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Box office hits

Created:

2 May 2008

Updated:

8 May 2008

Written by:

Amanda Vermeulen & Malar Velaigam

It is not hard to see why investors find it tricky to view listed film and television producers as viable investment opportunities - after all, this is an industry that relishes the 'make-believe', and is dominated by the 'talent' - actors known for their looks, rather than their financial acumen. As a result, investors who are already wary about the equity markets, have found all sorts of reasons not to invest in the shares of these companies. Apart from a somewhat nebulous business model that seems very linked to the fickle tastes of the viewing public, many of these companies have debt on their balance sheets, which is not necessarily a good thing right now. And the majority are small caps, which makes risk-averse shareholders nervous. These - and a few other factors (like 'Crowngate') have led to the down-rating of the sector, and many analysts believe that it has been overdone. But this is unwarranted, especially in the small cap arena, as consolidation in the industry continues to play out.

Copyright and Related Rights Regulations law in 2003 has allowed independent producers of content, who had previously been forced to sign over ownership to the commissioning broadcasters, to retain the rights to their content, and that has drastically changed the industry. Furthermore, broadcasters are now required to source programming from independent producers - such as the BBC, which obtains 25 percent of programmes in-house, and sources another 25 per cent from indies, with the remaining 50 per cent competed for between indies and in-house programmes.

This has proven to be a major catalyst for the growth in the industry. According to UK trade association Pact, this 'healthy industry continues to grow considerably and now generates combined revenues of £2.14bn" (in 2008, up from £1.06bn in 2005).

Pact, which recently published its 2007/08 Census, produced by KMPG and Bank of Ireland, says the independent production sector has grown 9.4 per cent since the 2007 Census was published, and since 2005, the compound annual growth has been 15.6 per cent. The best performers were the five largest companies: All3media, IMG, Freemantle, Hit Entertainment and Endemol, while strong growth was enjoyed by companies with average annual revenues of between £50m and £100m (although acquisitions accounted for nearly half their growth).

The consolidation trend in the industry has also paid off, with group-owned businesses doing better than single players, whose margins have been only 1.2 per cent against the industry average of 9.3 per cent. There are now over 700 independent production companies in the UK.

The broadcasters have played a key role in the industry's expansion, with commissioning budgets expanding following the changes in the law, and new media (non TV work) growing steadily each year, except 2007, which showed a small decline. Essentially, the demand for new content is growing, and there are a number of reasons for this. US costs have increased dramatically, and there is now growing demand non-US produced material in America and other parts of the world. There is growing demand for formats - the change in the rights ownership law allowed the producers of prorgamming like "Got Talent", "Big Brother", and "The Office" to sell them around the world to other markets that produced their own versions. Mobile telephony is another platform that is generating a market for content. And finally, while still a nascent factor, the emergence of internet viewing is gathering speed, especially as bandwidth improves, the viewing population becomes more technically competent, and hardware becomes cheaper.

Ivan Dunleavy, chief executive of Pinewood Shepperton, a group famous for producing the James Bond franchise says online viewing of film and television content is changing the way this industry works. An early indication of where it is going was heralded in April by the tie-up between Viacom (and its studio Paramount), Metro-Goldwyn-Mayer and Lionsgate to form a TV and internet joint venture that will show new releases, original programming and library material.

Mr Dunleavy says trends like this will speed up consumption of content, which theoretically, should increase demand and appetite for new material. "The challenge remains, however, to monetise these activities." The Viacom agreement is also spurred in part by increasing piracy, with television one of the hardest hit sectors. Content owners and producers are looking at how to make their material available online on shorter lead times, while making money out it and preventing costly programming and films from being viewed on illegal download sites.

Patrick Yau, an analyst at Ingenious - an independent group that advises and invests in media - is not that convinced that online viewing will take off as rapidly as projected. He says television has developed, culturally, as a group or family-oriented activity, whereas watching a movie on a laptop tends to be a comparatively solitary experience. Mr Yau, who will shortly publish a report on the investment qualities of a number of listed UK producers, says consumers also like the immediacy of television, whereas as downloads can take some time. "This leads me to think that TV will be around for a long time."

His view is supported by Jonny Slow, corporate development director at RDF, which creates and distributes content. RDF is currently in the throes of a potential private-equity assisted management buyout. The group, which floated on Aim in 2005, suffered a torrid 2007, being the production company behind what is now known as 'Crowngate', a documentary on the Queen, which used a snippet (to advertise the programme) that was creatively edited to suggest that the monarch had lost her temper over a photo-shoot. The programme was commissioned by the BBC, and heads rolled following the Palace's outrage at the misleading edit. The upshot was a blacklisting of RDF, and its subsequent share price plunge.

Mr Slow says there is huge excitement about the potential of the internet and what the technology promises. For the first time, there can be a real two-way relationship between the originator of content and the consumer. "But if you ask most people whether they want to wait for a download or watch something on television, they are still choosing TV." He believes it will take at least five years for the technology to catch up with the demand for increased bandwidth.

Nonetheless, Phil Stokes, a partner at PricewaterhouseCoopers, says the industry is in some flux, the the issue of how to monetise the growing digital trend top of many minds. "There are two ways of looking at it - either concern about traditional ways of making money coming under threat, or excitement that great content can be targeted very specifically at the people who want it - providing it can be monetised." And this has already proved a headache for the owners of social networking sites like Facebook, Bebo and MySapce.

However that the trend is very positive for content producers. The length of product being considered for internet sites is very different - a five minute segment that can go out daily or weekly, compared to and hour-long drama episode, which is very costly to produce - up to £1m an hour. Mr Slow says: "It appeals to advertisers because it can be very targeted and is interactive." The most successful so far was "Kate Modern", the UK's version of LonelyGirl15, the video diary of a Californian teenager that became a hit on YouTube, generating 50 million views.

UK companies who have tapped into this phenomenon, like Shed, a production company, have made money from it, helped by the willingness of social networking sites to share the advertising revenue on a straight split.

One company that has encompassed the spectrum is Ten Alps, which likes to see itself as a pure-play company "on a new sector", according to CEO Alex Connock. Ten Alps is modelled on providing video-based business-to-business services that link publishing and TV production - a one-stop multi-platform company that connects its content production capabilities with its contract publishing by producing an advertising medium that can be used on several media platforms, from online to television.

Mr Connock sounds a warning, though, that the online audience makes it difficult for content owners to extract full value, because the runaway success of YouTube and others has encouraged this generation to expect content for free. He sees merit in the old model of being paid to produce content, but adds that it makes sense to own the rights too.

Mr Stokes' concern for now is that even if more content was available, there are a finite number of broadcasting hours in the day, and producing more material would not change that. However, if digital delivery becomes a viable model, and not just a defence against piracy, Mr Stokes points out that the decision-making process about producing content will change. No longer will it be about needing to get a minimum number of viewers to break even. "Digital delivery pretty much costs nothing, so the owners of the content can make money off a small number of downloads."

This is where the potential of libraries will come into their own. Companies that own the rights to a significant library of film and television content will be able to make money off every download, and this is already happening.

With all the change that has happened, and continues to emerge, investors may find it hard to keep up, and make sense of what can be a very 'clubby' industry. But there are a few basic indicators to help investors make decisions.

Mr Yau says one of the most attractive benefitsof this is the ability of the producers to exploit high margin rights, and leverage them into other markets. The UK, in particular, has become a very attractive source of high quality programming for American broadcasters - a trend that gained impetus with the three-month writers' strike in the US. There has been a lot of corporate activity in this sector, as Pact indicates in its 2007/08 Census, and Mr Yau says this generally means an uplift for shareholders. And finally, many of the companies have excellent management teams that know their industries well.

The film and television production sector has great defensive qualities in an economic downturn, because it is regarded as a 'small-ticket' purchase that is not really affected by changes to discretionary spending. The growth of the industry, the growing demand for content, and the emergence of more and more platforms bode well for companies in this sector.

Companies to watch

Ten Alps: Interesting model and very good revenue visibility. It remains a Buy at 45p.

Last IC View: Buy, 58p, 17 Dec 2007

RDF: In a bid situation. Shareholders who have watched the share price drop to 95p prior to the buyout talks being announced may want to hold on for an offer that will probably include some premium. At 128p it may be good value for the brave.

Last IC View: Buy, 189p, 1 Nov 2007

Pinewood Shepperton: A good slate of films and property assets that will generate good annuity income make it attractive. But it is expensively rated.

Last IC View: Fairly priced, 245p, 8 Apr 2008

There are a number of smaller players, that may make for interesting investments as consolidation in the industry continues.

Shed

Indpendent production company Shed Media is the largest players in the indie arena with a market cap of £52m. The company - which is behind hit shows such as Footballers Wives and Bad Girls - has just reported steller results with management declaring a dividend of 1.1p. The group has managed to move into the usually difficult to crack US arena, and have also diversified its offering to include IP, which has brought about some stability in current market conditions. The group has also secured 64 per cent of its 2008 target revenue, which provides investors with added visibility. Trading at 66.5p, the shares are a buy.

Content Film

This company has positioned itself between the production and distribution aspects of the supply chain and as such, its chief executive Jeff Webb says it is not exposed to the risks associated with production or territorial distribution. The group has been under an offer period for the last 12 months which has led to brokers Evolution ceasing to produce reports, although last month, ContentFilm announced that its majority shareholder Syntek Capital no longer wanted to dispose of its stake in the group.

ContentFilm has since focused on builidng a solid library of film and TV distribution rights with the most recent being last month's acquisition of CBC International rights catalogue which included some 136 active titles comprising more than 1,000 hours of programming. Mr Webb says he aims to continue to make "smart library acquisitions". However, corporate acquisitions are also on the cards if the deal expands the group's library or distribution capability. Plans to penetrate markets in Asia and Eastern Europe, and to go into reality TV - an area ContentFilm has yet to tap into - are also on the drawing boards.

But in the near term, management will be busy trying to determine what to do with the group's US distrubtion arm, Allumination, which has been facing increasingly difficult trading conditions as US studios continue to discount production and lower price points. The division contributed to approximately 39 per cent of turnover, which may prompt management to maintain the business albeit some cost cutting initiatives. Alternatively, a buyer could be found, although the difficult environment may mean unfavourable valuations for the business.

The group turned into profitabilty last year, posting pretax profits of £1.5m from a loss of £3.5m in 2006, and has recently obtained a new £14m 5-year facility with JP Morgan for future growth, and acquisitions.

Brokers Evolution Securities are expecting 2008 EPS at 0.92p, rising 1.52p in 2009, so at 10p, the shares are trading at about 7 times 2009 earnings, and aside from industry specific risks such as a drop in demand for long episode dramas - ContentFilm's forte - and the issue with Allumination, the shares are a speculative buy.

Entertainment Rights

This distribution and rights company has only just emerged from an offer period, where it was in talks with two parties. Talks collapsed in April and no reason was given. Prior to this, the shares had alsready plummeted following Christmas distribution issues. Shares now trade at 9.8p, and analysts expect 2008 EPS at 1.4p rising to 1.6p in 2009, so trading at 6 times earnings, and bearing in mind sector consolidation, is a speculative buy.

Motive TV

With a market cap of just £1.76m, and shares trading at under 1p, independent TV show producer Motive TV is looking to secure as many BBC commissions as possible due to BBC's immunity from recession (as they do not depend on advertising revenue).

The Works Media Group

The Works has spent much of last year repositioning itself as a distrubtion company - again to avoid the costly risks associated with production. The new rationalised business has two divisions - UK distrubtion and International and chief executive Norman Humphrey says the business has never been more scalable, sustainable or predictable as it now stands.

Its business to business arm sells films to distribution companies that operate outside the UK. It currently holds the rights to about 100 titles including The Crying Game, Bend it Like Beckham and This is England.

The Works UK - set up in 2005 - is the comapny's business to consumer operation which markets and sells films to the consumers through cinemas, DVDs, video and other such mediums. This division has the added comfort of an output arrangement for DVD, video and internet with Universal - the UK's largest DVD distributor - which releases all titles on DVD. As such, the group only acquires titles which are approved by Universal. The group has also secured VoD arrangements with Virgin Media, BT Vision and BSkyB in 2007.

Although the UK operation is relatively young, it accounts for about 80 per cent of the group's turnover (2007: £3.3m). Mr Humphrey says that he is working to 'rebalance' this to either 60:40 or 50:50.

Mr Humphrey is targeting 12 title releases per annum and has a healthy pipeline of titles this year with Cashback being released in May and the Academy Award nominated Mongol slated for release in June.

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