Description

Note: Mondo TV reports in Euros (€), but often does dealings in US Dollars ($).

Mondo TV (MTV) is an Italian microcap content producer that is significantly under-monetized and has a massive growth runway ahead. Mondo’s primary business involves the production and subsequent licensing/distribution of low-cost children’s animation content. With the proliferation of various over-the-top (OTT) and pay-TV outlets to consume content, we think Mondo offers unique exposure to an extremely high growth opportunity at an exceedingly reasonable valuation.

History

Mondo TV was founded in 1985 as a producer and licensor of animated cartoons and television shows across Europe. In the early 2000s, Mondo shifted its business to de-emphasize content creation and licensing, and instead focus on the physical distribution of VHS and DVDs. As a leading operator in the Italian DVD market, this business grew rapidly through the early 2000s, but quickly crashed as DVDs fell out of favor. In the face of mounting losses and declining revenue, Mondo Home Video was sold to its business manager in 2008.

MTV has operated in its current form since 2008, which resembles its legacy business model of producing and licensing animated cartoons globally. MTV has undergone rapid growth since its transformation in 2008, increasing revenue from €4.6m to €31.2m and increasing EBITDA from (€0.8m) to 21.2m today.

Business

Content production is typically a very poor business to be in. Production requires heavy investment upfront without any guarantee that revenues (let alone profits) will follow. Furthermore, even if you end up producing a hit, the talent (actors, actresses, writers) will demand more and more compensation, limiting the value that can be derived even in a best case scenario. We usually try to avoid businesses like these. However, MTV has unique characteristics that make it attractive:

·         Low-cost, commoditized production expense

o   MTV focuses the vast majority of their efforts on creating the story board and executive design of productions, while outsourcing the actual animation and editing to Chinese studios. This significantly reduces costs for Mondo (e.g. MTV’s production costs average ~$2-3m USD per season vs ~$3m per episode average for cable TV). Furthermore, MTV works with several distinct Chinese partners. By doing so, MTV essentially commoditizes production, and makes any individual partner dispensable.  

·         Pre-licensing rights

o   MTV incurs very little principal risk in funding its TV shows. MTV does this by pre-licensing the distribution rights to shows concurrently with its production negotiations. These pre-licensing sales often cover substantially all of the production costs for MTV, while MTV typically retains significant global TV rights, as well as merchandising rights. For example, in May of 2016, MTV signed a production agreement for two animated shows costing $12m, and subsequently sold 50% of distribution rights and responsibility over distribution to New Information Tech for $10m. For NIT to break even on this deal ($20m sales), MTV stands to net $8m of profit ($10m from NIT, $10m from 50% rights), completely risk-free. This contract essentially guarantees that Mondo cannot lose money on this production!

·         Merchandising rights

o   Mondo TV has historically focused on licensing the video rights of their content, but in the last few years has emphasized the merchandising and toy rights of their productions. Management has spoken of a desire to create productions with distinct opportunities in merchandising, and recent productions (Heidi Benvenida, YooHoo & Friends, etc.) have clear merchandising/toy potential. Mondo launched Mondo Toys in 2016 and has thus far been focused on “market research”. We believe that just 2 employees work in this Toys segment, so the ramp may be slow but incremental margin will be near 100%.

Investment Thesis

1. MTV has very strong unit economics

As discussed above, Mondo’s business has very attractive unit economics. It is difficult for MTV to lose money on any single production and Mondo generates a substantial ROI by intelligently pre-selling distribution rights. To demonstrate we offer a few examples of production agreements from 2016:

-          “Final Fight” and “Naraka”

o   Cost: $12m for 2 seasons of 2 shows

o   Pre-sell revenues: $10m for 50% exploitation rights and responsibility for distribution in China

o   Net profit at distributor breakeven: $8m (67% return on investment)

-          Studio 56 animation projects (3)

o   Cost: $18.5m for production of 3 seasons of 3 shows

o   Pre-sell Revenues: $14.4m received for 50% of exploitation rights and responsibility for distribution in China/India

o   Net profit at distributor breakeven: $10.3m (56% return on investment)

-          Henan York animation projects (3), including “Sissi the Young Empress”

o   Cost: $24m for production of 3 seasons of 3 shows

o   Pre-sell Revenues: $19.9m for 70% exploitation rights in China, 10% ROW and responsibility for distribution in China

o   Other Revenues: Undisclosed licensing and Merchandising deals closed in Austria, Italy, Greece, Mexico

o   Net profit at distributor breakeven: $4.4+m (18.4+% return on investment) – assuming nothing from ROW

Note: The above are only revenue streams signed within CY16, and many more ROW deals have been/will be signed moving forward (see below).

As can be seen, the returns on the above deals are very high, even without supplemental licensing/merchandising opportunities outside of China.

2. Secular Growth in Children’s Content

 There has never been a better time to be a content producer than today. The tech giants, Amazon, Apple, Facebook and Netflix are investing a collective $12bn/year into content investments. The traditional media players Disney, Fox, Timewarner, CBS, etc. have continued to see their content costs increase high single digits or low double digits each year. Local players, such as Foxtel in Australia, Televisa in Mexico, TVB in Hong Kong have debuted their own streaming platforms in order to compete with Netflix.

Today 96% of North American households are streaming-enabled, and the EU is not far behind at 74%. Children are voracious consumers of animation and cartoons. And for good reason – we’ve all seen tired parents sit their kids in front of an iPad and turn something on in order to get some quiet time. At DHX Media’s Wildbrain, a kid-oriented streaming show, total watch time has increased at a 107% CAGR since 2013. Globally, there is a proliferation of digital platforms that need content in order to fill out their service. Disney has said that they will add 5 exclusive TV shows and several original movies per year to their Disney-branded streaming service, but not all players (especially not the local ones) have the capacity or finances to achieve this.

 This is precisely where Mondo TV comes in. Local language content is crucial to fending off Netflix, as Netflix’s penetration rate is far lower in low English-speaking countries. MTV’s animation is very easily dubbed into local language, and they’ve historically dubbed much of their library into local languages across Europe. With its lean production costs Mondo’s content doesn’t have to be  expensive to local buyers – it can be licensed for far below the cost of producing an original show, and would represent a win-win for all parties involved.

 We can already see this strategy playing out. Partnerships announced so far in 2017 range from the US to Kuwait to Korea (no financial terms announced):

-          Netflix

-          Nintendo

-          Amazon

-          Riverdrop (Greece)

-          CJ E&M (Korea)

-          Ravensburger (Italy)

-          Discovery Channel Middle East

-          Nickolodeon Latin America

-          PT Falcon (Indonesia)

-          Lux Communication (Slovakia)

-          Eva Air (Taiwan)

-          Yes Kidz (Israel)

-          Safe Media (Palestine)

-          Media Relation Company (Kuwait)

-          Ginger HD,Relato LLC, Rustavi2 (Russia)

3. Historical Under-Monetization

 MTV has been historically undermanaged. It is a family-run business, and founder Orlando Corradi made some questionable business decisions surrounding home video in the 2000s. The shift in focus de-emphasized creating and licensing content and has had lasting effects even until today. Current CEO Matteo Corradi took over from his father in 2012, and has so far done much better to monetize the strong assets of the company.   

-          Heavy hiring: In 2009 MTV had just 15 employees. Today that number is 36. The hiring has been heavily concentrated in licensing salespeople and storyboard writers. The results are striking. Investment in new productions has tripled since 2013 as Mondo has had more stories to execute on. New licensing hires have moved quickly to expand revenue opportunities abroad. MTV had historically been highly concentrated in Europe (~85+% of sales to Europe), but licensing hires focused on Asia have brought that figure down to 25%, as Asian revenue streams have exploded to ~80% of revenue.

-          Classic library: Over Mondo’s 30+ year history, Mondo has developed a “classic library” of about 1600 episodes of shows that are no longer in production. Mondo has curiously avoided aggressively monetizing this asset until recently, perhaps because they were understaffed. In 2015, MTV reached an $18m deal over 3 years (vs €28m revenue in FY16) for the classic library in China. This is a massive deal relative to MTV’s size, and proves the huge opportunity. In 2017 Mondo agreed to a licensing deal with Amazon in the US, UK, Germany and Japan also for a portion of their classic library (terms undisclosed). These revenues represent pure profit with no investment associated with them, and Mondo should find many more lucrative opportunities like these now that they are actively looking. As Mondo makes this more of a priority, and as their classic library grows larger, this could be a €30+m/year opportunity by 2021.  

-          Merchandising:  Finally, management attention has recently shifted towards merchandising, which should be another lucrative opportunity moving forward. Mondo is largely still in “market research” mode, according to management, but a few smaller deals have been made in 2017, including stickers for “Yoohoo & Friends” and 3D figurines for “Sissi.” For reference, DHX Media generates 40+% of revenue from merchandising, while Mondo earns next to nothing from this stream today. Opportunity: €25m/year by 2021.

Valuation

Mondo TV currently trades at 8.5x LTM EBITDA, or 17.5x our estimate of LTM maintenance unlevered FCF. Maintenance FCF = Net Income + D&A – Capex on Revenue Generating Productions. We think it is far too cheap given where other children’s content companies trade today.  DHX Media (10x Fwd EBITDA, 20x Fwd FCF) and Entertainment One (9x Fwd EBITDA, 32x Fwd FCF) may have more well-known properties (Peanuts, Strawberry Shortcake, My Little Pony), but have far fewer organic growth opportunities. At least an equal multiple is warranted for MTV.

All told, management has put out very aggressive long-term guidance for MTV. Management hopes to increase revenues from ~€30m in FY16 to ~€84m by 2021. EBITDA is projected to go from €18m (62% margin) in 2016 to €64m (75% margin) by 2021.

We think the revenue growth is achievable, as this business is highly scalable, and investment in content has tripled over 3 years (revenue lags 1-2 years behind contend spend). What management proposes is not crazy either – global “over-the-top” TV & video revenue is projected to nearly double from $37bn today to $65bn in 2021, and hitting guidance suggests only a small uptick in market share, after considering merchandising opportunities. However, to be conservative we haircut 2021 revenue by 25%. We think the margin growth is achievable as MTV moves to license and merchandise more aggressively. Content companies DHX Media and Entertainment One boast similar 60+% margins with much fatter cost structures. Again, though, to be conservative we maintain margin at today’s margin. For reference, past long-term guidances have tended to be slightly optimistic (though usually less than 10% off).

Using these figures we arrive at 2021 Revenue of €63m and EBITDA of €39m. Applying peer EBITDA multiples of children-focused content owners Entertainment One and DHX Media (~10x), gives a share price of $12.90 in 2020. This represents more than a double (2.2x multiple of money), or a 27% annual return over 3.2 years. 

Why does this opportunity exist?/Risks

Micro-Cap, Italian exchange

MTV is a €180m market cap company trading on the Italian exchange, making it easy to understand how it has been overlooked thus far. MTV’s Investor Relations website also leaves much to be desired in terms of navigability and English filings.

 Poor Cash Flow so Far

MTV has not been as FCF generative as its EBITDA would suggest. While MTV has been cash flow positive on a CFO basis, it has been negative on an unadjusted FCF basis. While this is obviously not a positive MTV, it is certainly understandable because of their rapid growth. Each year Mondo invests more and more into its content library, but does not actually derive revenue/cash flows from this investment until the production airs 1-2 years later. Thus, for a company undergoing 37% CAGR from 2013-2016 in content investment, investment in content will be larger than backwards looking amortization and FCF will necessarily lag behind accounting earnings. However, in a steady state, where amortization ≃ content investment, FCF ≃ NI. This “problem” should rectify itself as MTV’s growth slows.

 Another recent drag on cash flows has been an inability for MTV to collect on receivables from distributors in a timely fashion. ~15% of their receivables are past due by 12 months (although they are mostly covered by allowance for doubtful debt). However, management is working to address this situation. Nearly 25% of receivables for 2015 were past due by more than 12 months (~100% covered by allowance), so 15% in 2016 represents a significant improvement. Further, a more reputable client base (Amazon, Nintendo, Discovery Middle East) should make this less of a problem moving forward.

 Family Ownership

The founder, Orlando Corradi owns 45% of MTV. His son (Matteo) has been CEO since 2012, with Orlando as Chairman, while daughter (Monica), is a board member. Their total compensation is quite fair, though, as the 3 earn a combined €362,000 EUR, which is not egregious. No stock options are given, although management is significantly aligned through their significant ownership. Further, there is no dual-class share structure.

 Capital Structure

In order to finance MTV’s rapid growth, in 2016 MTV entered into financing deals with Atlas Capital Markets and GEM Investments that provided some convertible bonds. Most of these bonds have already been converted at a 2% discount, which we view as a positive sign. As part of these deals the firms were also given warrants that could add up ~10% share dilution, but they are only in the money between €6.50 (30% return) and €10.00 (100% return), which we view as acceptable.

Major Sources:

Mondo TV Filings

DHX Media Filings/Investor Presentations

Entertainment One Filings/Investor Presentations

Boston Consulting Group’s “The Value of Content”, March 2016

Factset Consensus Estimates

SNL Kagan Netflix country-by-country subscriber estimates

Catalyst

Higher profile content deals (see price move on day of Netflix deal)

Free cash flow equalizing with Net Income