Switch on to the underappreciated potential of eOne
The compelling investment case for TV and film business Entertainment One (ETO) has been obscured by concerns over its cash generation.
We think this situation is in the process of changing and believe investors should buy now before the market gives the company full credit for its ability to capitalise on growing demand for content – a trend driven by the increasing dominance of TV streaming.
The enduring potential in the dominant pre-school Peppa Pig brand as well as under-appreciated bits of the business, such as its music arm, give us further confidence in the outlook for the share price.
The valuation looks relatively undemanding on 16.1 times March 2020 forecast earnings per share.
VIDEO IN DEMAND
The increasing trend for people to sign up to subscription services offering a wide range of TV series and films to binge on has created a voracious appetite for content among these platforms. They need compelling material to attract new subscribers and hold on to existing ones. Clearly this benefits Entertainment One and other content creators.
A recent shift in the streaming space is seeing the likes of Disney and 21st Century Fox launch their own platforms, with a plan to limit their best shows and movies to these offerings.
This is likely to create a content gap for the likes of Netflix and Amazon Prime Video to fill, thus reinforcing Entertainment One’s position.
The jewel in the crown for the business is its ownership of Peppa Pig with the company benefiting from merchandising revenue and the animated series roll-out to new geographies, most notably China. Peppa Pig has helped the Family & Brands division to be the star of the show.
Theme park operator Merlin Entertainments (MERL) has plans to open 50 new Peppa Pig attractions worldwide which should benefit Entertainment One in terms of commission on ticket revenue as well as merchandise sales and increasing brand awareness.
NOT JUST ABOUT PEPPA
Fellow kids title PJ Masks has also been a winner for the company and helping to reduce its reliance on the cartoon pig. The forthcoming launch of new kids TV show Ricky Zoom will be a test of the company’s ability to create a conveyor belt of hit children’s titles.
If Family & Brands has been a star performer, the television and film operations have been through a period of transition amid structural shifts away from DVD and cinema-led distribution. It has also been a victim of box office success being hoarded by big blockbuster movies, leaving producers of mid-market titles like Entertainment One out in the cold.
The diminishing reliance on the television and film arm, which has lumpy cash generation, should improve the overall cash flow profile of the business. There are also changes being made to the way the division is run, with a focus on producing its own content rather than acquiring and distributing third party productions.
IMPROVING CASH FLOW
The latter involved significant upfront costs from acquiring and then marketing content without any guarantee of success. By contrast the new approach with content production is to secure revenue commitments from a broadcast partner, thereby covering a large proportion of the associated costs.
The company’s music business is profitable and has strong growth potential, particularly since the acquisition of music publishing business Audio Network for £178m in 2018.
The company’s music label is a potential beneficiary on the royalties created from an explosion in music streaming as well as licensing its library of songs to third party film and TV producers and scoring its own in-house titles.
KEY MAN RISK
The key risk for a prospective investor in Entertainment One to weigh, and one which applies across its TV, film and music operations, is a failure to deliver hit content.
There is a lot of reliance on the company’s chief content officer and industry grandee Mark Gordon. Reports he might be about to leave the business hampered the share price earlier in 2019.
Berenberg says: ‘We note that if Mark Gordon decided to leave Entertainment One before 2022, he cannot produce for any other company during this period. He also owns 8m shares in the company.’
A further element of downside protection is provided by the company’s existing media library which Berenberg believes is worth 370p per share based on the latest independent valuation. The quality of this existing content could also make Entertainment One a takeover candidate.