Moreover, if this week's half-year results are anything to go by it is only realistic to expect further gains in the future from the fifth-largest film distributor and largest independent film distributor in the UK with a market share of around 10 per cent. The group is also one of the largest and a highly competitive film distributor in Canada, boasting a market share of over 20 per cent.
In the six-month period to the end of September, the media group revealed that digital revenues in its film division surged from £31m to £77m, buoyed by entry into new territories, ongoing expansion over a number of platforms and demand from major players LOVEFiLM, Netflix and iTunes. According to chief finance officer Giles Willits, the contribution from this fast-growing segment, which accounted for a fifth of Entertainment One's revenues of £365m in the half year, could increase to around 30 per cent in the short to medium term.
Equally promising was news that the cost savings from the acquisition of Alliance Films are running ahead of the run rate predicted when the deal was announced 14 months ago. In fact, according to Mr Willits: "Guidance is for annual savings between 10 to 20 per cent ahead of the CAN$20m (£12.5m) anticipated and to be achieved within two years, rather than three years." Around two-thirds of these savings should be achieved in the current financial year to the end of March 2014, which means the profit upside in analysts forecast for the following financial year looks well underpinned.
Post results, and factoring in the contribution from Alliance Films, broker N+1 Singer predicts that Entertainment One's full-year pre-tax profits will increase by 40 per cent from £53.8m to £76.7m on revenues up a third to £827m in the 12 months to the end of March 2014. Forecasts for the following year are for pre-tax profits of £82.7m on revenues of £844m, so by my reckoning virtually all of the further costs savings next year account for the profit uplift, which certainly mitigates risk.
AMC deal significant
Although Entertainment One has not issued specific guidance on an exclusive three-year television deal with US-based AMC Networks (AMCQ: NYQ - $62.52), there is clear potential for the contract to deliver "significant returns" for the group. Mr Willits compares it with the deal the group agreed six years ago with film studio Summit Entertainment to exclusively distribute all titles released by Summit for the UK and Canadian markets. This has proved hugely profitable, underpinned by a number of hits including The Twilight Saga.
Under the terms of the AMC 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.
Importantly, 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. Mr Willetts points out that "if they (AMC and Sundance) perform as they have done in the past we will have a lot of content coming our way". To put this into some perspective, the agreement has potential to lift revenues in double digits for eOne Television, albeit this is likely to come through more in 2015-16.
eOne Television is a significant part of Entertainment One, accounting for £70m of revenue in the first half. The operation has now sold original and third-party productions to over 500 broadcasters in 150 countries, including key US networks and international pay TV channels, thus demonstrating the group's strong relationships with broadcasters and content providers.
Investing wisely in content
As you would expect Entertainment One's film division has been investing heavily in content and production rights. In fact, investment here doubled to £104m on a pro-forma basis in the first half, accounting for the acquisition of Alliance Films. But it's highly profitable with underlying cash profits rising 76 per cent to £20.9m from film, to account for three-quarters of the group total.
Notable releases in the six-month period include: Now You See Me, Rush, The Place Beyond the Pines, Scary Movie 5, Insidious: Chapter 2 and Behind the Candelabra. Having released 142 films in the half year, Entertainment One now expects to release over 130 films during the second half to the end of March, including The Hunger Games: Catching Fire, Prisoners, 12 Years a Slave and Ender's Game. Total investment in content and programmes is expected to increase to over £250m across the group in the 12 months to the end of March, up 14 per cent year on year on a pro-forma basis, and thereafter edge up slightly in the following financial year. Investment on this scale looks fully justified, too, given the healthy cash profit margins earned.
Moreover, the group can easily afford this hefty investment as adjusted net debt at the half-year end was £143m, or 45 per cent of equity shareholders' funds of £314m. I have excluded production net debt of £55.6m from this figure since this financing is independent of the group's senior credit facility. It is also secured over the assets of individual production companies within the production businesses and represents shorter-term working capital financing that is arranged and secured on a production-by-production basis. It's worth noting that although adjusted net debt increased from £79.6m at this stage last year, the £63m rise was driven primarily by normal seasonal cash-flow movements, the acquisition of Alliance Films in January and higher investment in productions and acquired content rights. By the 31 March financial year-end, expect adjusted net debt to have fallen back to around £110m to £120m.
Maiden dividend expected
So, with borrowings under control, and interest payments covered more than four times over by adjusted operating profits, this should enable the board to declare a maiden dividend at the full-year stage. Analyst Johnathan Barrett at broker N+1 Singer expects a 1p a share payout doubling to 2p and 3p a share in the next two financial years. That seems realistic to me as the dividend would be covered several times over by EPS of 19.6p for the current financial year, up from 16p in the 12 months to March 2012, and fully supported by the strong operational cash generation of the business. Furthermore, if investment in content only edges up in the coming financial year, as is the guidance, and the increased cost savings from the Alliance Film acquisitions come through as Mr Willits anticipates, then there could be scope for an even more progressive policy.
Low valuation
Even though Entertainment One's shares have re-rated, they are still only trading on a modest 12 times earnings estimates. There is also substantial value in the group's 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 around £406m at current exchange rates, or around 148p of the current share price of 243p.
True, the shares came within a whisker of hitting my upgraded target price of 250p earlier this month, so we are sitting on decent gains. However, the valuation is not stretched, there is potential for earnings upgrades over the coming six to 12 months, and the technical set up is positive, too. The 14-day relative strength index (RSI) is not overbought at a reading of 55 and the price is not overextended above its 20-day short-term moving average around 243p. From my lens, the risk is to the upside. Analyst Malcolm Morgan at broker Peel hunt also agrees as his target price is 280p.
So, having reassessed the investment case, I have lifted my fair value target price range to 265p-270p and continue to rate Entertainment One's shares a buy ahead of the next trading update in the first quarter next year.
Value in Marwyn Value Investors
The ongoing re-rating of Entertainment One is great news if you followed my advice to buy shares in Aim-traded investment company Marwyn Value Investors (MVI: 190p) when the price was 143p ('A highly profitable arbitrage play', 11 Feb 2013). I have been positive ever since and even upgraded my fair value target price from 185p to 200p ahead of Entertainment One's half-year results ('Exploiting an arbitrage opportunity', 16 Oct 2013).
To recap, the company was created in April 2008 through the amalgamation of two Marwyn funds and was admitted to trading as a closed-end investment company on the Specialist Fund Market of the London Stock Exchange in December 2008. The investment objective of the company is simple: to maximise total returns through the capital appreciation of its investment in Marwyn Value Investors LP, an open-ended fund domiciled in the Cayman Islands, which was launched in March 2006 with backing from more than 60 leading institutions and alternative funds.
Marwyn Value Investors LP specialises in the acquisition of growth businesses by taking significant stakes in quoted portfolio companies and has to date invested in 13 portfolio companies, which have together completed 68 transactions, with an aggregate transaction value in excess of £1bn. The fund managers operating the fund have been highly successful, having generated net asset growth of well over 140 per cent in that seven-year period. They have also been very successful at crystallising these gains for shareholders. In fact, in the past seven years cash realisations for investors have posted an eye-watering internal rate of return on invested capital of 30.2 per cent. Realisations include holdings in the following Aim-traded companies which succumbed to takeover bids: Talarius, Inspicio, Concateno, Melorio and Zetar.
It has been more of the same this year, too. In fact, by the end of September, Marwyn had a net asset value of 232p a share, up 24 per cent since the start of the year, of which the holding in Entertainment One accounts for around two-thirds of the total. And last month the value of these investments soared, adding a further 23p a share to Marwyn's net asset value per share. This means that the shares, trading on a bid-offer spread of 187p to 190p, are priced a hefty 25 per cent below book value of 255p.
Considering the company has recently banked hefty profits on its holding in healthcare software company Advanced Computer Software (ASW: 91p), and its major other major holding is in Breedon Aggregates (BREE: 34p), the largest independent aggregates company in the UK and a live Investor Chronicle buy tip, then a 25 per cent share price discount to book value looks unwarranted to me.
Needless to say, given my positive stance on Entertainment One, I continue to rate shares in Marwyn Value Investors (MVI) a value buy. I also believe that a price range around 210p to 215p a share is not an unreasonable valuation, either, and this is my new target price.
Finally, and in response to recent newsflow, I am currently working my way through a large number of updates on my following recommendations: Eurovestech (EVT), Heritage Oil (HOIL), Bezant Resources (BZT), Amino Technologies (AMO), Eros (NYSE: EROS), PV Crystalox Solar (PVCS), Crystal Amber (CRS) and API (API).
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■ Macau Property opportunities ('Hot property plays', 12 Nov 2013)
■ First Property ('Hot property plays', 12 Nov 2013)
■ Inland ('Bargain shares updates', 12 Nov 2013)
■ Terrace Hill ('Bargain shares updates', 12 Nov 2013)
■ LMS Capital ('LMS worth capitalising on', 18 Nov 2013)
■ Trifast ('A bolt-on purchase', 18 Nov 2013)
■ Global Energy Development (Awaiting pay dirt, 19 Nov 2013)
