Mondo TV — World-class animations group

Mondo TV has been producing and distributing children’s animated TV series for over 50 years. It develops its own productions, co-produces with major broadcasters and toy companies, distributes its large library and licenses rights for merchandise sales. Unlike many of its peers, productions centre on the development of existing brands (from books, comics or toys), which reduces risk and can improve the returns. Historically, the bulk of Mondo’s business was generated in Italy and France. However, with continued pressures on European broadcaster budgets, Mondo shifted its strategy in 2014 to increase its international sales, particularly in Asia where groups are increasingly seeking European input; it has scaled its production capacity significantly, and has invested in expanding its licensing capabilities.

Mondo has made good progress executing its strategy. It has projects underway with Henan York and Studio 56 in China, Aurora World (Kosdaq: 039830 KQ, market Cap $99m) and CJ E&M in Korea, as well as for its largest customer, Abu Dhabi Media., A realignment of resources within the group has enabled Mondo to support the increase in business with a modest increase in the cost base. The outcome has been a 57% CAGR in revenues and a 73% CAGR in EBITDA over the last three years. The production pipeline includes some significant new shows (YooHoo, Heidi, Invention Story) alongside recurring series (Sissi) and licensing interest appears strong. Additional funding has been put in place via a €15m convertible bond facility (of which €12m have been issued, €8.5m converted), enabling it to maintain investment in content at approximately €20m pa over our forecast period. A key metric we look at is the revenue to investment multiplier; management’s plan assumes that this peaks at approximately 2.7x. This is lower than that achieved historically (2.9x in FY16), which along with a number of multi-year deals announced, gives us additional confidence that budgets are underpinned.

Working capital requirements in TV production businesses are heavy; however, risks are mitigated through co-production and pre-sales agreements. For companies also involved in distribution and licensing as well as production, margins are high and successful shows can continue to deliver high-margin library sales over the long term.

After a period of consolidation in the European children’s content industry, Mondo, which has a very experienced management team, has been able to adapt its strategy. It is building a strong position as a European partner to Asian broadcasters and toy companies and has a promising and fully funded pipeline of shows that should support strong growth in EBIT over the next few years. Given the group’s recent track record, strong pipeline and significantly higher EBIT margins than peers, we would expect the shares to trade at least in line with peers in the children’s entertainment content industry and the Italian media sector in FY18, implying a value per share of €5.6. Announcements of additional licensing deals or significant new partners should help build confidence in the deliverability of its ambitious targets and close the 20% FY18 EV/EBIT discount to peers.

Forecasts may be subject to changes in delivery dates, but ultimately the success of a series is determined by children’s tastes. We assume moderate success across Mondo’s portfolio. A significant success or flop could have a considerable impact on forecasts.

Mondo TV is a leading Italian producer and distributor of children’s animated television series, and has also recently diversified into live teen fiction. It focuses on the production of content whose characters can be exploited for licensing and merchandising and which add value to its back catalogue of cartoons, which currently amounts to 1,500 hours of content. Mondo rarely uses its own IP; it typically co-produces TV series where the brand is already known either through toys (eg YooHoo), comic strips (eg Sissi) or books (eg Treasure Island) and brings them to life with animation. Partners tend to be toy companies looking to develop an existing toy brand (eg Aurora World Corporation), broadcasters (for instance its partnership with TF1 in France on Lulu Vroumette), or third-party producers looking to market an asset internationally. This gives Mondo an edge in a very competitive market place, de-risks its investment in production and supports a more rapid exploitation of higher-margin licensing and merchandising revenues. Mondo is also distinct from other Italian media groups in its international outlook; 83% of its FY16 revenues were derived outside Europe.

Revenues are generated from production services, rights sales, and licensing and merchandising, although often a single brand will drive revenues across all three categories (Exhibit 2):

Mondo TV has a long history in children’s animation. The group was established in 1964 when Chairman Orlando Corradi (previously CEO) began importing Japanese cartoons for distribution in Italy and Europe. It began producing its own animated cartoon series for television in the late-1980s, focusing from the start on classic children’s characters and stories such as The Jungle Book and Robin Hood. Orlando Corradi’s son, Matteo Corradi, previously in charge of strategy and international sales, took over from his father as CEO in 2012. CFO Carlo Marchetti joined Mondo in 2007, having previously been chief of accounting at Datamat SpA. The group has been quoted on the Star segment of the Borsa Italiana since June 2000. Orlando Corradi owns 43% of the shares with the remainder free float.

To support liquidity, dividends and the group’s profile internationally, the group has over the course of the last few years listed its three principal subsidiaries. Mondo TV SPA owns the majority of the group’s classic library, which it manages, as well as the business in Italy. It also provides central functions and strategic direction for its three listed subsidiaries: 30% Mondo TV France; 64% Mondo TV Suisse; and 72% Mondo TV Iberoamerica, which was the most recent subsidiary to be spun off in December 2016, facilitating the distribution of a dividend in kind of 13c per share and a cash dividend of 2c per share. Each subsidiary has a regional bias, as summarised in Exhibit 3.

Historically, the bulk of Mondo’s business was generated within Europe, principally in Italy and France, with the focus on production and licence sales to local broadcasters. However, since the advertising downturn following the 2008 financial crisis, European broadcaster budgets came under increasing pressure and by 2012/13 Mondo’s business was struggling, prompting a review of the group’s strategy in early 2014. Broadly, this involved an increasing focus on higher-growth international markets, a step change in the level of investment in programming and a re-organisation of the group. Management has made good progress delivering to this strategy:

The last 10 years have been a period of significant change in the television markets, and as is often the case in the media sector, children have been at the forefront of this change. Over the 10 years to 2010, children’s viewing of linear TV decreased as the market became dominated by global specialist channels (Cartoon Network, Nickelodeon, Turner, Disney, Sky, etc). This has been compounded in the last decade by the fact that children are heavy device users and families with younger children are more likely to be video on demand (VOD) subscribers. VOD viewing of kids’ content has shifted towards global VOD companies Netflix and Amazon, as well as YouTube, the ‘go to’ channel for many children.

Kids TV is an important part of pay TV and SVOD schedules. The large number of themed channels and an increasing number of OTT channels underpin a strong demand for kids’ content; according to Ampere, 12% of Netflix content is children oriented, 14% of Now TV and c 5% of Amazon’s content (mipcom TV 2015). Animation forms the core of children’s television schedules, accounting for approximately 60% of viewing (in the world’s 10 largest markets). Animation also has the benefits for international channels of travelling fairly easily as there are fewer dubbing issues and it is less culturally specific than non-animated series.

Content owners target the production and acquisition budgets of broadcasters and platforms estimated to be worth $2.2bn (IHT technology 2015, across 33 markets). Brands that have merchandising potential can also tap the $160bn market for licensed merchandise (The Licensing Letter, 2015). For instance, a successful brand such as Peppa Pig (eOne) generates retail sales of over $1.5bn annually, Peanuts (DHX Media) generates retails sales over $1.3bn annually.

Although demand for content remains strong, the pace of change has led to consolidation in the industry. Producers, traditionally aligned to the local free to air channels, have had a difficult time, resulting in a number of casualties; for example Entertainment Rights, EM-TV, TV Loonland, 4Kids.

Independent producers that flourish today are predominantly those that do not rely on the traditional ‘cost-plus’ model but have developed their own brands and forged alliances to support licensing and merchandising potential, mirroring the models of the larger vertically integrated groups. The UK’s Entertainment One (Peppa Pig, PJ Masks) and Canada’s DHX Media (Peanuts, Strawberry Shortcake, Telly Tubbies) are examples of independent groups that have had considerable success in creating sizeable kids IP business while remaining independent.

Deals done by the world’s two largest toy companies include Hasbro’s acquisition of 50% of Discovery Kids in 2009 and Mattel’s acquisition of Hit Entertainment ($680m in 2011; Thomas & Friends, Bob the Builder, Fireman Sam). Mega-mergers like these make reaching audiences even more challenging for the smaller toy manufacturers.

With IP increasingly concentrated among a smaller number of groups, mid-sized toy companies may be motivated to forge closer partnerships with TV companies either to secure quality brands (to distribute) or to secure access to TV audiences to promote their brands (as there is no advertising on subscription channels). Mondo’s co-production deals with Aurora World Corporation (039830. KQ), a leading provider of plush toys, is a case in point, as are previous relationships with Giochi Preziosi (Dinofroz, Gormiti) and Meg toys (Puppy in my pocket).

China has the world’s largest TV audience (both traditional and internet users). However, the media industry is highly regulated with foreign restrictions on both investment and importation of content. Nevertheless, co-production and joint ventures (where the Chinese party has the controlling share) are permitted and Asian networks appreciate the diversity and quality that partnering with European or US producers brings. Chinese rights owners also recognise the value in exporting brands to the US and Europe, which accounts for 78% of the value of the world’s licensed merchandising (by retail sales; China on the other hand accounts for a mere 4%).

Budgeting in the production industry can be challenging as revenue recognition is driven by delivery dates, which will depend on broadcast schedules, and longer-term success is determined by children’s tastes. Nevertheless, other than some fine-tuning year on year (which we would expect), in FY14 and FY15 the group delivered close to its FY14 plan. Although FY16 revenues were below those targeted in the FY15 plan, this was mainly due to slippage in delivery dates and EBIT was slightly ahead. Overall, we are encouraged to see that revisions to its budget over the last two years have been upwards (Exhibit 6 and Exhibit 7).

Exhibit 8 presents the most recent business plan, from October 2016. Management’s ambition is to almost triple revenues to €85m, EBITDA to €64m and net income to €25m over the next five years.

Mondo’s plan is underpinned by a number of key productions and relationships, and we estimate that approximately 70% of FY17 revenues are already committed.

Heidi, Bienvenida a Casa (co- production): Following its successful distribution of live teen fiction series (Yo Soy Franky, Grachi and Suena Conmigo), Mondo is now undertaking its first co-production in this genre in partnership with Alianzas Productiones (Chica Vampira, The World of Patti and Yo Soy Franky) for the co-production of 60 episodes of 60 minutes each of a live teen drama Heidi, Bienvenida a Casa; a modern adaptation of the classic children’s show following the adventures of a country girl in the city. It is investing €2.9m, retains 60% of the rights and Mondo will also be responsible for distributing the series worldwide (except in Argentina, Chile, Paraguay and Uruguay). The series started broadcasting in prime time on Nickelodeon across a number of markets in Latin America in Q117, covering the majority of development costs, and licensing interest is reportedly strong.

Final Fight (co-production): Final Fight (26 episodes, 22 minutes each) and Naraka (52 episodes, 11 minutes each) are Mondo’s first two series developed specifically for Chinese audiences in partnership with Taiwan-based New Tech Information (NTI) for a total budget of $12m. 50% share in the distribution rights for both series in China for a period of five years has been sold to New Tech Information (NTI) for $10m over three years. Finding a local partner is a key step to growing this side of the business.

Sissi The Young Empress (co- production): Long-term partner of the group (Eddie is a Yeti and Bug Rangers), Studio 56 has commissioned Mondo for the pre- and post-production of three new 3D series of Sissi (the first series sold to 35 markets and is well known in the DACH region). Mondo will invest $6.2m for each series, which are to be delivered by 2020 ($19.5m total budget). Production of the second series started in March 2017 and Mondo has announced the sale of 50% of the distribution rights in India and China for a period of 15 years to Broadvision Rights Ltd for $4.8m (for each series). Shows with multiple series tend to generate strong licensing interest and Sissi has already become Mondo’s most significant merchandising property.

Invention Story (production): In 2016 the group started work on a major new production for Chinese animation group Henan York (York), which has commissioned the production of 520 episodes of Invention Story for a total value of $25m paid in rising instalments by 2019. Mondo will be responsible for pre- and post-production and retains distribution rights outside China. Invention Story is based around the story of a fox that impresses the rabbit population in Carrot Town with his inventions. The series, which is still in production, is receiving considerable licensing interest.

Rowly Powly (co-production): A second deal with York has since been announced for the production of three series of another new brand, Rowly Powly. Production started in November 2016 and will be completed by 2020 for a total budget of $24m. Mondo has sold a 70% share in the rights to Nine Hong Kong Technology Limited I China (five years) and 10% elsewhere for €6.6m for each series (€19.9m in total).

YooHoo and Friends (co- production): A co-production with its creator, Korean manufacturer of plush (soft) toys Aurora World Corporation. The series (52 episodes, 11 minutes each) follows five animal friends who work to help tackle environmental issues, with characters based on the successful line of plush toys (c 80 million sold since 2007). Mondo is contributing $3m for production and retains 50% of the distribution and merchandising rights worldwide (although a smaller share in South Korea). In the past, the characters have been distributed by McDonalds, and Mondo management is excited about its prospects. Management has already signed a few rights deals and hopes to close an agreement with a global OTT platform.

Majed, Karamella and Casslan (Abu Dhabi Media – executive production): Abu Dhabi Media has been a key licensing partner for the group since 2014 with the transmission of four TV series (two produced by Mondo and two licensed). In 2015 it also agreed a major new direct production deal; Mondo will produce nine TV series over three years, each with 52 15-minute episodes. The series will be based on three characters who are already a success in the UAE: Majed, Karamella and Casslan. The total value of the production contract for Mondo is $14.4m. In FY16 Abu Dhabi Media accounted for 10% of group revenues.

Robot Trains (distribution and licensing): Mondo announced in February 2017 that it will be the key TV distributor and licensing agent in a number of territories (Turkey, Middles East, Africa, Portugal, Spain, Italy and Israel) for the popular Korean cartoon Robot Trains on behalf of Korean TV operator CJ E&M (which produced the popular series Super Wings). Mondo has already announced a number of deals (and retains a 30% share).

With the exception of pre-production, which Mondo brought in house last year, production is outsourced to a number of studios across India (Studio 56, Aries Epica) and China (Henan York Animation Film co) that Mondo works with regularly. Consequently, the cost base is adaptable, depending on the pipeline. For co-productions, management strives to break even on a production, and then multiplies the total return on a programme from the sale of broadcast rights and merchandising licences.

Animations are relatively expensive to produce, costing approximately $250k per 20 minute show. Production rarely starts before Mondo has found a partner to underwrite part of the production costs; this can either be by way of a co-production agreement, or by pre-selling the broadcast rights, reducing the financial risk considerably. While this reduces Mondo’s financial exposure, it will still have to bear the production and marketing costs upfront as even in a pre-sales situation, broadcasters generally pay on delivery. Initial viewing including the pre-sale of rights tends to take place at major trade shows and it takes approximately 18 months between commissioning and delivery.

We present in Exhibit 10 an illustration of what the cash flows on a successful series might look like, with payback within a year of delivery and distribution, and rights and library sales contributing to a rising return over time, depending on the success of a brand.

The funding has been put in place to finance the working capital required to support the planned increase in annual investment. Mondo TV has two facilities in place:

Exhibit 11 summarises Mondo’s historic KPIs. Since the change of strategy in 2014, the financial performance has improved considerably. In 2016, revenues increased 55% to €29.2m, EBITDA of €18.1m was a 109% increase on FY15, EBIT margins increased to 46% and net profit was €8.6m (FY15: €3.1m).

The group has a number of interesting new series in production and several long-term production commitments. With the budgeted level of investment, management is targeting a revenue to investment multiplier of 1.8x (we factor in a 12-month lag to take account of development time) in FY17, increasing to 2.4x in FY18 and 2.7x in FY19. Although one year can vary greatly to the next depending on the delivery schedule, this seems achievable given the FY15 and FY16 performance (2.9x in FY16) and the solid pipeline.

We estimate that 70% of management’s current year budgeted revenues are committed and in FY17 our forecasts are in line with management’s plan. In FY18, we err on the side of caution and apply a 5% contingency to management’s targeted revenues and EBITDA, increasing to 10% by FY19. In our forecasts we expect EBITDA margins to increase to 71% by FY19 from 66% in FY16, reflecting operational gearing effects from high margin rights and licence sales. To put this in context, DHX Media reported EBITDA margins of 70% in FY16.

At the same time, we expect EBIT margins to decrease to 39% as amortisation (which is done on a straight-line basis over seven years) will have an increasing impact as new shows are delivered. The delivery of two new shows (Disco Dragon and Rocky) in France, where costs are amortised fully on delivery, results in a step change in amortisation in 2018, which explains the lower EBIT margin in FY18.

Nevertheless, Mondo enjoys high EBIT margins due to the significant share of revenues from distribution and licensing as well as the flexible cost base. Compared to the larger listed children’s IP businesses, eOne and DHX Media, its margins are lower, as would be expected. eOne has higher profile assets and so direct like-for-like comparisons cannot be made; however, to add context, in FY16 the revenue multiplier at eOne’s family division was 11.5x and its EBIT margin was 65%. DHX Media also reported EBIT margin of 65%, providing an indication of the potential should Mondo successfully globalise its brands. Our forecasts are summarised in Exhibit 12 and Exhibit 13 and presented in full at the back of this report (Exhibit 15).

Up to €30m of warrants have been issued, attached to the GEM and Atlas facilities: 20% at €6.5 per share, 60% at €8.0 and the balance at €10.0. We have demonstrated the potential dilution risk should the shares trigger these warrants, although with the shares currently trading so far below the strike price we do not include this potential dilution in our forecasts.

Based on our forecasts, which are more conservative than management’s (and factor in a fairly long receivables cycle), Mondo appears adequately funded to execute its plan. We assume all the convertibles are triggered (and converted) by the end of FY17 and forecast net debt of €2.0m at the end of FY17. In FY17 we expect another year of working capital outflow, but by FY18 we reflect a neutral working capital requirement; consistent with the typical cash flow profile in the production sector (Exhibit 10). On this basis, the group would be cash flow generative in FY18.

At this stage of its development we believe the most appropriate way to value Mondo is by looking at EV/EBIT and P/E multiples, both of which capture the amortisation of content libraries (which may or may not be included in some peers’ EBITDA multiples, depending on a company’s accounting treatment). We have adjusted (upwards by €13m) Mondo’s headline enterprise value for the minority values of the listed subsidiaries. On this more conservative basis, Mondo trades on an EV/EBIT multiple of 7.0x in FY17 and 7.1x in FY18 and a P/E multiple of 9.7x in FY17 and 10.7x in FY18.

We have benchmarked its valuation against peers in the children’s entertainment content industry (kids) around the world, as well as the Italian media sector (media). We also prefer to look to FY18 multiples given the expected increase in amortisation and the dilutive impact of the convertible.

The average EV/EBIT multiple in FY18 for the kids companies is 9.0x and the average P/E is 14.6x (33% premium). Media companies average an EV/EBIT of 9.4x and P/E of 15.4x. If we take the average of the two peer sets, this implies that Mondo trades on an 23% EV/EBIT discount to peers in FY18, despite its significantly higher EBIT margin, and a 36% P/E discount.

Given Mondo’s recent track record, strong pipeline and significantly higher margins, we would expect this EV/EBIT discount to close. A peer average 9.2x EBIT multiple applied to FY18 EBIT forecasts implies a value per share of approximately €5.6.

Announcements of additional licensing deals or significant new partners should help build confidence in the deliverability of its ambitious targets and close the approximate 20% FY18 EV/EBIT discount to peers.

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. Our estimates are based on management’s business plan (allowing for contingencies) and the final outturn could be higher or lower depending on both internal and external factors.