Description
INTRODUCTION: With a 75% rebound in the share price, an unfavorable change in the economics of its digital cinema financing plan (not understood by the bulls) forcing the company to try to shift its business model to newly acquired businesses with major competitive pressures, the continued very high cash burn and the need for major dilutive capital requirements in the near future, I believe it is timely to reiterate my short recommendation on the shares. A sum of the value of the parts analysis of the company shows a fair value for the shares below $3.50, which illustrates the significant potential downside in the share price.
Note: For anyone interested in background on this company, I would refer you to my original write-up (under the stock symbol AIX) dated 10/20/05 as well as subsequent Q&A update postings dated: 1/13/06, 4/26/06, 9/28/06 and 10/12/06. Thus, the focus of this new posting will be on the current factors that I believe underscore my negative position on the fundamental outlook for the company and the shares at this time and makes this a timely call.
THE ECONOMICS OF THE DIGITAL DEPLOYMENT BUSINESS FOR AIXD ARE NOT ATTRACTIVE: As a starting point for understand my position on the stock, I think it’s important to understand the economics of the digital distribution business for AIXD. For those investors who have taken the time to get past the sizzle and hype, and run a spreadsheet on the economics of the digital equipment financing business (especially the AIX/Christie plan) the clear message that comes through is that this is not the outstanding investment opportunity that some make it out to be and that in the case of AIXD the ROI is not compelling. The following is my basic model for AIXD for revenues and costs on a per screen basis assuming completion of all 4,000 screens:
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Economic Model for Deployment Business |
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VPF Revenues |
$15,000 |
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Delivery Revenues |
$900 |
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Total Revenues |
$15,900 |
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Depreciation |
($7,500) |
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Interest |
($5,923) |
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Operating Expenses |
($250) |
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Pretax Income |
$2,227 |
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Taxes |
($891) |
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Net Income |
$1,336 |
In modeling this business I have assumed the following:
-- VPF’s averaging $1,000 per screen.
-- the industry average of 15 movies per year.
-- delivery fee revenues of $200 from 1,200 theater locations.
-- an average system cost of $75,000 and a 10 year depreciation life.
-- interest costs on the GE credit line (70% of the system cost) as per the terms (about $4,500 per year) and a portion of the remaining 30% system cost that AIXD has funded at the very unattractive terms in their recent private placement (see below), with the remaining piece (about $17,000) as AIXD’s equity piece.
-- modest administration and operating costs (delivery, administration, etc.) of about $250 per system per year.
-- a 40% tax rate.
Note, my model assumes full completion, no hidden costs (i.e. potential upgrades and hardware replacements) and full revenue streams (i.e. an all goes right scenario!). Factoring in all these variables, the model shows an annual CF of $1,336 per screen and a ROI for AIXD on its equity in this business is only about 8%.
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Per Screen ROI Analysis |
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System Cost |
$75,000 |
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GE Financing (70%) |
$52,500 |
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AIXD Financing (30%) |
$22,500 |
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AIXD Private Placement ($22M) |
$5,500 |
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AIXD Equity Component |
$17,000 |
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Net Profit |
$1,336 |
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ROI on AIXD’s Equity |
7.9% |
My discussions with some of the other companies looking at this business suggest that my calculation are consistent with their models and is the reason they have been somewhat tepid to jump into this market. Thus, I would ask: does an 8% ROI make this such an attractive business and justify all the hype from AIXD?
PHASE 2 HYPE LEADS TO A RALLY IN THE SHARE PRICE DESPITE LESS ATTRACTIVE ECONOMICS: I believe the recent move in the share price from the low to mid $5 levels is tied to the company’s discussion of phase 2 of its digital cinema conversion program. As has occurred in the past, the combination of management’s one sided spin on current events, the laziness of a number of sell-side analysts to do some of their own research (instead of just listening to management) and some favorable press articles has in my opinion aided the recent rally. However, there are a number of major factors and changes from phase 1 (which management has not highlighted) which in my opinion clearly reduce the economic return for AIXD.
Phase 2 of its digital cinema deployment plan, which will be formally announced by year end, is targeting an additional 10,000 screens in the US. While this sounds very compelling, there is one important thing that management left out of its discussion; the economics of phase 2 of their deployment plan will be significantly different and much less profitable for AIXD, than in the past. As I pointed out a number of times, what is sometimes more important than what management says is what they don’t say!
An important starting point in understanding the changes that are being negotiated in phase 2 is that the studios are not very happy with how phase 1 of AIXD’s plan has working out relative to their expectations. In phase 1 the major studios were willing to give a little more up to get the program started. However, they have learned a lot during the last deployment period and want to make a number of changes before reaching critical mass. For example, the studios were unhappy in paying VPF’s on many smaller/regional theaters where the return on their VPF payments are sub par. Also, in some cases the studios were being asked to pay multiple VPF’s on screens that would have shown the same 35mm film, recycled after running a week or two at a first run theater. Negotiations continue and no formal contracts have been signed yet between AIXD and any of the studios. However, the following are some of the important changes that the studios want that will significantly decrease the economics for AIXD in of phase 2 of it digital cinema deployment:
- the studios will have total transparency (unlike investors; sorry I couldn’t resist that one!),
- the VPF the studios pay AIXD will come down (at least commensurate with lower hardware costs),
- the VPF could be paid on a sliding scale depending on when the movie plays relative to its release date (i.e. the full VPF on the first week, and a lower percent on following weeks),
- the studios will not pay multiple VPF’s for “moveovers” (as discussed above) where the 35mm prints had been reused in the past,
- the studios will take a cut on the alternate content fees AIXD receives,
- the studios will receive an advertising usage fee from AIXD for pre-show advertising, and
- maybe most importantly, the studios have demanded that all revenues will go towards cost recouping hardware systems costs and terminate after completion (not after 10 years!). Thus, VPF’s will end completely when the projectors are full paid for and this revenue steam for AIXD will terminate!
Clearly these changes will reduce the profit potential tied to any new digital cinema asset financing plan. Our understanding is that there will be a caped return not exceeding 15% on the plan. To characterize the comments from one knowledgeable source in the discussions: the studios are not allowing this to be a big equity play and it will be tough to get a healthy return on investment from pure conversion. Thus maybe we are beginning to see why the National CineMedia proactively separated these operations, labeled Digital Cinema Implementation Partners (DCIP), from its core business pre-IPO and its CEO described these operations as nothing more than an equipment financing business and “unattractive” from a business model perspective. This may also help explain why we hear that Technicolor has said it does not expect to make any significant profits from its financing plan and why it has been very slow and cautious on moving forward with its rollout plan and others looking at getting into the business have changed their mind.
AIXD IS SHIFTING ITS BUSINESS MODEL TO NEWLY ACQUIRED UNPROVEN & MORE COMPETITIVE BUSINESSES: The recognition of the impact of these changes does not appear to be lost on the management of AIXD (though they forgot to communicate this to investors). In my opinion this is the reason they are attempting to change the entire focus of the company once again. Noteworthy is that the revenue stream of VPF’s on new phase 2 deployments will move to zero at some point in the future. This fact was recently highlighted in a July 8th Business Week article on Technicolor (“A Celluloid Hero Goes Digital”) and the challenges it faces. Discussing VPS’s, the article states “those fees start at about $1,200 and drop over time to zero”. Thus, the company’s latest strategy is to try to build a group of business to sell products and services to these exhibitors. The recent acquisitions of Unique Screen Media (USM) and The Bigger Picture appear to be the lynchpins in management’s new strategy. To emphasize this point management has stated publicly that The Bigger Picture division will be the biggest division of the company in five years. That’s a pretty big goal for a division that management has given guidance for $5 million in revenues this year. Hitting management’s five year goal would likely require tremendous growth over that period. Or it could be recognition of the fact that VPF’s will begin to dramatically drop off at that time!
Given the trend for VPF’s, what investors are primarily buying is really a company in the following businesses in which management hopes to leverage from its financing deals: software management (Hollywood Software), satellite transport/delivery (Boeing), pre-show screen advertising (Unique Screen Media) and digital content delivery (The Bigger Picture). Each of these businesses lack the sizzle factor that its financing business has with investors, are already highly competitive in that they have well established players with significant market share dominance. For example USM is a very distant #3 player in the pre-show advertising market that is dominated by two giants: National CineMedia and Screen Vision. USM’s current installed base of about 3,500 screens compares with the two leaders, who each have about 14,500 screens. This is important because currently Unique is primarily a provider of local market advertising. By contrast, both of these competitors have fully running digital satellite delivery networks already in place and a base of much more viewers (especially in major metropolitan markets) which make them much more attractive to national advertisers and helps in their goal of trying to gain more advertising dollars away from other national advertising mediums. This is where the big dollars and profits are to be had and where USM’s two major competitors are already well positioned. However, before USM can compete for these dollars it will have to spend a fair amount of its own to upgrade its infrastructure and significantly grow its screen presence before it can be competitive for this business. Maybe this is one reason why we understand that both National Cinemedia and Screen Vision passed on the opportunity to acquire USM while it was on the market for sale for quite some time prior to AIXD’s acquisition. For these reasons I believe it is very inaccurate and misleading for the management of AIXD to describe its USM division on its last conference call as “a smaller version of National CineMedia”. Thus, while I suspect that AIXD will be successful in growing its base of theaters for USM’s pre-show advertising services, one diluting factor is that in phase 2 of its digital cinema financing deal the studios will receive an advertising usage fee from AIXD on the use of its digital projectors for pre-show advertising. Thus this takes away a portion of the profit potential for AIXD and may be a reason why management has suggested that the revenue and profit picture from this division should remain similar in the future.
The Bigger Picture is a digital alternate content distribution company. While providing some fit, there are a number of issues that I believe will create a very challenging environment for the company to be the huge growth vehicle that management has communicated to investors. Notably, similar to the competitive situation with USM, The Bigger Picture has some major well established competitors. Maybe the most significant competitor is Hollywood itself and the major distribution divisions of the large studios, many of which have been moving to grow their business in this area. Noteworthy, in one of the largest revenue sectors for alternate content, concerts and related entertainment, the major provider of content is Live Nation. This company’s relationship with many of the major artists and its ownership on many venues for these events gives it a unique advantage. In looking for distribution for its content, Live Nation decided in May of 2006 to partner not with AIXD, but National CineMedia. Given Live Nations breath and depth of content in this area, this clearly puts AIXD at a competitive disadvantage. While The Bigger Picture has plans to add additional “channels” in regard to the type of digital content it hopes to provide one notable point is that most content distribution agreements are non-exclusive in nature. Thus, the same content could be available to exhibitors from different sources and no exhibitor wants to be locked into any provider. Also when looking at the financial impact, remember the studios are attempting to take a cut on the alternate content fees AIXD receives. Finally in discussing the subject of alternate content it is important to remember one thing, to date this content has not proven the bonanza that exhibitors had hoped for in filling up their seats during off-hours. Noteworthy, AIXD’s major exhibitor partner Carmike has stated that alternate content has been somewhat disappointing and that they are in the process of seeking new content providers. Thus, the bottom line is that there is not a lot of evidence to get too excited at this point about the future prospects for The Bigger Picture as a major explosive growth story.
THE SHARE PRICE CURRENTY ACCORDS A HUGE VALUE PREMIUM TO AIXD’S DIGITAL DEPLOYMENT BUSINESS THAT IS UNWARRENTED: So, given the uncertainty regarding AIXD’s new businesses, what is its core digital deployment business worth? By my calculations investors are paying an egregious sum for this business. Unfortunately, trying to value AIXD’s various businesses is difficult because management has refused until now to provide any segment breakdowns and has not even provided any pro forma historic results for any of its recent acquisitions. Thus, in my analysis of what investors are paying for this business I took the company’s EV and backed out the cost of some of their past acquisitions (including: Hollywood Software, Boeing, Pavilion, PLX Systems, Ezzi.net, Unique Screen Media and The Bigger Picture). I then bumped up the value of all but the last two at a 50% premium to their acquisition cost. I did this for conservative reasons despite my belief that some offer little if any growth and questionable value to the story. In regard to the USM and The Bigger Picture acquisitions I assumed that each company is already worth 2x their recent acquisition prices given that the AIXD umbrella provides a greater revenue opportunity. I did not factor any real value for the company’s hosting business given management’s recent failure to consummate its sale and its sharply declining sales. Subtracting the sum of these acquisitions from the current EV shows a valuation of about $285 million for the remaining digital deployment business.
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Valuation Of AIXD's Digital Deployment Business |
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Acquisition |
Est. Current |
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Price |
Valuation |
Premium |
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Acquired Businesses* |
$17,550 |
$26,325 |
50% |
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Unique Screen Media |
$16,400 |
$32,800 |
100% |
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The Bigger Picture |
$4,300 |
$8,600 |
100% |
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Total |
$38,250 |
$67,725 |
77% |
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EV |
$361,400 |
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Acquired Businesses |
$67,725 |
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Digital Deployment Business |
$293,675 |
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Note: * Includes: Boeing, Pavilion, Hollywood Software, PLX Sys. & Ezzi.net |
Thus, using the annual CF from all 4,000 screens of about $5.34 million shows that at about $294 million this business is being valued at a multiple of 55x phase 1 cash flow. I would submit that with mediocre ROI characteristics and the average company selling at 7-8x FC, this valuation significant overvalues this business. One might point out that my analysis does not consider the potential CF’s from phase 2. While I agree that there may be some “real option” premium from phase 2, the economics associated with this plan will be even less attractive than phase 1 and there are major questions as to who the exhibitors will be that sign on to the AIXD plan given the competition from DCIP (and its 14,000 screens) and Technicolor in the US and new competitors like Arts Alliance Media in international markets. However, let’s assume that my calculations are wrong and/or AIXD can find additional revenue streams to raise its ROI up to the 15% cap that Hollywood studios are now discussing. If I value AIXD’s digital deployment business at a healthy 15x CF (or double the average market company) and account for the company’s large debt position in calculating its EV, the adjusted market capitalization shows that the stock should sell at roughly $3.50 per share. This is my estimate of fair value for the stock for investors who believe that AIXD’s management can successfully raise the returns in its digital deployment business.
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AIXD Share Price Valuation |
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AIXD Equity Component |
$17,000 |
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ROI @ 15% |
$2,550 |
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ROI @ 4,000 screens |
$10,200 |
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Deployment Business @ 15x CF |
$153,000 |
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Premium value of Acq. Businesses |
$67,725 |
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Total EV |
$220,725 |
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Debt |
($166,700) |
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Cash |
$29,400 |
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Adj. Mkt. Cap. |
$83,425 |
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Shares Out. |
24,363 |
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Share Price |
$3.42 |
A PATTERN OF RECENT WEAK FINANCIAL PERFORMANCE AND EXCUSES: Noteworthy, quarterly results over the last few periods have been disappointing, with most analysts increasing their forecasted losses (and making excuses for the results). The Q4 FY07 (March) results reported 6/20 were no different. Relative to analyst expectations the Q4 loss was significantly more than expected and the guidance for the current year was short of forecasts. While sales were above expectations, the upside was due to the addition of sales from recent acquisitions and the inclusion of the previously discontinued hosting business (not stronger core business). With consensus estimates calling for a loss of $0.24, the reported number was a loss of $0.47 (including a loss of $0.10 from these previously discontinued operations). In addition, while not unexpected, debt grew notably and the company continued to burn significant amounts of cash.
One of the major reasons that the company continues to remain unprofitable and why the loss was greater than analysts had forecast was the huge growth in depreciation. Management makes the case (repeated by the analysts who follow the company) that investors should look at an “adjusted EBITDA” number to gauge their progress and that depreciation doesn’t matter because it is not a cash charge. Wow, this brings back memories of how valuations were justified during the internet bubble! I thought we learned a lesson from that period! Also, I’m reminded of Warren Buffet’s comments that cap-x and depreciation are the worst kind of expenses because the cash flows out immediately and are only expensed later. I would add in the case of AIXD it is unclear of the future revenue and stream of profits tied to those cash outflows. Moreover, as this company’s business model is centered on deriving a revenue stream from these assets (digital projectors), how can anyone logically make the case that investors should just forget about the financial cost of owning these assets? That would be like someone saying that in the case of Microsoft, R&D expenses should be eliminated from any profitability analysis. Finally, I would remind readers that a basic premise of financial analysis is that EBITDA is not a good benchmark for capital intensive businesses like AIXD.
THE CASH INCINERATOR WILL NEED TO RAISE MORE EXPENSIVE CASH TO BURN: As previously stated, during the last 24-36 months the company has burned through an enormous amount of cash, which has recently accelerated commensurate with the increase in installations. By my calculations the company burned about $39 million in cash in FY06 (March) and about $149 million in FY07. Looking out to this year, if the company completes its goal of installing 4,000 screens by October 2007 my model (assuming about 500 instillations on average per month) shows the company burning an additional $125 million this year. Management’s guidance for FY08 is for revenues of $82-90 million and adjusted EBITDA of $30-36 million, which is not based upon achieving the 4,000 screen goal, but only the commitments they have in hand. Assuming they reach the 4,000 goal and assuming a healthy increase in margins, my model shows: revenues of about $102 million, adjusted EBITDA of about $41 million, a net loss of about $17 million and a loss of $0.70 per share. Clearly if management stops new installations after phase 1 is completed in October, the cash burn would be less. However, that would likely be viewed very negatively by even the bulls, given the recent phase 2 hype.
With only $29.4 million in cash and remaining $53 million remaining on its $217 million GE credit facility as of March, the company will have to raise significant cash to fund its installation plans. Under the terms of the GE credit facility AIXD will have to fund 30% of the equipment cost, I estimate that AIXD will have to raise at least an additional $60 million this year, translating into huge dilution for shareholders. Note in the last 24 months the share count has risen about 2.3x and 3.2x over the last 36 months, despite the addition of a huge amount of debt (the debt/equity ratio was 184% last quarter). Management has stated that they will not be funding this future growth in the equity market and are evaluating alternatives in the debt markets. While some investors may welcome the news that the company does not intend on printing any more dilutive shares in the future, I would caution that: 1) terms in the overall credit markets have turned very unfavorable lately and 2) the recent history shows that the cost of debt for the company is far from attractive. Regarding the $217 million GE Credit loan facility, the interest rate is 400-450 basis points above LIBOR, which is also not cheap. But maybe most telling is that on top of this rate, GE Credit will only fund 70% of the cost of each installation, which leaves them with a lot of margin to resell the assets off in a worst case scenario. Moreover, the terms of the company’s last debt deal in October 2006 were even less attractive. While the press release suggested the company was raising $22 million in a private placement at an 8.5% rate, reading the fine print of the 8-K filing and considering the impact of the “kicker shares” raised the cost of the debt to a whopping 17% rate! I believe the terms that debt holders are requiring from the company is very revealing. The interesting question from this is if the story for Access IT is as strong as management projects to investors, why are very sophisticated investors demanding these aggressive terms to loan the company money?
Disclosure: The comments on this stock, and any other I discuss with VIC members on this site, represent my own opinion on the stock which are based on my own analysis and independent research from multiple sources that I believe are reliable. In keeping with the spirit of the club, I suggest others should do their own research before making any investment decisions and welcome any feedback or opinions from other VIC members. Consistent with my investment opinion, my firm has had and may continue to have a short position in the shares of AIXD.
Catalyst
• Continued losses and significant cash burn.
• The need for dilutive financing.
• Competitive actions.