Description

Cinar is a developer, producer and distributor of animated childrens programming and educational products. I believe a sale process, led by Merrill Lynch, is close to fruition with values in the $7-$8 range ($4.50 for a tape library, $2.50 for an education business and $0.50 for additional net assets). The stock current trades in the $4 range as a bulletin board stock in the U.S. and has been delisted in Canada.

Background

Founded by Ron Weinberg and Micheline Charest (husband and wife), Montreal-based Cinar is focused on childrens entertainment and education. Fueled by the success of programs including the Emmy-winning Arthur series, the company went public in 1993 and by 1998 revenue had reached $97mm (all figures in U.S.$), more than double the $42mm revenue recorded in 1996. By the fall of 1999, Cinar's stock price peaked at $30 a share – an almost four times increase from late 1995 levels. The company’s stellar track record began to unravel in October 1999 when Cinar announced it was under investigation for federal tax fraud. The charges focused on the company’s submission of Canadian programming scripts for federal tax credit under Canadian tax code that were alleged to have been written by Americans. As an internal audit soon revealed, Cinar’s tax improprieties were the tip of the iceberg. Most troubling was the unauthorized investment of $118mm of company funds in an offshore hedge fund called Norshield Investments (www.norshield.com), and an affiliated vehicle called Globe-X located in the Bahamas. To date, $62mm of these funds have been recovered and while there is a plan in place to recover the balance of the funds, Globe-X has missed payments or made payments less than those stated in the repayment agreement.

The detailed audit also revealed the company’s founders and CFO, Hasanain Panju, had effectively used company’s funds for their own personal benefit. The allegations are detailed in a $19mm suit filed by Cinar in late January 2001 and include, among other things, home renovations, payment of salaries to relatives unaffiliated with the company, private school tuition for their children, payments for gardeners and housekeepers, home rentals and home purchases. Charest, Weinberg, and Panju were fired (although Charest and Weinberg have refused to give up their board seats and continue to hold approximately 5mm shares, and maintain voting control through their ownership of Class A shares) and a new CEO, Barrie Usher, was brought in to run the company. In August, 2000 the company hired Merrill Lynch as an advisor to explore strategic alternatives to maximize shareholder value. Cinar hasn’t reported audited numbers since the emergence of the scandal, however there are compelling reasons to believe we are nearing the end of the company’s attempt to maximize value and that the values realized will significantly exceed Cinar’s current price.

One major impediment, in addition to the obvious lack of audited financials, to a sale was resolution of the tax issue. In late 2000, Cinar reached agreements with both the Canada Customs and Revenue Agency and the Quebec taxation authorities to relinquish all claims, make full restitution for improper claims and recognize new liabilities totaling (in aggregate) $18mm, or approximately $0.44 a share. Secondly, the licensing rights to Cinar’s tape library of 2,074 half hour shows of childrens programming (including Arthur, The Busy World of Richard Scary, Are you Afraid of the Dark, Wimzie’s House, Lassie, Caillou and Zoboomafoo) proved to be much more complicated than originally anticipated. However, it has been widely reported in the Canadian press that Merrill Lynch’s sale books are believed to have generated a significant amount of interest from both Canadian and international media companies.

Valuation

The most significant component of Cinar’s asset valuation is found in its’ tape library. Using three comparable tape library sale transactions - April 01’ Hallmark Entertainment/Crown Media; Oct. 91’ Hanna-Barbara/Turner-Apollo; and the Nov. 00’ Nelvana/Corus Entertainment) results in average values per half hour episode in the $125,000 range (with an adjustment for the Nelvana deal where Chorus paid a significant premium for radio station rights). Applying a 30% discount to that value for the uncertainty associated with Cinar’s licensing rights values the tape library at approximately $4.50 a shares (on 41mm shares). I attended the annual Licensing Show last month at the Jacob Javits Center in New York where one of Cinar’s Canadian competitors was presenting – Nelvana (purchased by Corus in November). A Nelvana representative told me Nelvana had recently completed their own audit of the Cinar library and implied they were clearly interested in Cinar’s assets.

To put Arthur (for those of you without children like me who had never heard of Arthur) in perspective – Arthur received its 3rd Emmy for “Best Children’s Animated Programming” in 2001, has been the #1 TV program for ages 2-5 and 2-11 for 10 consecutive quarters with 16mm current weekly viewers. Internationally, Arthur is broadcast in 60 countries and is one of only two children’s programs in the U.K. airing five days a week on the BBC and, finally, Sony’s Wonder Division sold 7mm Arthur videos last year.

Despite the turmoil and disruption associated with the aftermath of the 1999 audit, production continues at Cinar’s entertainment segment. During 2000, the company produced 226 half-hours of programming and, most significantly, even after losing access to its banks credit lines (announced in its March 01’ shareholder update), the company continues to maintain a production commitment of 121 half-hours in 2001 (72 rollovers from 2000 and 49 new half-hour episodes). These production levels are particularly impressive given that they were achieved outside of Cinar’s traditional Canadian business base. Due to the tax fraud charges the company’s funding and certification was suspended by Telefilm Canada, implying that current productions are being funded with internally generated cash.

Additionally, Cinar operates an education business that, based on the unaudited financials reported on 7/26/01, I believe conservatively generates $20mm of annual EBITDA (notably, reported revenue jumped $10mm sequentially to $19mm in the 2nd quarter of 01’ over the 1rst quarter of 01’). Applying an EBITDA multiple in the 5x range results in $2.50 in value per share. Also, the company controls a 20% stake in Teletune, a Canadian animation vehicle that is worth another $0.50 to $0.80 per share.

For a stock that trades in the $4.00 range I believe values are conservatively in the mid $7 range. And I’m assuming you never see any of the remaining cash invested at Norshield (an additional $1.00 per share) or any recovery from the former management (an additional $0.50 at full value of the pending suit). The home run scenario for Cinar is that a major international media player or Canadian entity bids for the entire company. When Nelvana was sold it was reported that Viacom was interested in Nelvana for its Nickelodeon cable channel (Nelvana's shows Maggie and the Ferocious Beast and Franklin were among the top shows on Nickelodeon Jr., the channels pre-school programming block). Notably, Viacom and Cinar maintain a licensing alliance with respect to the Richard Scary show. Furthermore, Vivendi has co-produced four shows with Cinar. However, there is also a scenario where piecemeal assets are sold and you’re left with pile of cash and shareholder suits that take some period of time to resolve. I believe the risk/reward is worthwhile in either outcome and that buyers of the stock below $4 will ultimately realize the true value of these assets.

Catalyst

nearing the end of a sale process, led by Merrill Lynch - values are in the $7-$8 range ($4.50 for a tape library, $2.50 for an education business and $0.50 for additional net assets). The stock current trades under $4 as a bulletin board stock in the U.S. and has been delisted in Canada.