Mondo TV — Exploring new horizons

Revenues in 2017 increased by 17% to €32.0m, underpinned by a tripling of licence sales, which now account for 50% of revenues, while rights sales and content production fees decreased. The change in revenue mix is in part due to the current stage of the content production cycle, and we would expect content and rights sales to expand again in 2018 as key titles are delivered. It is also a reflection of management’s strategy to scale the licensing part of its business, focusing on Asian markets, which represented 83% of revenues in 2017 (FY16: 80%). Revenues comprised:

EBITDA margins at 78% (FY16: 66%) reflect the change in revenue mix towards high-margin licence sales, with EBITDA increasing 38% to €25m. The ramp-up in investment in content in recent years (Exhibit 2) has not yet filtered through to costs and, after only €6.2m of content amortisation costs, EBITA of €17.6m increased by 38%.

Finance costs of €2.2m largely relate to foreign currency translation effects in the value of the group’s dollar-denominated trade receivables. Including this charge and €3.1m tax, net profit of €12.3m increased by 50% y-o-y, in line with management’s budget and our forecasts. The 20% effective tax rate benefited from Patent Box R&D tax credits and ACE offsets available against capital increases.

EBITDA to operating cash conversion was only 17% (FY16: 69%). During the year, Mondo invested €19.0m in content and €11.2m of working capital was absorbed, principally in relation to the production of Invention Story, Beastkeeper, Partidei, Sissi and The Rowly Powlys, as well as Heidi.

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 FY16 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. After this capital increase, net cash flow was broadly neutral during 2017, with year-end net debt reported at €2.0m.

We summarise FY17 results and our forecasts in Exhibit 3.

Key investments during 2017 included Sissi, The Rowly Powlys, Invention Story, Partidei, Beastkeeper, Final Fight, Naraka and Robot Trains, and Heidi. These key brands have now all moved beyond first deliveries, and as second and third series are produced, the rights and licensing potential should also increase. In 2018 we forecast a very similar level of investment in content and production (€21m), which will remain focused on these brands – along with the production of Mondo’s new flagship show, YooHoo & Friends, which was recently acquired by Netflix to air in 2019 (for more detail, please refer to our last update note, published on 4 December 2017).

Sales can be fairly lumpy, but we believe that Q118 results, reported on 15 May, put the group broadly on track to deliver to forecasts in FY18, with EBITDA up 20% to €6.6m and net income up 22% to €3.2m.

We make no substantial changes to our forecast profitability for 2018, where we expect a 47% increase in revenues as a greater proportion of the increased investment in content over the last two years moves to the delivery stage. This should also mean a partial unwinding of the negative working capital seen in FY17. However, we moderate our forecast for working capital in FY18. We now assume a 350-day receivable cycle and forecast €11.7m net cash flow and a €9.7m year-end net cash position in FY18 (down from €20.2m previously).

All of the bonds relating to the €15m Atlas Alpha Yield Fund have now been issued and converted. Subsequently, Mondo has put in place an additional facility with Atlas Special Opportunities, which provides for the issuance of a €18m convertible bond in two tranches of €11m and €7m during 2018. Based on our forecasts, Mondo has no immediate cash requirements. However, working capital cycles can be protracted, and the additional finance will provide flexibility to participate in additional projects, such as the theme park project, or increase content investment over and above that forecast, should new opportunities present themselves.

In March, Mondo announced that it is participating in a feasibility study, in partnership with Chinese animation group, Henan York, for the potential development of a theme park based around Mondo’s and other characters in Zengzhou, the capital of the Henan region in China. Of the total €250m investment considered, Mondo’s participation is expected at approximately 10%, €12.5m.

Zhengzhou is the capital of the Henan province in the middle of China, an important transportation hub and one of the eight central Chinese cities which operate as the political, economic and technological centres. Population growth in the area has been rapid, and there are now c 10 million people in Zhengzhou, and 100m in the Henan region. There are currently no other theme parks of this scale in Zhengzhou although the Asia Pacific region more generally has been a major driver for theme park growth in recent years. The region’s share of the global theme parks market grew from 35% in 2006 to 42% in 2015, according to the Themed Entertainment Association and AECOM.

Mondo’s participation is subject to the outcome of the feasibility study and is non-binding. An initial analysis performed by Henan York indicates that, based on a total €250m investment, the park would break even on 1.5m annual ticket sales, and that revenues of €100m and net profit of €14m in the first year post launch (6% ROI) could be expected. Should the project go ahead, development is likely to start in 2020 for completion in 2023. Mondo would expect to share in any profits as a minority investor in the JV, but would also expect to generate royalties from its brands.

It is common for major studio groups to invest in theme parks as a way to market brands and diversify revenues (Disney, DreamWorks and Universal all have parks in China). For a company of Mondo’s size, diversification of this kind is less common but does reflect the group’s growing ambitions and network in Asia. However, we estimate that the capital exposure represents less than 10% of the group’s FY19e net assets.

The shares peaked at €7 per share in December 2017 (shortly after announcing a deal with Netflix for YooHoo & Friends), but since then have been weak relative to peers and we believe the current price offers good value.

Mondo trades on EV/EBIT multiples of 7.3x and 5.5x in in FY18e and FY19e, respectively and P/E multiples of 9.8x and 7.9x in in FY18e and FY19e, respectively. This is a c 40-50% discount to peers on both multiples in both years. Mondo is forecast to deliver the fastest organic revenue growth in its peer group and has the highest EBIT margin. As such, the size of this discount seems exaggerated. Having said that, an element of discount may be appropriate given its smaller scale, emerging market exposure and the fact that content amortisation is not forecast to catch up with investment until 2020. Applying a 10x EV/EBIT multiple in FY19e (an arbitrary 20% discount to the peer group average) implies a value per share of approximately €9.2.

Announcements of additional licensing deals or significant new partners, which provide comfort that the group is delivering to budget, should help build confidence in the deliverability of Mondo’s ambitious targets and close the significant discount to peers.