 250 and FTSE SmallCap indices. That's also an important point to note because at current valuations the 376th largest company in the FTSE All-Share index - and the 26th largest company in the FTSE SmallCap index - is waste management company Shanks (SKS), which has a market value of £389m.
By comparison, there are five laggards in the FTSE 250 which have market values below this figure: Utilico Emerging Markets Trust (UEM: 178p - market value of £380m); Indonesian coal miner Bumi (BUMI: 214p - market value of £379m); software company Anite (AIE: 122p - market value of £363m); JPMorgan Indian Investment Trust (JII: 311p - market value of £328m); and oil exploration and production company Salamander Energy (SMDR: 126p - market value of £326m). Therefore, all five companies are live candidates to automatically drop down into the FTSE SmallCap index. In turn, this would mean that Entertainment One, Greencore, Cineworld, Hellermanntyton and Brammer would all be promoted into the FTSE 250.
Timing the changes
As I have noted in the past, the changes to these indices don't take place for another seven trading days after the FTSE International Committee quarterly meeting on Wednesday. In this case, the changes come into effect at close of trading on Friday 20 September. As a result, there is a trading opportunity to exploit by buying shares in the likely new entrants to the indices in the run up to their promotion. That's because there will be technical buying of the shares from asset managers tracking the specified index who will be forced to buy shares in these companies before the index changes are made irrespective of the price of the shares.
There will also be forced selling of the shares of the drop-outs by index tracking asset managers. More often than not, the combination of these two factors causes shares of the companies set to be promoted to outperform in the run-up to their inclusion in an index, while the likely drop-outs underperform as investors dump the shares.
And this is exactly what has been happening with shares in Greencore up 15 per cent since the June Quarterly Review, Hellermanntyton up by around 13 per cent, Brammer up 49 per cent and Cineworld up 24 per cent. Shares in Entertainment One are also up by around 24 per cent in the same three-month period. Having assessed the investment case of all five companies, and taken into consideration the likely share-buying by fund mangers, I firmly believe shares in Entertainment One have the most upside potential from the forthcoming index changes.
Blue sky territory
Importantly, after the recent re-rating, shares in Entertainment One are in blue sky territory as there is no overhead resistance to impede the price. Moreover, having taken out the 209p all-time high, dating back three years, a rally towards my target price of 240p now looks firmly on the cards. The 14-day RSI is not overbought, the share price has been trending up, and is not overextended in relation to the 20-day moving average which is around 216.5p. There is also near-term support from the rising 50-day moving average around 206.5p. The price action also looks ideally set for an assault on the mid-August all-time high of 222p. I expect this level to be taken out.
Importantly, the fundamental case fully supports the ongoing re-rating, both on an operational level and based on the value in the company. In a first-quarter trading update to the end of June, the group revealed that revenues in the three-month period increased 65 per cent on the prior year (pro forma in line year-on-year once you factor in acquisitions). This was driven by 68 box office releases (compared with 49 in the prior year) and a solid performance from the enlarged library of films. There is also substantial value in the library which includes more than 35,000 film and television titles, 2,800 hours of television programming and 45,000 music tracks. It also offers solid asset backing as the library alone is worth $650m. At current exchange rates that equates to 70 per cent of Entertainment One's market value, or £420m. Or put it another way, around 148p of the current share price of 218p is in the library alone.
But this is also a growth business as in the first quarter to end-June, total box office takings of $68m (£44m) were more than three times prior year levels. Film releases include Now You See Me, The Big Wedding and Behind the Candelabra. And, in television, Peppa Pig continues to perform well internationally. In the US, it is now enjoying two prime time slots on Nick Junior. In addition, the group has strengthened its licensing and brand management business through the acquisition of Art Impressions, an LA-based brand development and licensing business which owns three key brands, So-So Happy, Skelanimals and Galaxy Girls.
New contracts underpin investment case
Only last week, Entertainment One announced an exclusive three-year television deal with US-based AMC Networks (AMCQ: NYQ - $62.52). Under the terms of the agreement, eOne Television will handle the overseas distribution (including digital and home entertainment rights) for all original scripted series from AMC's US-based networks which comprise AMC and the Sundance Channel. The first three series to be part of this deal are Halt and Catch Fire, Turn and The Red Road.
The agreement represents AMC and Sundance Channel's first exclusive international output partnership for scripted content, and highlights the growing Entertainment One/AMC relationship. eOne is the producer and international distributor of ratings successes Hell on Wheels, and international distributor of The Walking Dead. Furthermore, eOne's current scripted series include suspense drama Rogue, starring Thandie Newton; Rookie Blue; Call Me Fitz; and Discovery Channel's television series, Klondike.
It's worth noting that eOne Television has now sold Entertainment One's original and third-party productions to over 500 broadcasters in 150 countries, including key US networks and international pay TV channels. This demonstrates its strong relationships with broadcasters and content providers. It also brings into focus the unwarranted low valuation being attributed to the company.
Low valuation
Ahead of a pre-close trading update for the first half at the end of September, broking house Peel Hunt currently expects Entertainment One to report a 40 per cent increase in pre-tax profits from £53.8m to £76m on revenues up a third to £840m in the 12 months to the end of March 2014. On that basis, EPS rises from 15.9p to 20p. So, even after the recent re-rating, the shares are still modestly priced on a prospective PE ratio of 11.
In my opinion, the combination of technical buying by fund managers, and likely positive newsflow in the forthcoming trading update, means there are the requisite catalysts in place for further share price upside. In the circumstances, I have no hesitation in reiterating my previous bullish stance on Entertainment One's shares ('Three special situations', 2 Jul 2013).
Priced on a bid-offer spread of 217p to 220p, they rate a trading buy and I maintain my conservative target price at 240p. If achieved, this will provide us with a further 10 per cent share price upside.
Value in Marwyn Partners
The ongoing re-rating of Entertainment One is also good news if you followed my advice to buy shares in Marwyn Value Investors (MVI: 163p) earlier this year at 143p ('A highly profitable arbitrage play', 11 Feb 2013).
Currently, shareholders in Marwyn Value Investors have interests in five companies: Entertainment One (ETO); healthcare software company Advanced Computer Software (ASW: 88p); Breedon Aggregates (BREE: 29.5p), the largest independent aggregates company in the UK; specialist asbestos services company Silverdell (SID; 12.75p); and transport and consumer goods investment company Marwyn Management Partners (MMP: 14p).
By far the largest holding is in film producer Entertainment One. That's because three-quarters of Marwyn's net asset value of 226.9p a share (figure correct as of Friday, 23 August) is accounted for by its stake in Entertainment One. This means that buying shares in Marwyn, which trade on an anomalous looking 28 per cent discount to net asset value, is a great way of gaining exposure to Entertainment One. True, the holding in Silverdell is likely to be marked down in value when the shares return after suspension. But the Silverdell holding accounts for only 4.4 per cent of Marwyn's book value, or around 10p of its 226.9p a share net asset value. So, although I would never try and gloss over the problems at Silverdell, in terms of Marwyn Value Investors the investment is not material.
The promotion of Entertainment One to the FTSE 250 aside, there could be further short-term upside to Marywn's book value through its shareholding in Marwyn Management Partners (MMP) which has just announced a listing of its subsidiary Marwyn European Transport (MET) on the alternative investment market (Aim). The flotation will raise up to €50m (£42.4m) of new equity capital from institutional investors to fund Marwyn European Transport's growth in the German bus market.
To date, Marwyn Management Partners has invested £16.6m of equity and debt capital into Marwyn European Transport and will remain a substantial shareholder upon its listing. The business is expected to generate revenue of £26m for the year ending 31 December 2013 and had a contracted order book of €138m to the end of June. Cash profits of the contracted bus operations (before head office costs) are forecast to be around £1.9m in the current financial year.
Needless to say, given my positive stance on Entertainment One, and the potential for upside from the flotation of Marwyn European Transport, I continue to rate shares in Marwyn Value Investors (MVI) a value buy on a spread of 161p to 163p. I maintain my target of 185p to potentially provide us with a further 13.5 per cent share price upside.
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