Lights, camera and get ready for action
Shares in film distributor and producer Entertainment One (ETO: 204p) are closing in again on a major share price breakout. This is partly driven by technical buying, but also a re-rating that looks fully warranted at an operational level.
In a first-quarter trading update to the end of June, the group revealed that revenues in the three-month period have increased by over 65 per cent on the prior year (pro-forma in line year on year once you factor in acquisitions). This has been driven by 68 box-office releases (compared with 49 in the prior year) and a solid performance of the enlarged library of films across the group. 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.
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.
Overall, Entertainment One's year-to-date revenues are up 40 per cent, mainly reflecting the contribution from the acquisition of Alliance Films. The company is also trading in line with analyst forecasts. For the year to the end of March 2014, broking house Peel Hunt expects pre-tax profits to increase by more than 40 per cent from £53.8m to £76m on revenues up a third to £840m. On that basis, EPS rises from 15.9p to 20p and the shares are very modestly rated on a prospective PE ratio of 10.
Technical drivers
There is a technical driver, too, as Entertainment One gained a full listing on the London Stock Exchange on Monday 1 July, so it will now be eligible for entry into the FTSE indices. And with a market value of £558m, the group is a live candidate for entry into the FTSE 250 at the next quarterly review in early September. This will force index-tracking funds to buy the shares.
Interestingly, the shares are now pressurising the 209p all-time high, dating back three years. If breached, a rally towards my three-month target price of 240p could be very sharp indeed as the share price would be in blue-sky territory.
So the combination of technical buying, and likely positive newsflow in the end-September pre-close trading update, means there are obvious catalysts in place for a re-rating. 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 202p to 204p, I rate the shares a trading buy.
Value in Marwyn Partners
The ongoing re-rating of Entertainment One should also be good news if you followed my advice earlier this year to buy shares in Marwyn Value Investors (MVI: 157.5p) ('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); Breedon Aggregates (BREE), the largest independent aggregates company in the UK; specialist asbestos services company Silverdell (SID); and transport and consumer goods investment company Marwyn Management Partners (MMP).
By far the largest holding is in film producer Entertainment One. That's because three-quarters of Marwyn's net asset value of 205.9p a share (end-July figure) is accounted for by its stake in Entertainment One. This means that buying shares in Marwyn, which trade on an unwarranted 23 per cent discount to net asset value, is a decent 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 once the company's financial position has been clarified. However, the Silverdell holding accounts for less than 5 per cent of the Marwyn's book value, or around 10p of its 205.9p a share net asset value. So, although I am not trying to gloss over the problems at Silverdell, in terms of Marwyn the investment is not material.
Needless to say, given my positive stance on Entertainment One, I continue to rate Marwyn's shares, on a spread of 154p to 157.5p, a value buy and maintain my price target of 185p.
Sparking a re-rating
Full-year results from Aim-traded investment company Spark Ventures (SPK: 11.75p) have beaten my estimates by a large margin after the company boosted net asset value per share by 12 per cent to 15.1p a share. This was after adjusting for a 2.5p capital return through the issue of 'B' and 'C' shares in January. For good measure, Spark has announced yet another capital return of "at least 2p a share" through the issue of 'D' shares after the forthcoming annual meeting. Moreover, having analysed the company's investment performance in quite some detail, we can expect further large significant cash returns over the next year, too.
That's because after the March year-end Spark sold 65 per cent of its stake in Kobalt, one of the world's leading music publishers, for £10m. This disposal not only resulted in a revaluation of the holding from £8.9m to £15.5m in Spark's accounts, but also means that the residual stake is still worth £5.5m, or 1.4p a share. To put the deal into some perspective, Spark has 410m shares in issue net of 40m shares held in Treasury, so the £10m share sale brings in 2.4p a share of cash.
At the end of March, Spark also held £3.6m of cash on its balance sheet and this will be bolstered by a further £3.6m, or 0.9p a share, in January when the company receives the outstanding consideration following the sale of semiconductor business Aspex to Ericsson. In other words, the current share price of 11.75p is in effect backed by 4.2p of cash or cash equivalents. Strip that cash out and it means that investments worth 10.9p a share are being attributed a value of only 7.55p - a hefty 30 per cent below their carrying value.
Unwarranted discounted to sum-of-the-parts valuation
Clearly, a discount of that order would be fully justified if Spark's investment portfolio was underperforming. However, this is not the case as the company has doubled the carrying value of its investment in California-based OpenX, a business that has developed a free open source ad server trusted by more than 30,000 web publishers in over 100 countries around the world. OpenX is now developing a set of tools to help publishers make more money from their web presence and is backed by financing from leading venture capitalists including Accel Partners. Sales growth has been robust, with trailing 12-month revenue figures "significantly in excess of $100m (£65m) and, for the second year running, revenues are over two and a half times the level for the equivalent period 12 months ago". Spark's holding in OpenX is now worth £5m, a valuation in line with a recently concluded funding round from Samsung and Dentsu (a Japanese advertising company).
There is also upside potential in Spark's stake in Mind Candy, the company behind Moshimonsters, one of the world's leading developers of social multi-player children's games. In the last financial year, Mind Candy's revenues were up 125 per cent and profits trebled. However, Spark's investment in Mind Candy is still only being valued in its accounts at £3.2m, in line with the price received when Spark sold half of its stake two years ago. That looks a conservative valuation.
Spark's stake in Notonthehighstreet.com, an internet marketplace for over almost 3,000 specialised UK-based businesses selling a wide variety of unique products, also looks conservatively priced at £10.2m, the valuation used at the time of a funding round in May 2012 when Spark sold 7 per cent of its holding to fund manager Fidelity. Notonthehighstreet's revenues surged 66 per cent to £45m last year and the company is "on course to deliver 50 per cent revenue growth this year". That's well ahead of budget.
The largest investment is a £16.2m holding in IMImobile, a highly-profitable provider of the technology infrastructure for mobile data, voice and video services to mobile telecom operators and media companies. This has been revalued up by £300,000, reflecting the fact that both revenues and cash profits rose in double digits in the year to the end of March. That wasn't a one-off, either, as cash profits have risen by a compound rate of 30 per cent over the past three years.
As a result of strong operational performances by investee companies, Spark's portfolio actually edged up in value in the 12 months to the end of March to £59.1m even though the company made disposals of £8.7m. That's not the type of investment performance that warrants the company being valued on a 30 per cent discount to the underlying value of its assets net of cash.
Target price
I initially recommended buying Spark's shares at 7p ('The spark for a re-rating', 10 Jul 2012) and repeated the advice four months later when the share price had drifted down to 8.75p ('Time to spark a re-rating', 8 Nov 2012). These buy-in prices have been adjusted for the 2.5p a share issue of 'B' and 'C' shares in January. Ahead of last week's full-year results I also reiterated the investment case at 11p ('Awaiting another spark for a re-rating', 9 May 2013).
Interestingly, Spark's shares are closing in once again on a 12-year high of 12.4p. In my view, a move above this level looks firmly on the cards given the imminent cash return, potential for further investment gains on the portfolio and disposals that in turn would lead to additional capital returns. Realistically, a share price around 13p is fairer value. On a bid-offer spread of 11p to 11.75p, the shares rate a buy.
Making a Fairpoint
Shares in debt management specialist Fairpoint (FRP: 104p) are modestly up on my recommended buy-in price after I included the company in my 2013 Bargain Shares Portfolio ('Bargain shares for 2013', 8 Feb 2013).
However, despite the lack of share price progress, the investment case remains fully intact. In a pre-close trading update ahead of half-year results on 12 September, the company confirmed that the diversification of the business is progressing well, especially its claims management activities. True, the IVA segment remains challenging, as we already knew, but softness there has been more than offset by the performance of the smaller divisions, which fully justifies the board's decision to diversify the company's income stream to reduce exposure to debt management.
Cash generation remains robust and net cash increased to £2.8m in the six-month period, reflecting £3.6m of cash generated from operating activities. That should augur well for the dividend after the board increased the payout by 22 per cent to 5.5p a share last year. Indeed, with the board "committed to a long-term progressive dividend policy, which takes into account the underlying growth in earnings and strong cash generation", analysts are pencilling in a dividend of 6p a share this year, implying a prospective yield of 6 per cent.
The shares are also attractively rated on an earnings basis. In fact, assuming Fairpoint raises full-year adjusted pre-tax profits from £7.5m to £8m, as analysts predict, that means EPS increases from 13.4p to 14.5p. On that basis, the shares are being rated on a forward PE ratio of seven. It's worth noting that the payout is more than twice covered by earnings and I would not be surprised to see the board announce a larger than expected boost to the dividend.
Ahead of half-year results, I continue to rate Fairpoint's shares a value buy on a bid-offer spread of 101p to 104p.
Finally, please note that I updated the investment case on six other small-cap shares in two other online articles today: Small-cap wonders and Deep value plays. My next article will appear online tomorrow morning.
