To recap, I advised buying the Aim-traded shares at 250p ahead of the US initial public offering (IPO) ('Time for some price action', 22 Oct 2013) and, having assessed the pricing of the offer, I remained positive in the run up to the IPO when the price had subsequently risen to 300p ('Get ready for some price action', 6 Nov 2013). I had good reason because as part of the IPO Eros planned to issue 12.5m 'A' ordinary shares at a price between $15 (£9.31) and $17 per share. Of these shares, 7.8m were to be issued by the company and a further 4.68m by selling shareholders.
The initial price range in New York reflected a proposed one-for-three consolidation of the Aim-traded ordinary shares in connection with the proposed listing. This implied a price range of 931p to 1,056p per 'A' ordinary share listed on the NYSE, which equated to a price range of between 310p and 352p per Eros ordinary share listed on Aim. So the investment risk looked favourable as there was potentially 17 per cent upside by buying the ordinary shares on Aim in early November and selling them in New York, assuming of course the investment bankers could get the IPO away.
But demand for the shares was far more subdued than either the directors had anticipated or, for that matter, the investment bankers leading the IPO had guided the board to expect. In fact, the IPO price was cut twice within a week, initially to $12 a share and then again to $11 by the time the shares were listed on the NYSE. Moreover, Eros only sold 5m new shares, raising $55m and giving the company a market value of $535m. At the current price of $10.26, the shares are down on the IPO price and are trading slightly below book value too. However, the third-quarter results from the company do offer good enough reasons to hold on for a recovery.
Earnings story in tact
Despite the shenanigans over the New York IPO, and serious questions raised over the actions of the company’s board of directors in deciding to pursue an IPO to the detriment of the interests of UK minority shareholders, the third-quarter results were impressive enough: revenues rose by over a fifth to $87.2m, operating profits increased by almost 30 per cent to $37.7m and underlying cash profits soared by half to $45.2m. The respective figures for the nine months to end December 2013 were operating profit 12 per cent ahead at $52.3m, and cash profits of $67.2m, a rise of 42 per cent, on revenues up 5 per cent to £172m.
In the latest three-month trading period, Eros released 15 films to take the total to 41 films released in the nine months to end December, including four out of the top 10 Hindi box office hits. This strong momentum in the release schedule has continued into the fourth quarter with two major releases, Jai Ho (Hindi) starring Salman Khan and One Nennokodine (Telegu), starring Mahesh Babu, both underpinned by strong pre-sale revenues. Other Tamil, Hindi and overseas only films will be released before the March financial year-end.
New film distribution across theatrical, television and digital channels along with library monetisation are providing Eros with diversified revenue streams from a library of over 2,000 films, including 231 releases in the past three financial years. For instance, Eros continues to make strides in non-traditional emerging markets including the Middle East, Europe and South Korea. Films are dubbed and sub-titled to tailor the content to the specific market with the benefit of producing higher-margin content. Revenues from the rest of the world segment rose by over 75 per cent in the first nine months of the financial year to account for almost a fifth of the total revenues of $172m.
Television syndication is also proving strong; Eros signed deals with MSM Satellite (Singapore), Private Limited (Sony) and Viacom 18 Media Private Limited (Colours) during the third quarter. The company is also delivering films from previously executed contracts for new and library films.
HBO Asia: A potential box office hit
The game-changing joint venture with US premium network operator HBO, bringing the best of Hollywood and Bollywood together, is gaining traction too. HBO Defined and HBO Hits premium channels both launched on Tata Sky digital pay-TV (direct-to-home satellite and cable) markets in India at the end of last year. The channels are now available on 11 major direct-to-home and digital cable platforms within India.
Driven by the growth in the middle classes, who spend far more on entertainment, analysts at KPMG predict digital pay-TV audiences in India will rocket from around 65m in 2013 to 161m by 2016. Assuming Eros can penetrate this market growth through its joint venture with HBO Asia, analysts have estimated that net profits from the joint venture could increase from around $3m on a net subscriber base of 800,000 in the current financial year to March 2014, rising to $16.5m in the financial year to March 2015 on a net subscriber base of 2.2m. Eros is not giving any guidance on subscriber growth rates although with only 12 screens per million people in India, a tenth of the total per capita in the US, India is hugely underserved which creates the opportunity for pay-TV audiences using digital platforms. There are currently around 130m digital homes in the country.
The same is true of the opportunity to bring film content to the internet to capitalise on the forecast 386m internet users in India by 2017. ErosNow, the company’s online service, provides full length films and music videos on a transactional or subscription basis. And to tempt potential customers to use the service certain content can also be accessed free.
These initiatives can only be good for future profits, further positive news on which will be needed to drive the stock price back above the IPO price and to a valuation that more accurately reflects the earnings of the company.
Depressed valuation
In fact, at the current depressed level, Eros has an enterprise value of only $616m once you factor in net borrowings of $118m to its market value of only $498m. For a company that made cash profits of $160m in the previous financial year, a valuation of 3.85 times historic cash profits is miserly to say the least.
True, it will take time for investors to forgive the board for failing to take into consideration the interests of minority shareholders in the New York IPO when the float price was dramatically slashed. A further consequence of the much reduced fundraising is a lower than normal free float which reduces liquidity and makes the shares more volatile. That said, it also means that if investors start to warm to the company then any good news is likely to provide an accentuated upwards move in the stock price.
It’s worth noting that Eros is up against some easy comparatives from last year, so the odds still favour a pretty decent uplift in the fourth-quarter earnings. In fact, Eros has made almost as much operating profit ($52.3m) in the first nine months of the current financial year to March 2014 as the $55m reported for fiscal year to March 2013. So, although I still feel dismayed at how the board of Eros behaved ahead of the IPO, actions which led to the paper losses being suffered by holders who followed my advice to buy, I still feel the investment risk is to the upside.
In the circumstances, I would recommend holding Eros shares for recovery until at least the fourth-quarter results.
