Mondo TV — MeteoHeroes are go for gaming

Mondo TV’s investment case centres on its ability to develop, produce and monetise children’s animated content for the global market. The following factors should also be considered:

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, owning the rights to over 1,600 TV episodes and films, which it distributes across global markets. Its production investment and sales strategy is focused on:

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. The collaboration with German partner Toon2Tango, described below, gives it early access to pre-qualified properties from a highly experienced developer. Mondo typically co-produces TV series where the brand is already known 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 marketplace, de-risks its investment in production and supports a more rapid exploitation of higher-margin licensing and merchandising revenues. Individual properties are described and illustrated below.

Mondo TVs revenues derive from three categories: production services, distribution and brand licensing.

Production has historically been mostly done under the supervision of management but using third-party designers, screenwriters and directors, keeping its cost base flexible. In FY16, Mondo established its own in-house pre-production team in the Canary Islands (Producciones Canarias) to work on the development of concepts and storyboards. This facility has now been upgraded and expanded to take on more of the group’s production work (and thereby retain more margin), with additional capability in 3D CGI. Generally, Mondo either works for a fee or will be involved in co-productions, retaining a share of the worldwide distribution rights. Co-productions support some of the financing of a production or part of the organisational requirements.

The joint venture with Toon2Tango was set up in June 2019. Toon2Tango was at that stage a newly established German children’s and family entertainment venture founded by Ulli Stoef, a well-known and established figure in the industry, now working independently. The alliance was set up to focus on developing, producing and distributing unique and high-quality programmes with strong merchandise appeal. The agreement targeted Toon2Tango developing at least eight new animated TV series over the following four years, which the two groups would co-produce and distribute. Three further animated series have since been added. These are to be targeted at the international market, with Mondo concentrating on its strongest regions across Southern Europe and Asia and Toon2Tango managing Germany, Austria, Switzerland, the United Kingdom and Ireland, Scandinavia and Benelux. Distribution, licensing and merchandising rights vary by territory, with the two groups co-operating on some multi-territory deals. Under the terms of the agreement, Mondo and Toon2Tango co-own the underlying IP and revenues accruing from the projects will be divided equally.

The first project from the collaboration, the animated series Agent 203 was launched in FY19, along with four other projects. The increasing scale of the partnership strengthens the group’s positioning in Northern Europe.

The group also has a longstanding collaboration with Henan York Animation in China, with which it developed Invention Story.

Most of Mondo’s productions target the under-10 audience, although its live fiction with the co-production of Heidi, Bienvenida a Casa is aimed at a teen audience. House of Talent is also live action, but reality, featuring social media influencers with younger followers. Production of these was obviously limited by the conditions of the pandemic in FY20.

Production revenues comprise a mix of recurring series and revenues from new shows, with new shows becoming a more important part of the mix over the course of the five-year business plan.

Mondo has a sales team of nine involved in the sale of rights plus a number of sub-agents, which gives it permanent representation across Southern Europe, France, the Middle East, Latin America and Russia. Successful animations have enduring appeal and as the children’s audience is replenished yearly, can be re-sold to a new generation of kids over and over again. We estimate that approximately €3.5m of Mondo’s annual licence sales are from its library and the remainder from more recent titles. Although Mondo is very conscious of regional tastes, most animations are dubbed into a number of languages and are marketable in multiple territories. As well as selling its own library, Mondo has a number of distribution deals, for instance with Turner, Cake and Your Family Entertainment.

While most sales are of series, the mindset of the distribution is more firmly on building franchises around the properties that help with a broader monetisation strategy.

Mondo TV handles both its own brands and third-party properties for which it is the representative, where it receives a commission. Rights are sold to merchandisers and toy manufacturers and there is therefore no physical stock risk. These are not necessarily linked to a TV series (although most are). In October 2019, it was appointed the licensing agent in Italy, Spain and Portugal for the classic Julia Donaldson/Axel Scheffler property, The Gruffalo.

The recently announced deal with Sony Interactive to develop and promote video games for MeteoHeroes indicates another potential licensing avenue.

Matteo Corradi is the son of the founder and is president and CEO of the group, having joined 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 by two independent directors. This team’s strategy, honed and published in late 2018, broadened the revenue generation model. It looks to:

As at 31 December 2020, the group had 53 employees, of whom four are executives, up two employees compared to 31 December 2019. The Italian operation is the largest within the group, with 25 employees, while the scale-up in the production facility in Gran Canaria has taken the number at Mondo TV Producciones Canarias to 15, with the intention to build staffing up to 50 over time by:

The current group structure is shown below. It has just been announced (26th May link: https://www.mondotv.it/wp/wp-content/uploads/2021/05/COS52.0-Progetto-fusione-inversa-Mondo-Iberoamerica-con-Mondo-Canarias-26.05.2021.pdf) that Mondo TV Producciones Canarias will reverse takeover the Spanish entity, Mondo TV Iberoamerica. This will simplify the group structure and help towards the objectives outlined above.

The deal flow has been coming through regularly and covers an encouraging range of properties, as well as further monetisation of the library assets. We have selected some of the key transactions and summarised them here. We would note that most relate to European distribution, but that it is worth highlighting the appearance of the US in the list with the VlogBox contract, as Mondo’s management has long had ambitions to make more significant inroads into that important market.

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 depending on how they are received by their target audience of children. Our estimates consider management’s business plan (allowing for contingencies) and the final outturn could be higher or lower depending on both internal and external factors.

Having recovered from a low of €1.19 at the onset of the pandemic, the share price climbed to €2.19 in early June 2020 and then lost nearly all of that gain over the subsequent eight months. Having bottomed out at €1.21 at the end of January, it has staged a good recovery to reach current levels.

Despite the recent rebound, the share price remains at a substantial discount to global peers, as shown in Exhibit 7 below. At least some of this discount will be attributable to the limited liquidity in the stock. We have added Boat Rocker, which listed on the Toronto Stock Exchange in Canada in March this year, to the list of relevant peers. While it has a broader business model than Mondo TV, it does have a strong focus on children’s content.

If the valuation gap with these peers were to be closed, on averaged earnings multiples across FY20–22e, the implied share price would be €3.84/share (April 2021: €3.81).

We have also looked at a DCF approach, under varying WACC and terminal growth assumptions.

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 €2.10, based on our medium-term modelling, which builds in a level of contingency against management’s published five-year business plan. This compares with a figure of €2.01 at the time of our last update in April.

The midpoint of these two valuation approaches is €2.97. It is also worth noting that the balance sheet value of the group’s library is €44.7m, equivalent to €1.03/share.

FY19 showed a marked recovery from FY18, which was a particularly difficult year for the group in trading and with the death of the founder (who still played a strong role in the business), 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 shift in emphasis to other regions apart from Asia (79% of FY20 revenue) was made more difficult in the year by the pandemic conditions, as shown in Exhibit 4, although we do not model the group on a geographic basis. Given that the deals announced over the last year have predominantly been for European customers, we would expect this reorientation to show more strongly from FY21.

The exhibit above clearly shows the rebasing of the group, with FY18 set to have been the nadir of its fortunes. Given that these projections are issued directly by the company, we have reviewed them for reasonableness and compiled our thoughts on how revenues and costs break down considering the historical reports and comments made in various management statements.

At the time the business plan was drawn up, there was obviously no foresight of the disruption reaped by the pandemic. However, as shown here, the impact on the business was well contained, partly reflecting the longer-term nature of the client relationships, partly reflecting the resilience of demand.

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

Exhibit 11 above shows 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 at around 15% of revenues, are steady, with growth across management’s business plan forecast period at a little over 10%.

In terms on margin, the progression is set to accelerate from FY21 as more production is carried out in-house at Producciones Canarias, rather than subcontracted to third parties. Margin is also driven by the balance of licensing and merchandising income in the mix. Again, we would expect this to increase in light of the deals announced over the last year or two. Our modelling indicates EBITDA margin to production value increasing from 61.8% in FY20 to 70.5% for the current year and 74.2% for FY22e.

Following the strong start to the year reported in the Q121 update, with production value of €8m, up 35% on Q120 (pre-pandemic onset), we leave our full year FY21 estimates unchanged for now given the unaltered previous management guidance and the upgrades that we put in place after publication of the FY20 figures in April. At that juncture, we introduced forecasts for FY22e and we have now edged these up slightly by reducing the contingency against the business plan forecasts. The effect is to raise our projected production value from €36.2m to €36.9m, which lifts FY22e EBITDA from €26.9m to €27.4m, still some way below the management plan to deliver €28.2m.

Cash flow boosted by Atlas cash injection

Operating cash flow in FY20 benefited from relatively modest absorption of working capital as payment terms with the major platforms and broadcasters stayed more stable than many had anticipated (some have poor reputations for stringing out settlement).

Investment stepped up over FY19 as new series went into production, but with an increasing element of pre-sales, the risk associated with this investment is considerably lower than it was for the group prior to FY18. The other element of investment is in scaling up the production facility within Producciones Canarias, with an initial investment of around €0.3m in offices and equipment.

The key item of note is on the financing line, bolstered by the funding from Atlas Special Opportunities in the form of a €10.5m issue of convertible bonds in FY20, €6.25m of which was issued in that year with the balance of €4.25m coming through in Q121.

By the year-end, €4.5m of the convertible bonds had already been converted into shares. Since then, the balance of €4.25m of convertible bonds have now also issued and the outstanding €6.0m (being the €1.75m issued but unconverted from FY20 and the €4.25m issued in Q121) have been converted (no further related share issuance outstanding).

The historical dispute with the Italian financial authorities, relating to deferred tax assets for the years FY12-19, was resolved in December 2020. Settlement was agreed at payment of €2.8m in several instalments over four years. We have assumed in our modelling that these are equal payments.

The cash inflow from the issue and conversion of the Atlas bonds put the balance sheet into a much-improved position. At the year-end, net debt was €4.1m, but this included €1.75m of debt related to the bonds, since converted. By end March, net debt was €0.9m. Excluding lease liabilities of €0.8m, the balance sheet was effectively ungeared at that point.

Total warrants outstanding to Atlas now number 1.95m, of which 0.45m are exercisable at €7.5 with an expiry date of 21 June 2023 and 1.5m are exercisable at €3.0, expiring on 31 October 2025.

The group’s library is now valued at €44.7m (as at end FY20 and tested annually), an increase of €9.0m, up 25% on the prior year. While 81% of this value rests with Mondo Italy, the increase in business through Mondo TV France swelled the value of its library from €2.4m to €5.7m.