|Shares Out. (in M):||157||P/E||0||0|
|Market Cap (in $M):||65||P/FCF||0||0|
|Net Debt (in $M):||-19||EBIT||17||21|
Film Finances Inc Holdings (“FFI”) is a busted IPO underpinned by substantial insider ownership (38%), insider buying at levels 2-4x the current share price, a low forward EBIT / EV valuation (2.2x), a durable moat in its core business (80% market share) and numerous cross-selling opportunities as management executes on its strategy to become a diversified services provider to the entertainment industry. With a share price down by 80% since listing in June 2017, FFI is trading at a significant discount to intrinsic value and offers a multi-bagger opportunity to the investor willing to look through the short-term noise and focus on the underlying earnings stability, growth potential and attractive valuation.
FFI is the world leader in the provision of completion contracts, also known as ‘completion bonds’, to the entertainment industry for films, television, mini-series and streaming product. Completion contracts guarantee that productions will be completed on time, on budget and to a pre-agreed specification. Producers pay an upfront fee, typically 150 to 200 bps of a film’s total budget, for the guarantee which then unlocks further production capital. As guarantor, FFI actively monitors the production from start to finish and is the intermediary between the ‘capital’ and the ‘creatives’. On issuing a completion contract, FFI simultaneously mitigates its risk by buying insurance (30-50 bps) and makes money on the spread. It is a high-margin (60-70%) cash generative core business.
The group was founded seven decades ago and is headquartered in Los Angeles with 11 offices globally including London and Shanghai. Since 2008, FFI has issued completion contracts to all the major financiers involved in the entertainment industry unlocking funding for over 1,800 productions with a gross production budget of $19bn. The business consistently bonds 150-200 projects per annum at an average budget per project of $14m.
FFI’s longevity and monopolistic market share is evidence of a business with high barriers to entry. Based on my conversations with management, competitors and financiers I believe that FFI’s monopolistic position will likely continue for the following reasons:
1. It has built up an extensive network of relationships with all the key players involved in the production of films and other content; the studios, mini studios, streaming companies, producers, distributors and financiers. It is a trusted and iconic brand. As one financier put it; “you can sleep soundly at night knowing that FFI is behind a production”.
2. It has built up a deep knowledge and expertise of the film production process. Its archive contains copies of all the key production documents for over 3,000 films spanning 67 years of film making history. This proprietary database allows the company to better gauge the probability of failure and allows it to offer guidance to producers to ensure a project is completed on time and to budget.
3. It has a strong claims record which not only builds a high level of trust between FFI and other key stakeholders in the production process but also enables it to obtain insurance from third party insurers at very favourable rates. The insurance market views the film and content business with a lot of caution and any new entrant would find it difficult to get the same reinsurance rates.
4. While the completion bond market might be growing it is still quite niche. With an 80% market share FFI generated $40m of completion contract revenues in 2018 suggesting a market opportunity of $50m plus. That’s comparatively small versus alternative industries and building up the network and the expertise takes a long time. It also carries a lot of execution risk for new entrants.
5. The product and the service provided by FFI is mission critical to the film production process. Independent producers have much smaller budgets than the large Hollywood studios, less resources and less prominent reputations. However, they are often more creatively ambitious which can make the sourcing of production financing challenging. To mitigate its risk, a producer will seek forward commitments from distributors to deliver the film or TV series to audiences. The distributor promises a series of payments to the producer once the content has been delivered on time and to a pre-agreed specification. These legally binding payments are then used as collateral by the producer when seeking debt or equity financing for the production stage. As part of their risk management, financiers often insist that the producer obtain a completion bond to mitigate the potential loss of principal through poor execution. A producer’s ability to repay its funding hinges, on part, upon receipt of the minimum guaranteed payments from the distributor which in turn rests upon the producer’s ability to deliver the finished content on time and on budget. This is why the guarantee, and the project oversight provided by FFI, is so important.
6. Despite being crucial to unlocking production funding completion bonds are a low-cost item in the context of a film’s total budget. The substitution risk for clients is therefore high and the appetite to replace a trusted supplier is low.
7. There is often a tense relationship between the creatives and the financiers. Talent, especially of the creative sort, can be difficult to manage. Financiers can be difficult to please. In its role as guarantor, FFI acts as an intermediary between those providing the capital and those producing the content. Financiers are spared from having potentially difficult conversations and producers feel less micro-managed by their funders. Therefore, the decision on whether to have a completion bond and which company to use, isn’t purely an economic one. It’s more multi-faceted. Some of the major studios use completion bonds this way. They utilise FFI’s infrastructure to provide the necessary checks and balances but adhere to their promise to the film maker that he/she can work independently.
8. The service provided isn’t purely a financial one. Because of FFI’s extensive network of relationships and deep industry expertise it’s able to provide clients with a number of value add consultation services - advice, referrals, information – that get wrapped up in the package.
FFI listed on AIM in June 2017 at £1.50 per share providing a market cap of £236m / $300m. The company raised gross proceeds of £31.5m from the issue of circa 21m new shares and circa £27.5m from the sale of existing shares by the CEO (Steven Ransohoff) and the Bahamas based investor David Haring who reduced their stakes in the company to 30% each. The IPO was undertaken to leverage FFI’s extensive network of relationships and gatekeeper role in the production life cycle to provide various ancillary services and products to the makers of film and television productions via a platform model. The group has set out an ambitious fourfold growth and diversification strategy comprising;
1. Acquisitions of non-creative ancillary services businesses.
2. Expansion of its core completion contract offering into China.
3. Strategic low risk investment in content.
4. Lower insurance costs through the creation of a new captive insurer.
Growth, Diversification and Cross-Selling
1. Acquisitions of non-creative ancillary services businesses;
Productions require non-creative ancillary services such as editing solutions, localisation, post-production accounting and visual effects as they move from development, to production, to distribution and marketing. Producers are often agnostic when deciding who should provide these non-creative ancillary services provided they are priced on a competitive basis. This is a fragmented industry and FFI’s strategy is to acquire businesses at low multiples with good management teams and leverage its network and knowledge of proposed projects to build a trusted ecosystem to service the entire production cycle, cross-selling and packaging services into FFI’s loyal and captive client base. FFI is an attractive proposition for ancillary businesses who get to benefit from its iconic reputation, network of relationships and access to information to accelerate their own growth. Combined, it allows the group to capture more value through the production life cycle. And the addressable market within FFI’s existing client base is significant. For year end March 2018 the total value of FFI’s bonded projects was $2bn. Circa 15% of project costs relate to post-production services providing an annual $300m existing customer revenue opportunity.
FFI has acquired six companies since February 2017 to add to its platform. This has been done in a very capital efficient manner, with the majority agreed on a partial earnout basis, enabling FFI to fund the acquisitions largely through operating cash flow. This has also been done at very attractive valuations (typically 3-5x EBITDA multiples). Only one of these acquisitions has contributed to a full year of accounts with the majority acquired towards the final four months of the most recent reporting year.
Pivotal Post was the first business acquired by FFI outside of its core completion bond business. Pivotal provides post-production editing equipment rental and software for film makers around the world. There is evidence that the cross-selling thesis is bearing fruit. At acquisition, Pivotal had 89 rental suites for content editing but at year end had more than 150 editing suites.
EPS-Cineworks was acquired in November 2017 to complement Pivotal; both provide access to editing equipment but each has a distinct market focus. Where as Pivotal has strong client relationships across the film industry, EPS-Cineworks has a strong following amongst producers of television content. The business is witnessing strong growth due to the increased content being produced by streaming companies that do not have traditional post-production capabilities.
Buff Dubs, a leader in encoding, transcoding, media duplication and mastering, was acquired in December 2017. It provides services to the likes of Netflix, Apple and Google. Where as Pivotal and EPS-Cineworks sit at the front end of the production process, Buff Dubs is a back-end provider dealing with finished films and converting digital assets into formats that can be accessed by digital users.
Signature Entertainment was acquired in April 2018 and is the largest distributor of films in the UK by volume. Its primary focus is streaming media content via video on demand and it acts as an aggregator of smaller budget films ($5-20m) for Netflix, Amazon Prime and Sky. Similarly to Pivotal Post, Signature offers FFI strong cross-selling opportunities; only 3% of its book of titles is bonded by FFI, it can refer its production clients to Pivotal, EPS-Cineworks and Buff Dubs for non-creative ancillary work and FFI can introduce its production clients to an important distributor of films to the UK market.
FFI has also expanded into entertainment insurance services through the acquisition of Reel Media in December 2017. This was on the back of growing demand for general risk cover from its clients. Reel Media is an insurance agency and speciality brokerage that offers numerous insurance products to the entertainment industry across the entire production life cycle, from pre to post-production risk mitigation. Shortly after its acquisition, Reel Media acquired a motorsports insurance book of business and entered into a strategic underwriting relationship with Allianz to become their largest entertainment Managing General Agency of its North American Global Corporate and Speciality business. Management is very excited about what it calls FFI’s “most transformative insurance relationship to date”. This agreement gives Reel Media delegated underwriting authority for the US-based AGCS studio, independent film and television business, as well as its US loan-out corporation and touring business. The relationship also extends into Canada where Reel Media will have similar privileges as well as authority over Allianz’s documentary, industrial, commercial and education business. This strategic alliance allows FFI a significant opportunity to cross-sell entertainment insurance services into its existing client base and has the potential to drawf the core completion contract business over time.
2. Expansion of its core completion contract offering into China;
China is becoming the largest entertainment market in the world with significant growth in the number of movie theatres and film production companies as well as strong demand for content given the prevalence of mobile phones as the platform of choice for Chinese viewers. However, the film-making infrastructure in China is in its infancy. Around 70% of the 600 or more films produced annually in China are never screened resulting in enormous waste for its nascent film industry and significant losses for financiers. A lack of standardisation, quality controls and completion financing for stalled projects are cited as the main culprits.
China enacted a Film Industry Promotion Law in March 2017 to encourage insurance companies to develop products that can support the development of the film industry. The law promotes the use of financial security instruments that provide completion guarantees and spread the risks of film production. Management believes that the developing film production market in China and growth of the country’s entertainment market present an opportunity for FFI to grow its core completion contract business and other ancillary services. Especially as the film-making process in China becomes more standardised.
The group benefits from first mover advantage having opened a Shanghai office in 2015. It launched a strategic partnership with the People’s Insurance Company of China, the world’s largest insurance company, which offers it considerable customer reach. In 2016, it was the first foreign agent to obtain a licence to issue completion bonds in China. It will take time but FFI is making inroads by building relationships with the key producers and financiers. In 2017 it bonded its first Chinese film (Bleeding Steel, starring Jackie Chan). At first the producer (Heyi Pictures) was sceptical, noting the “additional workload and expenses”. However, as the film progressed the more the producer “appreciated the service provided by FFI which went beyond supervision to help and guidance to ensure that everything was delivered on schedule”.
‘Guanxi’ is an important lubricant of personal and business life in China. FFI’s relationship-driven approach ought to mean it is well positioned to capitalise on this crucial tenet of Chinese culture. FFI’s own culture ought to help too. According to two of FFI’s London-based Managing Directors each international office is run very autonomously as management respects the cultural intricacies of each geographic region.
3. Strategic low risk investment in content;
FFI is occasionally asked or is given an opportunity to invest in content where a predetermined sale to global distributors can be identified on a profitable basis. By strategically investing in content to complete the financing of projects, management believes it can generate compelling returns on a low risk basis given its network and relationships with distributors.
Of the circa 150-200 projects per annum that FFI provides completion contracts for, management expects to see 5-6 projects per year which are appropriate for this type of strategic low risk investment. For example, in 2016 FFI acquired rights associated with the film ‘Snowden’ for $1m. At the same time, it was able to secure an onward distribution deal with a major studio for $2m in a little over 12 months. FFI has also co-financed the production of a 45 minute IMAX documentary film about Pandas. The film will be distributed and partly financed by IMAX and Warner Brothers and FFI will be entitled to circa 21% of the net revenues after repayment of production costs and distribution expenses. Pandas has been well received by critics and is expected to be a staple of IMAX theatres worldwide from late 2018. Management expects Pandas to have a lifespan of up to 10 years as IMAX documentaries, on average, have much longer runs than movies.
4. Lower insurance costs through the creation of a new captive insurer;
FFI used circa $8m of the IPO proceeds to set up a captive insurer to reduce its insurance costs by no longer paying for insurance that was neither required nor used by the group. This new arrangement, concluded in September 2017, has significantly lowered the groups insurance costs whilst still offering its counterparties the same level of security. The captive is fully supported by MS Amlin, a strategic partner and long-time shareholder (6.88%), and Allianz Global Corporate and Specialty (who are behind the transformational partnership with Reel Media). Following the creation of its in-house insurance captive, gross insurance costs fell significantly during the financial year 2018 to 33.7% of net completion guarantee fees versus 42.5% in 2017. This has resulted in significant margin expansion for the core completion contract business.
Overreaction to Temporary News
Despite these positive initiatives the share price is down by 80% since the IPO. When I spoke with management they alluded to being mystified about the share price decline. Indeed, they have been aggressive buyers of their own stock. In January, the COO spent £220,000 buying 250,000 shares at £0.88p, the Non-Executive Chairman spent £173,000 buying 225,000 shares at £0.77p, the FD also spent £173,000 buying 225,000 shares at £0.77p, an independent director and his wife spent £57,000 buying 75,000 shares at £0.76p and another Non-Executive spent £182,400 buying 240,000 shares at £0.76. That same Non-Executive also acquired 350,000 shares at £1.56 worth £546,000 shortly after the IPO. These are meaningful share purchases totalling £1.35m at prices 2-5x the current share price.
So what has caused the share price decline? There are primary causes at the operational level and at the capital markets level. First, the share price halved in December 2017 when the Harvey Weinstein scandal broke. The Weinstein Company helped pioneer ‘indie’ movies in the US and was an influential producer of small to medium budget alternative movies. It was a large client and several planned productions were either delayed or cancelled affecting FFI’s core completion contract business. Second, the share price halved again in August when management flagged higher than expected corporate overhead as a result of the listing, IT upgrades and the build out of the Reel Media platform.
The company is getting penalised at the capital markets level because of the limited free float. Circa 75% of the shares are held by insiders or strategic investors and daily trading volumes are low. Therefore, any ‘heavy’ trading results in quite extreme moves in the share price. IPO investors are also probably a little weary of negative operational news so soon after a listing. That the term ‘Fallen Angel’ forms part of investors’ vocabulary suggests such weariness exists and perhaps justifiably so.
Furthermore, completion contracts are a niche corner of the entertainment industry and investors are probably unfamiliar with them. FFI is also difficult to value as it’s been transformed in the last 12 months and is a radically different more diversified company. Can management execute on its growth strategy? Can it successfully integrate the companies it acquires and prove the cross-selling thesis? Clearly the revenue line will grow but what about the upfront costs to service and integrate that platform? Will the revolution taking place in the entertainment industry – the cord cutting, the declining attendance at movie theatres, the shift in power from the major studios to the likes of Netflix and Amazon – render FFI obsolete?
These are all valid questions. Even concerns. However, I believe the uncertainty is priced in with the rewards outweighing the potential risks.
At its current share price of £0.32p, FFI has a market cap of $65m. Net cash of $19m results in an EV of $46m. This is for a business that reported a 30% increase in underlying EBIT of $16.6m on revenue of $58m and expects to report another 30% increase in FY 2019 underlying EBIT to $20-22m. FFI’s core completion contract business generated an operating profit of $13.69m on revenue of $39m reflecting a high operating profit margin of almost 35%. Considering FFI’s dominant market position, supported by high barriers to entry, the completion contract business alone is worth a minimum 8-12x operating profit reflecting an EV of between $108m to $164m, or 2-4x the current share price. That excludes the value of the non-creative ancillary businesses acquired in the last 18 months and their inherent cross-selling potential. It also excludes the anticipated, yet unknown, revenue stream from the Pandas documentary.
To Infinity and Beyond…
FFI has seen numerous changes in its almost seven decades of business. Whilst the technology, players and means of which content is viewed might change, the demand for readily available independent content remains insatiable. Management is aware of the transformation taking place around it. It has a level of expertise that is unrivalled amongst its peers. It is incentivised to execute on its growth and diversification strategy by way of strong equity ownership. And it now has the platform and capital backing to deliver on its potential of becoming an integrated services provider to the entertainment industry.
Let’s hope it does. A big chunk of my net worth is on the line.
Time. Execution. Familiarity. Rising earnings. Pandas and Reel Media.