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Creative Studios spin-off plan

Technicolor 28 February 2022 Update
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Technicolor

Creative Studios spin-off plan

FY21 results

Media

28 February 2022

Price

€2.72

Market cap

€642m

US$1.12/€

Net debt (IFRS, including leases) at end December 2021 (€m)

1,039

Shares in issue

235.8m

Free float

90.6%

Code

TCH

Primary exchange

Euronext

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

8.6

2.6

45.0

Rel (local)

9.9

8.1

26.9

52-week high/low

€3.60

€1.93

Business description

Technicolor is a worldwide technology leader operating in the media and entertainment industry. Its activities fall into three business segments: Technicolor Creative Studios, DVD Services and Connected Home.

Next events

Q1 results

5 May 2022

Capital market days

End May/early June 2022

H1 results

end-July 2022

Analyst

Fiona Orford-Williams

+44 (0)20 3077 5739

Technicolor is a research client of Edison Investment Research Limited

Technicolor’s FY21 results were in line with guidance, with strong demand for both Technicolor Creative Studios (TCS) and Connected Home, despite fulfilment of demand being constrained by the effects of the pandemic. The key development is management’s plan to spin off 65% of TCS as a separately listed entity, with an accompanying refinancing. This should result in two coherent, quoted businesses, each with good growth prospects, a clear investment narrative and on a stable financial footing. Existing shareholders are backing the facilitating €300m loan note placing and, if all goes to plan, the new shares will be listed during Q322.

Year end

Revenue
(€m)

EBITDA
(€m)

EBITA
(€m)

PBT*
(€m)

EPS*
(€)

EV/EBITDA
(x)

12/20

3,006

163

(59)

(46)

(0.36)

10.6

12/21

2,898

268

95

(6)

(0.11)

6.4

12/22e

3,036

385

180

88

0.31

4.5

12/23e

3,180

422

231

135

0.47

4.1

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

Underlying improvements

FY21 results were in line with management guidance and FY22 guidance (adjusted EBITDA: €385m; adjusted EBITA: €180m) is unchanged. TCS revenues were up 37.2% like-for-like on the prior year, with EBITDA margins lifted to 17.9% from 3.6%. Two-thirds of FY22’s pipeline is already committed, and the underlying market remains robust. While Connected Home’s revenues were down 10.0%, underlying demand was ahead of FY20, showing the impact of component shortages and supply chain bottlenecks. The cost reduction programme and close supplier and customer relationships led to a minimal effect at the EBITDA level, moving margins up from 6.0% to 6.7%. DVD Services margins also improved as the benefits of the efficiency moves started to flow through. Our new FY23 forecasts show continuing improvements.

Two from one

Management’s proposal envisages Technicolor ex-TCS (Connected Home and DVD Services) retaining a 35% stake in TCS, to be separately listed on the Paris stock exchange. A €300m mandatory convertible loan note, backed by existing shareholders, converts at €2.60/ on the spin-off, subject to approval by a two-thirds majority at an EGM to be held by 25 May. Management intends to renegotiate the rest of the group debt to put appropriate packages in place for both entities.

Valuation: Underlying value likely higher

The valuation reflects the current complexity of the group and the cost and constraint imposed by the debt. The proposed restructure tackles both issues. Our sum-of-the-parts, based on compiling segmental FY23e earnings-based valuations, variously discounted, derives a value equivalent to €4.95/share, up from €4.49 in our last report, reflecting the shift in year, peer price movements and lower net debt. A group-based DCF, using a WACC of 9.0% and 1% terminal growth, gives a value of €3.94/share. Both valuations are well above the current price.

TCS driving adjusted EBITDA growth

We recently published an Outlook report on Technicolor following the FY21 trading update, released in January. This described each operation in some depth, in terms of operations and financial dynamics. These results bear out the operational experience and financial performance as expected, with adjusted EBITDA of €268m against the indicated level of €270m and free cash flow (before financial results and tax) that came in at negative €2m, against the guided break-even. Adjusted EBITA was actually a little better than guided, at €90m from €60m.

Exhibit 1: FY21 group revenue progression

Source: Technicolor

Exhibit 2: FY21 group adjusted EBITDA progression

Source: Technicolor

TCS experiencing significant demand

As shown above, the most significant accretion to adjusted EBITDA came from TCS, particularly in the second half of the year as demand from several aspects of the entertainment sector picked up as pandemic restrictions eased. Operational issues centred around the difficulties of staffing in very tight markets for skilled labour globally. TCS succeeded in lifting the number of employees from 7,700 at end December 2020 to 10,560 a year on, which puts it in an advantageous position to cope with continuing strong customer demand.

Ahead of the planned demerger, TCS has been simplified and reorganised into key brands to face its key markets: MPC for film and episodic visual special effects; The Mill for advertising, including branded and immersive experiences; and Mikros Animation and Technicolor Games (again, these were described more fully in our Outlook report).

In FY21, MPC worked on over 30 theatrical films either released in 2021 or scheduled for the current year or beyond, and more than 60 episodic or streaming projects. This is a considerable step up in capacity, aided by the enlarged workforce and improved ability to work from different locations globally. The Mill worked on over 3,000 projects, while Mikros Animation worked on four feature films (with preparation ongoing for three further films) and numerous series and specials. The separation of Technicolor Games signals management’s ambition to make this a significant revenue stream.

Connected Home demand outstrips its ability to supply

The situation on the supply of componentry and the global logistical issues have been very well documented and are common to all suppliers. Overall revenue at constant exchange rates was down 10% on the prior year, having dipped by 18.3% in H221, with North America down 11.0% (24.0% in H221). The (smaller) Latin American market continued to be particularly difficult, but new customers won there should help to reverse the declines in FY22. Figures cited by management show that the group serves 60% of the top 10 global broadband suppliers and has a 14% global market share in home gateways.

Video product was more affected than broadband, which continues to benefit from consumers’ increased needs and expectations for the performance of their domestic broadband provision. Broadband accounted for 64% of the segment’s revenues in the year, up from 61% in FY20.

Connected Home has now shipped over 20m RDK broadband gateways (an open-source software platform that standardises core functions used in broadband devices, set-top boxes and IoT solutions) and continues to win business across Europe and the Americas. Good progress is also being made in Wi-Fi 6/6E in Europe, the Middle East and Africa, and the Americas.

Management’s view is that the supply issues will not be completely resolved before FY23 but that there is already an amelioration that started in Q421. Close relationships with both component suppliers and customers are helping to make sure that Connected Home is not squeezed in the middle.

DVD Services

Volumes continued on their downward trend, but at a much lower rate than historically, with the overall revenue from the segment actually increasing by 1.6% as new distribution and freight revenues in the United States started to make their mark.

Four facility closures, mostly in the United States, along with other cost initiatives and the benefit of the new non-disc business being won, helped lift the adjusted EBITDA margin from 7.5% to 9.5%.

Guidance for FY22 unchanged

Management guidance for FY22 is confirmed with these results:

Revenues from existing operations to continue to grow

Adjusted EBITDA from continuing operations of €375m

Adjusted EBITA from continuing operations of €175m

Free cash flow before financial results and tax of €230m.

Our FY22 modelling reflects this guidance.

Management has not issued guidance for FY23 at this stage but has indicated that it will do so at the time of the proposed capital market days for the two newly configured companies in late May/early June. While there are some more forward-looking numbers in the full year results statement, these do not constitute guidance and were included for the purposes of determining the terms of the loan note.

Our preliminary modelling for FY23 is therefore based on our current view of the prospects of the group companies, with the current financing arrangements continuing in place.

The proposed spin-off and refinancing

Sale of Trademark Licensing

Firstly, the group has agreed the sale for €100m cash of the Trademark Licensing business, reported historically under ‘Corporate and Other’. This Corporate and Other segment generated revenues of €23m in FY21 (flat year-on-year) and registered an adjusted EBITDA loss of €14m, although not all will be attributable to Trademark Licensing. Completion is expected in H222.

Elements of the proposed plan

The stabilisation of the business post the significant upheaval of the last few years (again, more detail is in the recent Outlook note) is now allowing management to propose a further set of measures that are intended to set the group on a course to drive growth and value. A deleveraging of each of the businesses should allow the two management teams to develop and pursue opportunities and build on their leading positions in their respective industries. TCS will be a pure-play investment opportunity in VFX, in a market where the demand for content shows no sign of abating. Technicolor ex-TCS will continue to be a global market leader in Connected Home and in DVD Services. With a de-levered balance sheet, it should be more agile and able to take commercial opportunities as they arise. This involves:

A spin-off of 65% of TCS through a distribution in kind to Technicolor shareholders.

TCS to be separately listed on Euronext.

The Technicolor ex-TCS business (ie Connected Home, DVD Services and the remaining 35% holding in TCS) to retain its Euronext quotation.

The issue of a €300m mandatory convertible loan note, which will be converted into Technicolor shares at €2.60 on the successful listing of TCS. This has been supported by selected shareholders who have agreed to subscribe for the full amount.

A renegotiation of the existing debt on more advantageous terms. This would involve separate debt structures for the two businesses, and it is not clear at this stage how the debt would be apportioned.

A sale of the 35% TCS stake, dependent on market conditions.

The first stage of actioning this process is an EGM to approve the mandatory convertible loan note. This requires a two-thirds majority at an EGM. This will be called ‘in early Q2’, with a backstop date of 25 May.

With two independent listed entities as an end result, there will be dis-synergy costs, which are currently estimated at €30–40m, and there are obviously costs and fees associated with the entire process, likely to be in the order of €75m. This is a substantial sum and is broken down as:

€30–40m to carry out the refinancing (including make-whole of the current debt),

€25–30m relating to the separation, spin-off and TCS share distribution, and

€10m miscellaneous related costs.

Management intends to hold two capital markets days, one for TCS and one for Technicolor ex-TCS, at end May/early June, after the scheduled Q122 results on 5 May.

The AGM and a second EGM to approve the spin-off should be held towards the end of June with the listing and distribution pencilled for Q321.

Our modelling will remain based on the group as it is currently configured until any of the proposed events happen.

Exhibit 3: Financial summary

€m

2019

2020

2021

2022e

2023e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

IFRS

INCOME STATEMENT

Revenue

 

 

3,800

3,006

2,898

3,036

3,180

Cost of Sales

(3,375)

(2,729)

(2,493)

(2,579)

(2,718)

Gross Profit

425

277

404

457

462

EBITDA

 

 

325

163

268

385

422

EBITA

 

 

42

(59)

95

180

231

Amortisation of acquired intangibles

(54)

(41)

(38)

(38)

(38)

Exceptionals

(79)

(151)

(53)

(11)

(10)

Reported operating profit

(121)

(267)

30

159

207

Net Interest

(84)

77

(127)

(120)

(120)

Joint ventures & associates (post tax)

(1)

0

0

0

0

Exceptionals

0

155

0

0

0

Profit Before Tax (norm)

 

 

(73)

(46)

(6)

88

135

Profit Before Tax (reported)

 

 

(206)

(191)

(97)

39

87

Reported tax

(3)

(5)

(24)

(5)

(10)

Profit After Tax (norm)

(75)

(51)

(30)

83

125

Profit After Tax (reported)

(208)

(196)

(121)

34

77

Discontinued operations

(22)

(15)

(19)

0

0

Net income (normalised)

(75)

(51)

(30)

83

125

Net income (reported)

(230)

(210)

(140)

34

77

Average Number of Shares Outstanding (m)

15

126

241

247

247

EPS - normalised (c)

 

 

(492.18)

(40.77)

(12.26)

33.40

50.50

EPS - normalised fully diluted (c)

 

 

(492.18)

(35.73)

(11.42)

31.17

47.13

Dividend per share (c)

0.00

0.00

0.00

0.00

0.00

Revenue growth (%)

(5)

(21)

(4)

5

5

Gross Margin (%)

11.2

9.2

14.0

15.0

14.5

EBITDA Margin (%)

8.6

5.4

9.3

12.7

13.3

EBITA Margin (%)

1.1

(2.0)

3.3

5.9

7.3

BALANCE SHEET

Fixed Assets

 

 

2,082

1,665

1,730

1,657

1,592

Intangible Assets

1,483

1,242

1,283

1,248

1,198

Tangible Assets

476

288

305

265

250

Investments & other

40

62

59

59

59

Deferred tax and other

84

72

83

85

85

Current Assets

 

 

1,127

1,344

1,268

1,304

1,378

Stocks

243

195

335

315

321

Debtors

507

425

359

339

355

Cash & cash equivalents

64

330

196

271

324

Other

312

394

378

379

379

Current Liabilities

 

 

(1,542)

(1,379)

(1,359)

(1,390)

(1,403)

Creditors

(825)

(710)

(671)

(703)

(755)

Tax and social security

(41)

(21)

(29)

(29)

(29)

Short term borrowings

(95)

(72)

(65)

(65)

(65)

Other

(581)

(576)

(594)

(593)

(554)

Long Term Liabilities

 

 

(1,631)

(1,466)

(1,505)

(1,521)

(1,537)

Long term borrowings

(1,203)

(1,070)

(1,170)

(1,186)

(1,202)

Deferred tax

(27)

(15)

(20)

(20)

(20)

Other long term liabilities

(401)

(381)

(315)

(315)

(315)

Net Assets

 

 

37

163

134

50

30

Minority interests

0

0

0

0

0

Shareholders' equity

 

 

37

163

134

50

30

CASH FLOW

Net profit

(208)

(196)

(121)

34

77

Depreciation and amortisation

322

261

222

215

205

Working capital

(69)

(101)

(81)

72

31

Tax and interest

(76)

(41)

(50)

(105)

(110)

Exceptional & other

101

(9)

43

0

(10)

Operating cash flow

 

 

70

(86)

14

215

192

Capex

(169)

(104)

(95)

(140)

(140)

Acquisitions/disposals

(2)

(3)

27

0

0

Equity financing

1

60

0

0

0

Dividends

0

0

0

0

0

Other

3

(21)

(3)

0

0

Net Cash Flow

(97)

(154)

(57)

75

52

Opening net debt/(cash)

 

 

733

1,234

812

1,039

980

FX

(16)

16

0

0

Discontinued

(35)

(23)

(29)

0

0

Other non-cash movements

(369)

615

(156)

(16)

(16)

Closing net debt/(cash)

 

 

1,234

812

1,039

980

943

Source: Technicolor accounts, Edison Investment Research

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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 £60,000 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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Copyright: Copyright 2022 Edison Investment Research Limited (Edison).

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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 £60,000 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.

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Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2022 Edison Investment Research Limited (Edison).

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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.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

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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

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

1185 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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