New CEO at the helm

Technicolor 15 November 2019 Update
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Technicolor

New CEO at the helm

Board change and Q3 results

Media

15 November 2019

Price

€0.83

Market cap

€344m

€0.90/US$

Net debt (m) as at 30 June 2019

1,060

Shares in issue

414.6m

Free float

100%

Code

TCH

Primary exchange

Euronext

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

12.4

13.0

(30.5)

Rel (local)

7.8

1.0

(39.2)

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

Final results

27 February 2020

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 has announced the appointment of Richard Moat as CEO, taking over from Frédéric Rose, who had been in situ for 11 years. He is a turnaround specialist, with a telecoms background, and is tasked with accelerating growth, value creation and financial sustainability. The Q3 trading update indicated improvements in adjusted EBITDA and free cash flow, as anticipated. We have made minor downward adjustments to our full year and FY20 forecasts to reflect the shift in mix. The valuation remains well below that of peers and our DCF-derived level of €2.10.

Year end

Revenue (€m)

PBT*
(€m)

EPS*
(€)

DPS
(€)

EV/EBIT
(x)

P/E
(x)

Yield
(%)

12/17

4,253

7

0.02

0.06

8.8

42.9

7.2

12/18

3,988

(3)

(0.01)

0.00

18.9

N/A

N/A

12/19e

3,809

(69)

(0.23)

0.00

17.2

N/A

N/A

12/20e

3,747

(10)

(0.02)

0.00

9.0

N/A

N/A

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments. FY19e and FY20e include IFRS16 impact

Q3 trading swings and roundabouts

Detailed Q3 figures were not given, with the broad picture painted of both adjusted EBITDA and free cash flow improving. As outlined in our August update, we expect a stronger working capital performance in H2 after the H1 outflow. Q3 performance was mixed segmentally, with good growth at both Production Services and DVD Services, but more bumps in the road for Connected Home. The latter is the largest part of the group (54% H1 revenue) and had a tough quarter. Revenues were down double digits, with good broadband growth insufficient to offset the decline in video. Weaker Latin American markets were also cited. Margins are set to pick up as the transformation plan takes effect and lower component prices kick in. Production Services revenues were up double digits, with strong growth in Film & Episodic VFX and in Animation & Games. DVD Services also had a better Q3 and, notably, has renegotiated a contract with a larger customer on ‘materially improved terms’.

New CEO

The new CEO, Richard Moat, will doubtless take some time to appraise the strengths and weaknesses of the three group businesses before clarifying any changes to strategy. Frédéric Rose has resigned from the board after an 11-year tenure, when he fundamentally reshaped the portfolio. Moat joins from Eir Ltd, the Irish telecoms operator, having previously been at EE and Orange. The group’s statement draws particular attention to his business transformation experience.

Valuation: Significant discount to peers, DCF

Good performance and corporate activity within global entertainment service peers has lifted comparator ratings for this segment, which we have discounted by 20%. Our sum-of-the-parts valuation is now €1.52, from €1.42 in August. A DCF, based on an 8% WACC and 2% terminal growth, gives €2.10, 2.5x the current share price. Given the degree of flux within the business operationally, financially and in terms of the management team, a degree of caution is appropriate, but the current discount looks overdone.

Mix shifts

The trading commentary gives no headline numbers beyond the broad percentage revenues changes by, and within, the trading segments. At the group level, revenues were slightly behind prior year, while EBITDA and cash flow were ahead.

Guidance was reiterated for H2 to show ‘significantly’ improved profitability and a better cash flow result, despite the impact on working capital of the downgrades from the ratings agencies as disclosed mid-October. We have made minor cuts to our projections in absolute terms, with the percentage changes exaggerated by being so close to the break-even level. It should be noted that all our modelling is on an IFRS 16 basis, which adds around €68m to the Entertainment Services EBITDA number and €8m to Connected Home.

Exhibit 1: Adjustments 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

(0.15)

(0.23)

-50

(44)

(69)

-57

78

60

-23

2020e

0.02

(0.02)

N/A

15

(10)

N/A

116

99

-15

Source: Technicolor accounts, Edison Investment Research. Note: EPS normalised, fully diluted.

In terms of divisional results, the remodelled split of revenue and EBITDA for FY19e and FY20e is shown below.

Exhibit 2: Divisional splits

FY19e old

FY19e new

FY20e old

FY20e new

€m

Revenue

EBITDA

Revenue

EBITDA

Revenue

EBITDA

Revenue

EBITDA

Connected Home

2,105

106

2,007

88

2,097

146

1,946

118

Margin

5.0%

4.4%

7.0%

6.1%

Production Services

838

878

879

922

DVD Services

884

903

839

858

Entertainment Services

1,721

233

1,782

233

1,719

244

1,781

248

Margin

13.5%

13.1%

14.2%

13.9%

Corporate & Other

20

(20)

20

(20)

20

(20)

20

(20)

Group

3,846

319

3,809

301

3,836

363

3,747

346

Margin

8.3%

7.9%

9.5%

9.2%

Source: Edison Investment Research. Note: Figures include IFRS 16.

Improving free cash flow

From negative free cash flow of €262m in H119, we expect 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 small negative free cash flow figure, revised from an inflow of €13m at the time of our August update, rising to €71m (from €74m) for FY20e.

Connected Home

Q3 constant currency revenues down in double-digits

The revenue decline is attributed to a slowdown in demand in Latin America, not previously a notable issue, and strong comparatives in Broadband.

Broadband continues to be a good market in North America, but the tail-off in the video segment has been marked. However, the group is picking up good business in android-TV solutions, where it is a leading provider.

The focus on DOCSIS 3.1 and on fibre moves Connected Home further from the more commoditised market segments, with the first wins from the new Wi-Fi 6 platform coming through in the quarter.

Margins should continue to improve in Q4, with the excess inventories now sold through and the productivity improvements from the transformation programme having a greater impact.

Production Services

Q3 double-digit revenue growth

A very busy quarter in Film & Episodic VFX generated ‘strong double-digit’ growth, with 11 major projects completed, including several for Disney. 17 theatrical projects and six non-theatrical (ie episodic and/or streaming) projects are in progress into Q4, for clients including Disney, Fix, Universal and Netflix. Advertising is described as achieving high single-digit revenue growth year-on-year, with Animation & Games producing strong double-digit increases. This is across both elements, with work continuing on The SpongeBob Movie and two other feature films as well as episodic animation work, while games included completion of new titles for Electronic Arts (FIFA2020, NHL20) and for 2K (NBA 2K20). The exposure to the more difficult post-production market has been limited by the decision to exit underperforming businesses last year and like-for-like business was slightly ahead.

DVD Services

Replication volumes up 7% y-o-y in Q3

The gain refers specifically to volumes and there is no mention in the statement of revenues for this segment.

However, this is a better situation than we had earlier envisaged, which may in part be due to some phasing of production into Q3 that had been expected in Q4.

The most important news for this segment is the progress in the contract renegotiations with major clients. When we published in August, the first contract extension with a major customer had been completed, taking effect on 1 July. A more significant contract has now been renewed with one of the largest studio clients on ‘materially improved terms’. As described in our initiation, renegotiation of contracts to volume and activity-based pricing is the crux of the investment case for this division, and this progress is encouraging. 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 across the contract base.

Valuation

Our valuation methodology is the same as previous notes, looking at the group on a sum-of-the-parts basis. Entertainment Services is valued on an EV/EBIT basis whilst Connected Home is valued on an EV/EBITDA multiple.

The major difference this time around is in the ratings of the peers for the Entertainment Services business, where corporate activity has been the primary driver of multiple expansion. At the end of July, the peer EV/EBITE multiple for FY19 was 19.0x and for FY20e was 14.8x. These have lifted to 22.5x and 19.1x respectively. We have now discounted the comparative multiple by 20% to reflect corporate activity within the sector. In future periods we will also include forthcoming IPO, DNEG, in the peer set.

This has lifted the implied value per share from €1.42 to €1.52.

Exhibit 3: SOTP

€m unless stated

Valuation method

FY19e

FY20e

Average implied EV

Applied multiple

EBIT or EBITDA
(x)

Implied EV

Applied multiple

EBIT or

EBITDA (x)

Implied EV

Entertainment Services

Peer group EV/EBIT

22.5

53

1,193

19.1

72

1,375

1,284

Discount by 20%

1,027

Connected Home

Target EV/EBITDA

7.9

88

695

7.9

118

932

814

Less net Corporate & other

 

10

15

(150)

10

15

(150)

(150)

Total EV

 

 

 

 

 

 

 

1,691

Less net debt and minority

 

 

 

 

 

 

 

(1,061)

Implied equity value

 

 

 

 

 

 

 

630

Implied equity value per share (€)

 

 

 

 

 

 

 

1.52

Source: Edison Investment Research

We have also repeated our DCF exercise on the adjusted forecasts and here the revision is down from €2.50 in August to €2.10 now.

Both techniques derive values well in excess of the current share price of €0.83. Although some degree of caution is appropriate, given the degree of flux within the business operationally, financially and in terms of the management team, the scale of the discount looks overdone.

Exhibit 4: Financial summary

€m

2017

2018

2019e

2020e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

INCOME STATEMENT

Revenue

 

 

4,253

3,988

3,809

3,747

Cost of Sales

(3,651)

(3,521)

(3,363)

(3,272)

Gross Profit

602

467

446

475

EBITDA

 

 

341

266

301

346

Operating Profit (before amort. and except.)

 

 

103

48

53

101

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)

(38)

42

Net Interest

(96)

(51)

(121)

(111)

Joint ventures & associates (post tax)

0

0

0

0

Exceptionals

0

0

0

0

Profit Before Tax (norm)

 

 

7

(3)

(69)

(10)

Profit Before Tax (reported)

 

 

(56)

(170)

(160)

(69)

Reported tax

(112)

(54)

51

18

Profit After Tax (norm)

7

(3)

(93)

(9)

Profit After Tax (reported)

(168)

(224)

(109)

(51)

Minority interests

1

(1)

0

0

Discontinued operations

(5)

157

0

0

Net income (normalised)

8

(4)

(93)

(9)

Net income (reported)

(172)

(68)

(109)

(51)

Average Number of Shares Outstanding (m)

413

413

414

414

EPS - normalised (c)

 

 

1.9

(1.0)

(22.5)

(2.1)

EPS - normalised fully diluted (c)

 

 

1.9

(1.0)

(22.5)

(2.1)

Dividend per share (c)

0.06

0.00

0.00

0.00

Revenue growth (%)

(8)

(6)

(4)

(2)

Gross Margin (%)

14.2

11.7

11.7

12.7

EBITDA Margin (%)

8.0

6.7

7.9

9.2

Normalised Operating Margin (%)

2.4

1.2

1.4

2.7

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

1,495

1,403

Stocks

238

268

261

244

Debtors

684

677

634

592

Cash & cash equivalents

319

291

177

144

Other

310

423

423

423

Current Liabilities

 

 

(1,669)

(1,909)

(1,927)

(1,935)

Creditors

(947)

(1,135)

(1,078)

(1,086)

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

280

36

Minority interests

3

1

1

1

Shareholders' equity

 

 

339

274

281

37

CASH FLOW

Op Cash Flow before WC and tax

269

92

128

160

Working capital

34

(12)

(21)

53

Exceptional & other

9

91

0

0

Tax

(13)

(14)

51

18

Net operating cash flow

 

 

299

157

158

231

Capex

(145)

(162)

(160)

(160)

Acquisitions/disposals

(25)

1

0

0

Net interest

(44)

(39)

(103)

(111)

Equity financing

1

0

0

0

Dividends

(25)

0

0

0

Other

(13)

28

(4)

7

Net Cash Flow

48

(15)

(109)

(33)

Opening net debt/(cash)

 

 

679

778

733

1,081

FX

(39)

1

5

0

Discontinued

(88)

105

Other non-cash movements

(20)

(46)

(244)

(62)

Closing net debt/(cash)

 

 

778

733

1,081

1,176

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

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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 £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.

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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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The Investment Research is a publication distributed in the United States by Edison Investment Research, Inc. Edison Investment Research, Inc. is registered as an investment adviser with the Securities and Exchange Commission. Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

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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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