Description
OVERVIEW: The shares of BTN may be interesting to VIC members due to the following characteristics: a market share leader with reasonable entry barriers operating in an industry with a growth kicker on the horizon, a repositioned product offering to capitalize on the industry transition to digital, a proven management team that is shareholder friendly, a good business with a 13-14% ROIC, a FCF story with a rapidly growing cash position which is now one-third of market capitalization, and a valuation of only about 7x 2006 EBITDA with a EV/FCF yield of 13-14%. I submit that BTN is the type of name value investors should be attracted to due to its underlying characteristics of being a pretty good business from a return on capital perspective while being valued at an attractive price on an EBITDA and FCF yield basis. Noteworthy, I believe this combination should appeal to value investors who buy into the theory articulated in a certain little blue book on investing that has recently been released! I originally wrote BTN up on 12/9/04 and provided a number of updates in the interim, which should provide a fair amount of background information for VIC members new to the company/stock. I think it is timely to re-visit the idea because the shares are about at the same level as when I originally posted the idea. However since that time a number of things have occurred that: make the shares more attractive, provide clarity on the major issue that has been clouding the shares and increase the company’s financial strength. Moreover an important near-term catalyst for the stock is on the horizon. While not evident in the share price, during the last year the company has posted strong results from a sales growth, earnings and FCF perspective that have exceeded the forecasts in my original write-up. Moreover, the company has put a number of strategic elements in place relative to the transition in the movie industry to digital that I believe will ensure the company’s solid position when exhibitors begin to transition to this new technology. After a period of putting a number of the pieces in place on this strategic plan, I believe that the beginning of a revenue stream from digital sales in mid-year should be the catalyst to get the shares moving higher. In addition with management now prepared to take a more proactive role in meeting with investors, I believe this will also help some of the underlying value in the shares to become evident to investors. Thus, I believe the shares could be valued at about the $7 per share level based upon an EV/FCF multiple on 2006 results consistent with its ROIC or a multiple of about 11.5x 2006 EBITDA.
KEY STATISTICS:
Price: $4.40
52 Week Range: $3.50 - $5.16
Shares outstanding: 14.0M
Market Capitalization: $62M
Enterprise Value: $42M
Cash: $19.6M ($1.40 per share)
Total Debt: Nil.
Tangible Book Value: $2.57
ROIC: 13%-14%
C05/06E Sales:$53.9M/$57.2M
C05/06E EBITDA: $7.6M/$8.5M (+12% growth)
C05/06E GAAP EPS: $0.32/$0.34
NTM FCF $5.5-$6.0M (13%-15% EV/FCF yield)
BTN’s 35mm BUSINESS IS HEALTHY WITH A LONG TAIL LIKELY: First I believe it’s important to address the major issue surrounding the shares: the health of its traditional 35mm film projector business. Despite all of the well publicized issues concerning the slump in box office ticket sales, growth in sales of the company’s traditional 35mm film projector business to exhibitors in both the US & international markets has remained very healthy (and exceeded my estimate), with sales in the 2005 year rising at above trend line level of about 15% (excluding the impact of a special one-time $2.1M sale in 2004) versus a very strong 2004 year. As I have pointed out previously, BTN’s sales have not been dependent on attendance/box office receipts. Note, box office attendance has been declining for the past 50 years or more since the advent of television. Indications from both the company as well as contacts in the industry indicate that order rates in the first half of the year continue to look reasonably healthy. To try to be conservative, I have modeled growth of about 6% this year, which would be more consistent with the traditional level of mid single digit growth in the industry. This growth is being fueled by traditional theater upgrade programs and some growth in locations among BTN’s major domestic theater chains coupled with more opportunities for new expansion among its international customers. While I will discuss the impact of the transition to digital later, my read on the 35mm projector business is that it will have a pretty long multi-year tail as the industry transitions to digital in a slow measured pace and that there are certain exhibitors that will have little interest in being anywhere else but at the trailing edge of this transition for economic reasons. In international markets the transition could take even longer. Thus, while some investors may fear that the company’s current business in going away, I suspect that this will take a number of years to occur and that the on-going cash flows from this business will be quite healthy over this period. Noteworthy, the senior executive in charge of digital for 20th Century Fox (who is an advocate for the transition to digital) recently speculated in the press that the conversion to digital in the US will take about six to eight years to complete.
A SLOW TRANSITION TO DIGITAL IS A BEST OF BOTH WORLDS SCENARIO: While the transition to digital has been hyped by some companies with self serving interests as at the point of exploding on the market, the reality is a lot different. The transition to digital has been talked about as being imminent for the last 5-8 years and I believe it’s fair to say that the industry is still in the discovery/evaluation stage. For example, the July 2005 announcement of a set of standards from the industry workgroup, Digital Cinema Initiatives (DCI), was hailed as a major milepost in the move forward on the path to digital transition. This announcement was the motivation behind the move to establish financing/business plans from one very aggressive company in this space (followed by others) and the signing of a number of major studios (and a small number of exhibitors) to embrace/test this technology. However, as it stands today, the DCI standards are still not really finalized, their has been only a relatively few major films released in digital (only three in the 2006 year so far) and most of the major exhibitors are now speaking about not rushing into anything with 2006 being a year of testing when the standards are finally really completed. For example, the President of the National Association of Theater Owners (NATO), the primary industry trade organization for the exhibitors has publicly called for the need to extensively test these systems in the field for an extended period before any major roll-out. In addition, as I previously mentioned certain limitations on producing key components for these systems will also stretch out any transition. This sentiment is shared by industry stalwart Technicolor, who despite announcing its own digital financing/transition plan (and signed a major theater chain as a customer) has talked about the need to wait for standards to be completed, equipment to be compliant and a period of testing (likely to be all of 2006), before rolling out the technology. This said, I still believe it is not a question of “if” the industry will transition to digital, but “when” this will occur. The point here is that a slow transition to digital would be the best of both worlds for BTN because the company offers both technologies and unlike its major competitor (Christie) does not appear to be trying to push its customers to digital projectors before they are ready.
BTN’S STRATEGIC PLAN FOR DIGITAL IS UNFOLDING: In the past year BTN has been quietly putting together the pieces on its strategic plan to be a major beneficiary of the move to digital among its customers. This low public profile, which is commensurate with managements conservative nature, probably has worked against the stock and contrasts the approach that certain other companies in the industry have taken to hype every little thing they have done. A key element of BTN’s strategy was the May 2005 partnership with NEC (one of the three licensees to the Texas Instruments DLP technology) with exclusive rights to resell its digital projectors in certain geographic markets. Of the choices available, NEC appears to be a very good partner for BTN in that: they provide a complete end to end solution (enabling them to differentiate themselves from the other competitors and generate a higher ASP), don’t have a direct sales force to compete with BTN in the US, have scale advantages relative to their position in the server market, and may offer additional opportunities for the company in the future. While the current agreement is structured similar to a distribution agreement, I would not be surprised if in the future BTN were to find some additional value added (margin enhancement) opportunities. In addition to this, BTN is putting the final touches on a program to repurchase 35mm projectors from its customers to give them the flexibility to put them back to the company (to be resold in certain international markets) and move to digital projectors when they are ready. This should help smooth any potential sales transition issues in the future. Also, management has discussed buying/building its own service and support network in the near future to assist/supplement the in-house organizations of many exhibitor chains and help penetrate smaller organizations.
A FORTHCOMING STREAM OF DIGITAL REVENUES SHOULD BE A CATALYST TO THE STOCK: I believe that despite the company’s solid execution and strong cash flows, the major issue that has clouded the stock and held back its valuation has been the threat of the digital transition and that BTN could be left behind. I believe this issue is about to moderate in the mind of investors with the beginning of a stream of digital revenues showing in BTN’s financial results in the first half of this year. As such, I believe this will be a major inflection point in investment sentiment and a catalyst to the shares. I believe their digital revenues will come as a result of the company’s strategic partnership with NEC. Recently NEC’s digital projector was one of two products selected by Technicolor to be part of its upcoming beta test for Century Theaters. This beta test beginning in the first half of this year will entail the deployment of equipment for about 90-120 screens, with the intent to install systems in Century’s entire network of 1,000+ screens in the future. With BTN being party to this sale, the company should begin to see its first stream of revenues from this beta test. In addition, I understand that with the release of two new digital projectors from NEC last week at the ShoWest trade show, a number of BTN’s major exhibitor customers will begin selective tests of their own, which will also contribute to revenues. While I would not suggest that the initial revenue and profit impact from these sales will be huge, I believe the significance to investors will not be measured in their size, but in the statement that it sends, that BTN is well positioned to participate in the move to digital cinema.
A STRATEGIC MISTAKE BY BTN’S MAJOR COMPETITOR COULD CREATE AN OPPORTUNITY: BTN’s major competitor in the projector market, Christie Digital Systems (privately held), back in the Fall of 2005 signed a partnership with the financing division of Access Integrated Technologies (AIX) to be the exclusive supplier of projectors under their digital financing plan. In speaking with a number of people in the industry there seems to be some confusion as to why Christie locked themselves up with AIX, which could adversely impact their competitive position going forward. Notably, I understand that some of the other companies proposing competitive digital financing plans to AIX (i.e. Technicolor and National CineMedia) now don’t know how to view Christie. Are they friend or foe? This could shut Christie out of the role as the primary supplier of projectors under their plans and open up the door to BTN. Noteworthy, Christie was not one of the vendors that Technicolor selected as one of its equipment partners for its digital cinema beta test. In addition, I also understand that the pushback from many of the potential exhibitors that AIX would like to sign up is that they don’t like the fact that they do not have the freedom to choose what equipment/vendors they would like to install in their theaters. Finally the other push back from exhibitors is AIX’s shaky balance sheet and reputation as a new comer to the industry. What all this means is that I believe Christie’s alignment with AIX could prove a strategic mistake and translate into market share losses for Christie to BTN as the industry shifts to digital projectors.
A STRENGTHENED FINANCIAL POSITION & ATTRACTIVE VALUATION: From a financial perspective, during the last year BTN exceeded all my projections (i.e. sales, profits & FCF) and strengthened its financial position. In 2005 the company generated about $5.5M in FCF, reduced its inventory, increased its cash position by about 40% to close to $20M ($1.40 per share) and remained basically debt free ($43,000). Looking forward, I am estimating about a 12% increase in EBITDA this year and management has stated that FCF in 2006 could be up an additional $5.5M-$6.0M, which would put the cash at year end 2006 in the mid $20M range. As I pointed out in the opening paragraph, this level of profits and FCF make the shares very attractively priced to value investors. Selling on C06 estimates at an EV/FCF yield of 14%-15% and 7x EBITDA, I think this is attractive for a company with a RIOC of 13%-14%. In the current market environment, I don’t know of too many other companies offering investors the combination of a being a pretty good business from a return on investment perspective and an attractive valuation on EBITDA and FCF.
Given the company’s size, its cash has given BTN a healthy amount of financial flexibility. I believe that management has allowed cash to build to give them the capability to make a strategic acquisition which would aid in the company’s transition to digital. While I am not a big believer in companies making big acquisitions for the self serving ego boosting sake of growing the corporate sales base, I do think smaller targeted strategic acquisitions do make sense in certain cases. I know that this cash has not been burning a hole in management’s pockets, as they are taking their time to find the right fit that would enhance their digital strategy and, at the right price, would be accretive to the business model. Management has discussed building a service network (maybe part of which via an acquisition) as one possibility, which I think would make sense. Another possibility would be to manufacture something commensurate to their digital product push. Depending on the size of an acquisition, there could be an option in the future to also repurchase some shares or return some to shareholders.
Catalyst
-- The beginning of a revenue stream from digital sales.
-- Continued strong profits and FCF.
-- The announcement of partnerships with some of the digital financing entities.
-- Management taking a more active role in meeting with investors.