Entertainment One — Strong performance across the group

Revenues increased 35% y-o-y to £1,082.7m, 8% ahead of our forecast. Television grew by 85% y-o-y (19% higher than forecast), Family by 33% (13% ahead of our forecast) and Film 7% (in line with our estimates). Acquisitions (65% of Renegade 83 acquired in March 2016, as well as the full year impact of Sierra Pictures acquired in December 2015 and some smaller deals) contributed £50.2m (6%) to revenue growth and currency 15%. Underlying EBITDA of £160.2m increased 24% y-o-y (or 15% at constant currency), 2% ahead of our forecast (Exhibit 1). The EBITDA margin at 14.8% decreased by 1.3pp y-o-y reflecting mix effects, in particular the impact of first revenues from productions contracted under the independent studio model by MGC, the impact of the lower margin Sierra acquisition and a 74% increase in central costs related to the growth of the business. Acquisitions contributed 0.5% to EBITDA.

Adjusted PBT of £129.9m is broadly in line with our estimate and includes £25.4m of net finance charges. This was higher than those incurred in FY16 (£20.6m), despite the lower average corporate net debt level, reflecting the full year impact of higher interest rates following the December 2015 refinancing. Reported PBT of £37.2m was affected by significant one-off charges relating principally to the re-shaping of the Film division (see our note: Exceptional charge to restructure Film). Adjusted EPS of 20.0p (in line with our forecast) increased at a slower rate than PBT, as a result of the dilutive impact of the October 2015 rights issue.

In line with our forecasts, eOne invested £408m in content and productions, a significant increase on the £218.5m invested in FY16 with the vast majority of the increase seen in the Television division, alongside a better cinema slate in Film.

More than half of this content was financed through production financing (which increased to £152.3m at the year-end), with £215.7m of the total financed by eOne. The up-front payments required with a strong film slate and the ongoing working capital impact of the transition to a digital distribution model, affected adjusted cash conversion which decreased to 52% (FY16:62%). Year-end net debt increased slightly to £187.5m, 15% ahead of our forecast; on a consolidated basis net debt was broadly in line (£339.7m). The board is proposing a full year dividend of 1.3p per share (FY16: 1.2p).

Management is guiding to another strong year of revenue and profit growth in Television and Family and expects a more stable performance in Film in the current year.

eOne increase its investment in Television by 154% to £260.2m in FY17 and the impact was clearly evident in the division’s performance. Revenues increased by 85% to £452.7m and EBITDA by 60%. EBITDA margins decreased by 2.1pp to 13.9% due to mix effects, with MGC’s new productions (which are sold under an independent studio model) growing disproportionately strongly. Growth was strong across the three sub-divisions (Exhibit 2).

The strong performance looks set to continue in the current year and management is budgeting a 13% increase in investment. There is a good pipeline of returning shows and a number of new series waiting to be green-lit; eOne Television is targeting around 1,000 half hours of programming in the current year and has 60% of its budget already committed; MGC’s return series continue to perform well (Criminal Minds, Greys Anatomy, Ray Donovan and Quantico) and Designated Survivor has been renewed for a second season. It also has a number of film projects underway for which it is receiving producer fees; 84% of FY18 budget has been committed. In addition, the TV sales force for eOne Television and Film has been combined to better leverage the group’s scale (on content windows outside of cinema) and is expected to result in improved revenues and profitability from the current year.

FY17 was another stellar year for Family, which increased revenues by 33% and EBITDA by 28%. Growth continues to be driven by its largest asset Peppa Pig, which generated retail sales of over $1.2bn in FY17 (FY16: $1.1bn), buoyed by the widening of the licensing and merchandising programme in the US (+170%), now eOne’s largest licensing market. While the UK, Australia, Italy and Spain are arguably now fairly mature markets for Peppa, the brand has been refreshed this year with an additional 52 episodes and its first film release (Peppa Pig: My First Cinema Experience) and last week’s announcement that a further 117 episodes will be delivered between 2019 and 2023, which should keep the brand fresh for some time to come. Growth opportunities remain in Asia, notably China, and a number of other European markets which should continue to power growth internationally.

It is particularly encouraging to see that one of eOne’s newer brands, PJ Masks, is now having a considerable impact; revenues increased by 500% y-o-y to £13.3m (15% of total revenues). The show is now being rolled out in 85 territories across the Disney Junior Network and France TV and the licensing programme, which started in the US in September last year will be widened this year.

Management expects Family revenue and EBITDA to grow significantly in FY18, although increased investment in the sales platform in a number of markets and higher royalty payments for PJ Masks will lead to a decline in the EBITDA margin.

Revenues increased by 7% to £594.2m, although higher up-front costs associated with a film’s release to cinema, as well as the full year impact of the acquisition of the lower margin Sierra Pictures meant EBITDA was flat y-o-y at £52.7m.

The volume of films distributed decreased to 172 (FY16:210); however, several high profile releases including the BFG, The Girl on the Train and multiple Oscar winning La La Land enabled theatrical revenues to increase by 50%, offsetting the headwinds in home entertainment (down 22%) and broadcast and digital (flat) from the previous year’s weaker slate. Production and international sales increased by 79% to £108.0m following the acquisition of Sierra Pictures in FY16 and the buyout of Sierra Affinity in the current year.

eOne believes that it can drive a more consistent and improved performance by taking greater control over the content it distributes; this means fewer large output deals where visibility beyond the early years tends to be low, becoming involved in a film earlier in the production process, and by focusing on fewer, but higher quality films. This strategy is already evident with the relationships that eOne has developed with Spielberg’s Amblin, MGC and (announced last week) the new Brad Weston venture, MAKEREADY and yesterday’s (22 May) announcement of a new distribution partnership with Annapurna Pictures.

It is also accelerating the restructuring programme initiated last year (targeting £10m cost savings) which will involve the continued streamlining of operations, the creation of a merged sales team for TV and Film, and the consolidation of other functions. eOne has provided £47m to cover the re-shaping of the Film division, including a one off £20m charge related to the renegotiation of one of its larger distribution agreements.

For the year ahead, management is budgeting a 40% increase in investment. The cinematic slate looks solid, including titles from Luc Besson (Valerian and the City of a Thousand Planets), Spielberg (The Post), Aaron Sorkin (Molly’s Game) and George Clooney (Suburbicon). Home entertainment should benefit from the tailwinds of the stronger Box Office performance in FY17.

Cash conversion (excluding production financing) was 52% of which Television was 96%, Family 91% but Film -16%. The low cash conversion in Film is partly to be expected in a year of a strong cinema release slate due to the timing of up-front minimum guarantee payments (and should unwind during the course of the current year). However, cash conversion also continues to be affected by significant working capital outflows related to the growing proportion of sales derived from digital distribution (where revenues are recognised up front, but cash is received monthly). After interest expenses (£24.2m), exceptional costs related to the restructuring of the film division (£17.6m), payments for acquisitions (£9.6m), dividends (£8.3m) and foreign exchange (£7.6m), year-end net debt increased slightly to £187.5m (FY16: £180.8m), equivalent to 1.2x EBITDA.

The use of production finance increased during the year to £152.3m (FY16: £118.0m), consistent with the group’s strategy to become closer to the production process in Film and to scale its Television activities.

FY18 looks set to be another good year for eOne in both Television and Family, and Film appears to be on a more stable footing. We have updated our forecasts to reflect the significant revenue beats in Television and Family. However, a lower EBITDA margin profile and a slightly higher tax rate (22%) translate to a 7% reduction in our EPS estimate to 22.0p. We also introduce forecasts for FY19, which assume ongoing strong growth in Television and Family, with a more stable performance in Film. Our changes to forecasts are summarised in Exhibit 3 and full forecasts are presented at the back of this report.

Based on the more conservative calculation of EV (including production finance), eOne trades on a FY18e EV/EBITDA multiple of 8.4x and a P/E of 10.9x. According to Bloomberg (21 May 2017), eOne’s closest US peer, Lionsgate (TV/ Film content) trades on 12.7x FY18e EV/EBITDA and 16.1x P/E and Canadian listed DHX Media (children’s content) is on 9.0x EV/EBITDA and 18x P/E.

The operational, financial and risk profile of eOne has improved considerably over the last two years and we consider this discount unjustified.

Taking an average of the Lionsgate and DHX EBITDA multiples implies a value for eOne of 343p.