Child’s play

Mondo TV is a leading Italian producer and distributor of children’s animated television series, with additional interests in live teen fiction. It has one of the largest animation libraries in Europe, with more than 2,000 episodes of television series and more than 75 feature-length animated films. Over the last year, Mondo TV has adapted its production and sales strategy, focusing its efforts and investments mainly on new productions with high licensing potential, co-produced with third parties, and on the distribution of third-party libraries. Its properties (both owned and licensed) are predominantly character-based. Mondo rarely uses its own IP, as this requires far greater levels of upfront investment to familiarise the market to the characters. It typically co-produces TV series where the brand is already known either through toys (eg YooHoo), comic strips (eg Sissi), or books (eg Treasure Island) and brings them to life with animation. Partners would typically be:

This approach gives Mondo an edge in a very competitive market place, de-risks its investment in production and supports a more rapid exploitation of higher-margin licensing and merchandising revenues. These individual properties are described on page 7, below.

Mondo TV started out importing Japanese animation into the Italian market, which was greatly underserved with animated content at the time. The group listed in June 2000, with a business model focused on production and distribution. The basic premise stayed the same until around 2012, working with toy companies and distributors as well as publishers and producing animated series based on the group’s own IP. Management then sought to replicate this with third-party IP, looking to create global brands with significant merchandising opportunities based on localised IP. Asian markets (Korea, China) were particularly targeted due to their size and structure, particularly as the local Italian market was struggling. The Mondo TV portfolio was greatly expanded in order to build a market presence that would be sufficient to attract higher-quality IP propositions. This gave the group a high level of knowledge and understanding of the market, designed to support building global brands from local intellectual property.

Revenues are generated from production services, rights sales, and licensing and merchandising, although often a single brand will drive revenues across all three categories (Exhibit 2). The group has commercial relationships with over 150 TV networks and digital platforms worldwide. In digital media, it works with all the US-based major platforms, including Netflix, YouTube, Facebook, Apple and Amazon, as well as with global players such as Huawei (China), ICFlix (Middle East and North Africa) and Megogo.net (CIS).

Mondo TVs revenues derive from three categories:

Mondo TV Group, based and quoted in Italy, is the main operation, but the group has operating subsidiaries in Iberia, France and Switzerland, with local stock market quotes. The deal with Netflix/Aurora for YooHoo and Friends was struck via Mondo TV Suisse, with the property becoming a Netflix Original series. It is to be co-produced with Aurora and Netflix and will premier in spring 2019 globally. The importance of this deal should not be underestimated as it launches Mondo TV as a serious global player and raises its profile in the important US market. In April 2019, Mondo TV Iberoamerica announced a major deal with Amazon for Latin America for a large proportion of the Mondo TV library to be distributed on the Amazon Prime Video Direct platform. The deal includes animated properties including The Treasure Island, The Drakers and The Jungle Book.

Mondo TV Iberoamerica, founded as Mondo TV Spain in 2008, is not just active in distributing Mondo TV’s animated catalogue in the region but has recently begun producing, and co-producing, original series.

During FY18, particularly during the second half, the group encountered a combination of issues that compromised its strategy. Sales in Asia slowed markedly in Q3. Having reported revenues ahead by 5% and EBITDA up 16% in September, all looked to be on track for delivering full year figures in line with the previously published five-year business plan. However, as Q3 progressed, and exacerbated by the death of co-founder Orlando Corradi, trading took a turn down. The principal client for Rowly Powlys, and Dee and Duh, withdrew shortly after. Then, in the second half of November, three major Asian customers gave notice that they wished to review their investments in various properties following weak demand in their local markets. Consequently, Mondo decided to suspend further investment in these projects, which have now been completely written off. The write-down in the library value was €32.9m, with a further adjustment to working capital in trade receivables (mainly from advance sales on these projects) of €23.9m. Net of the related tax offset, this made a total extraordinary non-recurring charge in FY18 of €43.8m.

These issues threw the group strategy into some disarray, prompting a fuller reappraisal of the state of the market and the best way for Mondo to re-establish profitable growth. This remains predicated on a core business model of the production of cartoon series in co-production with toy makers, particularly in Asia.

Matteo Corradi, son of the founder, is now the president and CEO of the group, having joined the group after graduating in 1996. He was appointed CEO in 2012. The CFO is Carlo Marchetti, an accountant who joined the group in 2008 and was appointed a director the following year. The other executive director is Monica Corradi and the board is completed with two independent directors. This team has drawn up and published a revised strategy that seeks to broaden the revenue generation model. In particular, it has identified the following strands:

In July 2016 Mondo reached an agreement with Atlas Alpha Yield Fund (Atlas) and Atlas Capital Markets (ACM) for the issue of up to €15m of convertible bonds (€250k each). €4.5m were issued during 2016 and a further €7.5m were issued during 2017, with €9.4m of these converting during 2017. The final €3m was issued in January 2018 and has also subsequently converted.

In April 2018, the board agreed a further investment agreement with Atlas Special Opportunities for a new line of convertible bonds for up to €18m in two tranches of €11m and €7m. The first tranche of these were issued in June 2018 and fully exercised by mid-July 2018 and the second tranche followed soon after, with all exercised by mid-September 2018.

As part of the April 2018 deal, Mondo TV also issued Atlas a global warrant, exercisable within five years from the issue date, for the subscription of 450,000 Mondo TV shares at a price of €7.5 per share (a total maximum value of €3.375m, but clearly well out of the money).

The Atlas funding has given the group the confidence to be able to support the investment programme in its key properties, which are identified below.

The content market has been undergoing structural changes for a number of years and the pace of that change shows no sign of easing.

Mondo TV has more than 50 years’ experience in animation and knows its markets well. However, it has invested considerable resources in developing new titles for licensing, which may be less successful than it hopes. Our estimates are based on management’s business plan (allowing for contingencies) and the final outturn could be higher or lower depending on both internal and external factors.

From a peak of €7.5 in December 2017, the shares drifted through the first half of FY18, reaching a low of €3.43 in early July. Although causality cannot be directly determined, it is likely that this reflected a combination of a lack of substantive contract announcements and shareholder disillusionment with the dilutive impact of the stream of Atlas bond conversions. There was also some uncertainty surrounding a proposed joint venture on a theme park in China, which management evaluated and from which it then withdrew in July, which may account for a bounce in the share price around that time. The combination of disappointing Q318 numbers and the death of the co-founder (and major shareholder) in November led to a further sharp decline in the share price to a low of €1.13 in mid-December. The confirmation that Orlando Corradi’s shareholding would pass to his immediate family, several of whom are actively involved in the business, has reassured investors that his death will not result in an overhang.

We have adjusted Mondo TV’s enterprise value to strip out the value of quoted subsidiaries. It is clearly trading at a substantial discount to the global peer set across all relevant metrics. EBITDA ratios are difficult to compare in this peer group due to the varying treatments of capitalisation of production costs, which is less of an issue for Mondo TV than for some of the others. We would therefore prefer to compare on EV/EBIT. Parity on this basis would imply a share price of €2.89, more than double the current level. On a P/E basis, again averaged across years one and two, parity equates to a share price of €1.95.

The company’s report and accounts show management’s calculation of the group’s WACC at 11.6%. Using 11.5% and a terminal growth rate of 2%, our DCF shows a suggested share price of €2.23, based on our medium-term modelling, which builds in a level of contingency against the published management five-year business plan. This nevertheless indicates that the current market share price sits at a discount of 72%.

Mondo TV issues its five-year business plan targets to the market to facilitate understanding of the business model. It last revised these numbers in December 2018 (see update note), significantly rebasing expectations by reducing forecast revenues by 50–60% over the period, resulting in EBIT projections lower in a range of 62–79%.

As shown above, we had significantly lowered our FY18 numbers at the end of the year. In the event, revenues undershot our revised forecasts, but the degree of change that the group has undergone meant that forecasting a specific period was always going to be a challenging proposition. As well as the revenue number, the group also discloses the value of production, being the total of the revenues earned in a period added to production costs capitalised in that period. For FY18, this value was €22.2m, down 40% from the prior year.

The decrease in FY18 over FY17 primarily reflects the termination of contracts with four major Asian clients in November, referred to above, on top of a more general slowdown of growth in Asia that had been experienced through Q318. This prompted a more thorough re-evaluation of the library, resulting in an amortisation and impairment charge of €41.7m being taken through the income statement, of which €24.5m related directly to the termination of the Asian clients.

As is clear, FY18 was a very difficult year for the business, in trading and with the death of the founder, which led to a significantly poorer financial outcome. The consequent root-and-branch reappraisal of the existing business and its prospects resulted in the rebased five-year plan (FY19–23), as published in December 2018. The pivot from Asia, which represented 81% of FY18 revenue, will be substantial in FY19, although we have not modelled the group on a geographic basis.

The value of production metric shown above is the total revenue from rights sales, production plus licensing and merchandising revenues together with the capitalised production costs. These capitalised production costs relate to Mondo TV’s own productions.

The exhibit above clearly shows the rebasing of the group, with FY18 set to have been the nadir of its fortunes. With the shift in business strategy as explained above, there should now be a greater degree of confidence in the management projections. Given that these are issued directly from the company, we have reviewed the numbers for reasonableness and compiled our own internal thoughts on how revenues and costs break down in light of historical reports and comments made in various management statements. Edison forecasts for Mondo TV Group are therefore based in this context on the company’s own published business plan, rather than from the ground up. However we have included an inbuilt contingency, increasing over time from 2% in FY19 to 10% from FY21, to reflect the execution risk. We will revisit these discount factors over time.

Investment in content remains a key lead indicator and we demonstrate that here. Without investing in production, there is nothing to sell in future periods. The shift towards greater pre-sales should mean that the risk profile associated with the investment improves.

Exhibit 18 above shows that there is a fair degree of inbuilt visibility of earnings from new productions over the short to medium term, but individual contract values are not disclosed for reasons of commercial sensitivity. Library sales, which we estimate constitute about 15% of revenues, are fairly steady, with growth over management’s business plan forecast period of a little over 10%.

The FY18 cash flow position showed lower operating cash before changes in working capital, primarily due to the deferred tax effects of the write-offs, with a large swing in working capital meaning that the overall operating cash flow was slightly ahead of the prior year. The cash brought into the business from the conversion of the Atlas bonds (€20.9m net) covered much of the investment in intangible assets in the period of €28.5m.

The forecast period will have different cash requirements. The emphasis on a smaller number of properties, a larger proportion of co-productions and pre-sales should mean lower capital investment in FY19 and on through the rest of the five-year plan. We are also assuming in our modelling that no cash tax will be paid. Management has suggested that the group will be broadly cash neutral in the current year before turning cash positive. We have built in a slightly more cautious scenario, with an outflow of €1.8m in FY19e, followed by an inflow of €6.9m for FY20e and €9.6m for FY21e. This is based on capex of €13.1m followed by €11.1m in subsequent years.

As at 31 December 2018, Mondo TV had net cash of €8.1m on the face of the balance sheet, consisting of cash and cash equivalents of €12.5m less short-term financial payables of €3.1m and longer-term financial payables of €1.3m. This compares to the prior year-end position of €1.9m of net debt. The key factor behind this strengthening is the capital raised through the conversion of the Atlas bonds, as described above.

The other important alteration to the balance sheet is the write-down in the value of the library.

Hong Kong Nine Technology, the principal client for Rowly Powlys, and Dee and Duh, withdrew shortly after the death of Orlando Corradi. Then, in the second half of November, three major Asian customers (Broadvision Rights Ltd., Hong Kong Yiqi Culture Film & Television Media Co. Ltd. and New Information Tech.) gave notice that they wished to review their investments in Naraka, Final Fight, Play Time Buddies, Beast Keepers, Partidei and Adventures in Duckport following weak demand in their local markets. Consequently, Mondo decided to suspend further investment in these projects, which have now been completely written off. The value of the assets has been written down with the FY18 results for a total of €56.8m at the consolidated level. This represents a write-down of the library value of €32.9m, with a further adjustment to working capital in trade receivables (mainly from advance sales on these projects) of €23.9m. Net of the related tax offset, this made a total extraordinary non-recurring charge in FY18 of €43.8m.

Our modelling indicates that net cash at the end of FY19 will be a little lower at €6.3m, then starting to build, reflecting the reduced capital investment requirement under the five-year business plan.