Technicolor — An improving picture for H2

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Research: TMT

Technicolor — An improving picture for H2

Technicolor’s H1 results were in line with management expectations and we have made only minor adjustments to underlying forecasts (numbers now reflect implementation of IFRS 16). Work on The Lion King contributed to a very busy H1 for Production Services, which also has a good H2 pipeline. Connected Home has market leadership in broadband gateway access and has made good progress with its cost saving plan. We expect working capital to swing back to the group’s advantage in H2 and operating margins to start to rebuild. The share price has recovered from recent weakness but remains well below peer based and DCF valuations.

Fiona Orford-Williams

Written by

Fiona Orford-Williams

Director, TMT

TMT

Technicolor

An improving picture for H2

Interim results

Media

1 August 2019

Price

€0.76

Market cap

€314m

0.90/US$

Net debt (m) as at 30 June 2019

1,060

Shares in issue

413.4m

Free float

100%

Code

TCH

Primary exchange

Euronext

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(5.7)

(28.1)

(35.9)

Rel (local)

(5.6)

(27.1)

(35.4)

52-week high/low

€1.29

€0.70

Business description

Technicolor is a worldwide technology leader operating in the media and entertainment industry. Its activities are organised in two business segments, Entertainment Services (the combined Production and DVD Services businesses) and Connected Home.

Next events

Q3 update

30 October 2019

Analysts

Fiona Orford-Williams

+44 (0)20 3077 5739

Dan Gardiner

+44 (0)20 3077 5700

Russell Pointon

+44 (0)20 3077 5700

Technicolor is a research client of Edison Investment Research Limited

Technicolor’s H1 results were in line with management expectations and we have made only minor adjustments to underlying forecasts (numbers now reflect implementation of IFRS 16). Work on The Lion King contributed to a very busy H1 for Production Services, which also has a good H2 pipeline. Connected Home has market leadership in broadband gateway access and has made good progress with its cost saving plan. We expect working capital to swing back to the group’s advantage in H2 and operating margins to start to rebuild. The share price has recovered from recent weakness but remains well below peer based and DCF valuations.

Year end

Revenue (€m)

PBT*
(€m)

EPS*
(€)

DPS
(€)

EV/EBIT
(x)

P/E
(x)

Yield
(%)

12/17

4,253

7

0.02

0.06

8.5

39.3

N/A

12/18

3,988

(3)

(0.01)

0.00

18.3

N/A

N/A

12/19e

3,846

(44)

(0.15)

0.00

12.3

N/A

N/A

12/20e

3,836

15

0.02

0.00

7.4

N/A

N/A

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Mix effects in margins

Production Services had a good H1, with constant currency revenues up 10%, offset by DVD Services dipping 6% over prior year. In Connected Home, revenues down 7% reflect declining US video sales, partially compensated by good broad-band growth. As anticipated in our recent initiation, underlying H119 EBITDA margins experienced some pressure in both segments, 7.0% from 7.2% in H118 in Entertainment Services and to 2.1% from 2.5% in H118 in Connected Home. Within Entertainment Services, this reflects the mix between Production Services, which performed better than we had anticipated in both revenue and margin, and DVD Services, where a reduction in volumes and a greater proportion of standard DVDs in the mix more than countered cost reductions. As referenced in Q1, delays in the sales of new products in Connected Home led to an inventory build-up and prevented the benefit of lower commodity costs feeding through to the sales mix.

Working capital set to improve in H2

As anticipated, working capital performance in H1 was more markedly negative than usual, resulting in a free cash outflow of €262m, compared to €137m in H118. This figure was swollen by the €83m tied up in the Connected Home inventories and by the timing of Production Services milestone payments, which reduced cash flow by €23m compared to prior year. Project timing is weighted to H2 in FY19. With Connected Home now having worked through all of the higher-cost inventory, we expect a strong working capital performance in H2 and hence stronger FCF.

Valuation: Sum of the parts and DCF point to upside

On the same sum-of-the-parts basis as in our recent initiation, using averages of FY19e and FY20e EV/EBIT for Entertainment Services and EV/EBITDA for Connected Home, our base-level fair value of 1.42 is above the current price (up from €1.10, reflecting peer price rises and the positive impact of IFRS 16 on Connected Home). At a WACC of 8% and a terminal growth rate of 2%, our DCF indicates a value of 2.50 (vs 2.74).

Better outlook for H2

The main changes to our forecast model relate to the implementation of IFRS 16. For H119, this increased the EBITDA (by €42m) and the depreciation (by €46m), decreasing the EBIT by €4m.

Exhibit 1: IFRS16 changes to EBITDA

EBITDA
Old (€m)

EBITDA
New, pre IFRS16 (€m)

EBITDA
New IFRS16 applied (€m)

FY19e

239

258

319

FY20e

295

301

363

Source: Edison Investment Research

The interest charge is also increased (more so in the short term, less as the leases mature) leaving us with a reduction in the adjusted PBT and earnings, as shown below.

Exhibit 2: Changes to forecasts

EPS ()

PBT (m)

EBITA (m)

Old

New

% chg.

Old

New

% chg.

Old

New

% chg.

2018

(0.01)

(0.01)

-

(3)

(3)

-

98

98

-

2019e

(0.05)

(0.14)

280

(30)

(44)

47

60

78

30

2020e

(0.01)

0.03

N/A

21

15

-29

111

116

5

Source: Company accounts, Edison Investment Research

The other significant impact is on the balance sheet, where net debt is inflated by the value of the operating leases, adding €75m to short-term debt and €239m to long-term debt. This visually obscures the improvement in free cash flow and net debt that we model for H219. Debt covenants are based on non-IFRS figures. Our model now shows year-end net debt of €1,060m. Less the operating lease element, this would be €746m, little changed from our previous estimate of €741m.

From negative free cash flow of €262m in H119, we anticipate an inflow in H219 as indicated by management, with the inventory position in Connected Home correcting and stage payments in Production Services being made. For the full year FY19, we now forecast a positive FCF of €13m, rising to €74m for FY20e.

As FY18 numbers have not been restated for IFRS 16, the segmental discussion below is based on non-IFRS numbers. This is more pertinent for Entertainment Services, where the bulk of the operating leases rest, lifting H119 adjusted EBITDA from €56m to €90m.

Connected Home (54% of H119 revenue)

H119 revenues were down 7.4% year-on-year at constant currency.

H119 adjusted EBITDA margin was down from 2.5% to 2.1% in H118 (on a non-IFRS basis).

The revenue decline was ‘in line with expectations’ and the mid-single-digit fall reported for Q1. Adjusted EBITDA fell to €20m, down €6m or 25% at constant currency, year-on-year. The trend described over the last year, namely declining video sales in the US (particularly Charter) partially compensated for by strong broadband growth, continued but in addition the company saw softness in the Latin American market (described as growing in Q1). As referenced in Q1, delays in the sales of new products saw a build-up in inventory and prevented the benefit of lower commodity costs feeding through to the sales mix.

The company remains confident about a strong recovery in profits and cash flow in H2. This is primarily due to the combination of falling commodity costs and the cost reduction plan (more than 70% of the €140m annual savings run-rate had been achieved by H1). With all excess inventory now burnt through, H2 sales will be higher gross margin and cash flow should improve. In addition, the headwind from declining US video sales should abate.

Our FY19 forecasts already factor in a modest abatement in the revenue decline and a strong recovery in profitability in H2, so our numbers are maintained. In the longer term, the company continues to make headway in securing market leading positions on growth platforms. It is now a clear market leader in broadband with a 21% share globally, it has a 40% market share on DOCSIS 3.1 and Android sales rose 33% year-on-year. As we referenced in our recent initiation, we see strength on these platforms as key to outperforming in a tough market over the long term.  

Production Services (24% of H119 revenue)

H119 revenues were up 9.9% at constant currency.

Adjusted EBITDA ‘grew significantly’ (NB published segmental EBITDA is merged with DVD Services).

Recurring EBITA was down year-on-year, due to increased cloud rendering costs resulting from an exceptionally heavy delivery schedule. The business worked on visual special effects (VFX) for 25 film projects and 10 episodic streaming projects in the period, including Disney’s The Lion King (which we confirm is visually stunning).

The successful use of cloud-based rendering potentially gives the group options over managing the capacity constraints that would not necessitate capex on buildings and equipment. Additional technical people and artists are being recruited and trained and the costs of this are built into our forecasts.

The pipeline for film and episodic VFX is strong for H2. A new long-term production agreement with a major global streaming platform is also now in place, which supports the medium- to longer-term outlook. In animation, production on the new SpongeBob movie was delayed from H1 and a number of other projects will be coming through for features, episodic productions and games.

Technicolor is typically paid in staged payments, with down payments, then milestone payments through to a final payment on delivery. The timing of substantial projects can therefore make a considerable difference to the cash flow generated from the business. This was an issue for the group in H1, as flagged, which should correct in H2.

DVD Services (21% of H119 revenue)

H119 revenues were down 6.1% at constant currency.

By implication, adjusted EBITDA will have been well down, given that the combined EBITDA with Production Services was down 0.3%.

Volumes were down 11% on the prior period, but the mix was unfavourable, with a greater proportion of standard definition DVDs as the studios pushed more catalogue product in the absence of blockbusters and a generally weak start to the year in theatrical box office. Blu-Ray had tough comparatives and also suffered from weak box office in Q1. H2 looks better in this respect, with a number of releases likely which will show particularly well on Blu-Ray.

The good news from this segment is that the first contract extension with a major customer has been completed and will take effect in H219. Renegotiation of these contracts to volume and activity-based pricing is the crux of the investment case for this division, as described in our initiation. The major studios still make a lot of cash from physical product and there are very limited alternative options given the amount of capacity that has been taken out of the global market. Timing on improving divisional operating margins will depend on when agreement is reached.

Exhibit 3: Financial summary

€'m

2017

2018

2019e

2020e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

INCOME STATEMENT

Revenue

 

 

4,253

3,988

3,846

3,836

Cost of Sales

(3,651)

(3,521)

(3,396)

(3,350)

Gross Profit

602

467

450

486

EBITDA

 

 

341

266

319

363

Normalised operating profit

 

 

103

48

71

118

Amortisation of acquired intangibles

(9)

(81)

(59)

(59)

Exceptionals

(54)

(86)

(32)

0

Share-based payments

0

0

0

0

Reported operating profit

40

(119)

(20)

59

Net Interest

(96)

(51)

(115)

(103)

Joint ventures & associates (post tax)

0

0

0

0

Exceptionals

0

0

0

0

Profit Before Tax (norm)

 

 

7

(3)

(44)

15

Profit Before Tax (reported)

 

 

(56)

(170)

(135)

(44)

Reported tax

(112)

(54)

43

14

Profit After Tax (norm)

7

(3)

(60)

8

Profit After Tax (reported)

(168)

(224)

(92)

(30)

Minority interests

1

(1)

0

0

Discontinued operations

(5)

157

0

0

Net income (normalised)

8

(4)

(60)

8

Net income (reported)

(172)

(68)

(92)

(30)

Basic average number of shares outstanding (m)

413

413

414

414

EPS - normalised (c)

 

 

1.9

(1.0)

(14.6)

2.0

EPS - normalised fully diluted (c)

 

 

1.9

(1.0)

(14.6)

2.0

Dividend (c)

.06

0.00

0.00

0.00

Revenue growth (%)

(8)

(6)

(4)

()

Gross Margin (%)

14.2

11.7

11.7

12.7

EBITDA Margin (%)

8.0

6.7

8.3

9.5

Normalised Operating Margin (%)

2.4

1.2

1.8

3.1

BALANCE SHEET

Fixed Assets

 

 

2,161

2,101

2,529

2,385

Intangible Assets

1,567

1,591

1,743

1,606

Tangible Assets

243

233

509

502

Investments & other

351

277

277

277

Current Assets

 

 

1,551

1,659

1,524

1,454

Stocks

238

268

264

250

Debtors

684

677

640

606

Cash & cash equivalents

319

291

198

175

Other

310

423

423

423

Current Liabilities

 

 

(1,669)

(1,909)

(1,943)

(1,958)

Creditors

(947)

(1,135)

(1,094)

(1,109)

Tax and social security

(33)

(34)

(34)

(34)

Short term borrowings

(20)

(20)

(95)

(95)

Other

(669)

(720)

(720)

(720)

Long Term Liabilities

 

 

(1,707)

(1,578)

(1,817)

(1,817)

Long term borrowings

(1,077)

(1,004)

(1,243)

(1,243)

Other long term liabilities

(630)

(574)

(574)

(574)

Net Assets

 

 

336

273

293

64

Minority interests

3

1

1

1

Shareholders' equity

 

 

339

274

294

65

CASH FLOW

Op Cash Flow before WC and tax

269

92

143

157

Working capital

34

(12)

(13)

62

Exceptional & other

9

91

0

0

Tax

(13)

(14)

43

14

Net operating cash flow

 

 

299

157

173

233

Capex

(145)

(162)

(160)

(160)

Acquisitions/disposals

(25)

1

0

0

Net interest

(44)

(39)

(97)

(103)

Equity financing

1

0

0

0

Dividends

(25)

0

0

0

Other

(13)

28

0

0

Net Cash Flow

48

(15)

(84)

(30)

Opening net debt/(cash)

 

 

679

778

733

1,060

FX

(39)

1

5

0

Discontinued

(88)

105

Other non-cash movements

(20)

(46)

(248)

0

Closing net debt/(cash)

 

 

778

733

1,060

1,090

Source: Company accounts, Edison Investment Research. Note: Historical numbers have not been restated for IFRS 16.

General disclaimer and copyright

This report has been commissioned by Technicolor and prepared and issued by Edison, in consideration of a fee payable by Technicolor. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

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New Zealand

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General disclaimer and copyright

This report has been commissioned by Technicolor and prepared and issued by Edison, in consideration of a fee payable by Technicolor. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

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Copyright: Copyright 2019 Edison Investment Research Limited (Edison). All rights reserved FTSE International Limited (“FTSE”) © FTSE 2019. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

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United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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BONESUPPORT — On track to reach profitability

In Q219, total revenues were SEK37.3m, surpassing the previous peak achieved in Q217 (SEK37.1m), when Bonesupport was selling through an exclusive distributor, Zimmer Biomet, in the US. US business segment revenues were SEK14.8m (up 28% q-o-q, 6% y-o-y). Bonesupport has secured new GPO contracts including with Kaiser Permanente, and is actively monitoring and updating its distributors (six were replaced in the quarter). Europe/RoW sales grew by 6% q-o-q and 59% y-o-y, where CERAMENT G/V is still performing well. Bonesupport is now looking to its R&D projects, having decided to focus on CERAMENT plus bisphosphonate and CERAMENT plus DBM. Our valuation is virtually unchanged at SEK1.70bn or SEK32.8/share (vs SEK33.1/share).

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