Description

New Frontier Media, Inc. ("NOOF" or the "Company") is a microcap provider of adult-oriented programming.  The Company provides its product to most of the large MSOs and satellite television operators.  The Company dominates the pay-per-view and video-on-demand adult entertainment categories (the company refers to these services as its Transactional TV segment).  Today, you can purchase NOOF in the public markets at roughly 3x earnings, net of its cash, and in the process get free options on a couple of interesting growth projects.

Historically, the Company's Transactional TV segment has seen its primary competition from Playboy's Entertainment division.  NOOF and Playboy have been duking it out for years over carriage and channel availability on the major multichannel television provider ("MTP") platforms, and NOOF has been consistently winning this battle.  The MTPs have moved consistently towards more explicit fare over the last decade, and this shift has favored NOOF given its ability to provide a much broader range of product than Playboy.  Buy rates by end consumers/viewers on NOOF product tend to be well in excess of Playboy's and, often, NOOF gives the MTPs more favorable revenue share agreements than Playboy.  As a result, the economics of the NOOF relationship tend to be much more profitable for the MTPs than the Playboy relationship. 

Television-based adult entertainment has also seen competitive pressures from the Internet in recent years.  Despite this, buy rates have remained relatively consistent and digital real estate related to adult entertainment tends to be some of the most lucrative for the MTPs.  As such, MTPs have been devoting increasing amounts of their bandwidth to adult-themed entertainment.  NOOF has also seen pressure in recent years during periods of renegotiation for the carriage agreements with the MTPs.  Due to relatively heavy customer concentration, the big MSOs and satellite providers know that they have significant negotiating leverage with NOOF and they work aggressively to improve their share of the take during negotiations on new contracts.  This has driven a decline in NOOF's EBITDA margins over the last few years from the mid-40s to the mid-30s (still very healthy, by any sort of absolute standards).  NOOF is now in a period of relative stability, given that it has renegotiated all of its primary carriage agreements within the last few years.

Several years ago, NOOF purchase a production studio (MRG Entertainment) which now constitutes its Film Production segment.  The Film Production segment has longstanding relationships with a number of networks, including Cinemax, Showtime, and Starz!.  The Film Production segment focuses on more mainstream content than NOOF's traditional product, and the acquisition was intended to diversify NOOF away from its historical focus on solely adult-oriented content.  Results for MRG have been lumpy and, in general, mediocre due in part to the weak economic environment's effect on filmed entertainment.

The domestic adult entertainment industry grows at 5%+.  Historically, the top line has been somewhat recession resistant.  NOOF has been focused almost exclusively on the domestic market for its history, but this is changing.  Recently, NOOF signed its first two international carriage agreements (Mexico and Canada), and is working on additional locales.  To the extent they are successful in these endeavors the upside could be substantial as the inherent operating leverage in the model is tremendous.  As you might expect, adult-themed entertainment does not require much modification to be successful in new markets.  In addition, NOOF is currently beta-testing a direct-to-consumer product in Europe which provides product through a set-top box with Internet connectivity.  Expenditures related to this initiative have been running at $700-$800k/qtr and are being expensed as incurred.  This represents a 500-600bp hit to margins, obscuring the profitability of the underlying (legacy) businesses.

NOOF's core Transactional TV segment is healthy.  Margins have held steady in recent years and the Company continues to drive incremental penetration of its product.  After several years of revenue declines for this segment as a result of renegotiated carriage agreements with the MTPs, the top line is once again growing steadily.  The Company's consolidated financials have obscured this progress in the core business, though, due to recent spending on the direct-to-consumer initiative in Europe, as well as lumpiness in the Film Production segment operating results.  Management has committed to either fish or cut bait on the direct-to-consumer initiative by year-end, so the spend related to this initiative will either disappear or the top line will begin to show a benefit.  With respect to the Film Production unit, results in the next couple of quarters should be quite strong as the Company delivers a 13-episode series (and books the associated revenue/operating income) that has been in the works for some time.  Net-net, I believe that earnings surprises should be to the upside.

NOOF's balance sheet is strong, with roughly $11mm of net cash ($0.60/shr).  The Company has actively repurchased its own shares in recent years, reducing the shares outstanding by about 20%.  In November of 2008, the Company bought 2.6mm shrs @ $1.55/shr to take out its largest shareholder, Steel Partners.  Steel was a long-time shareholder and had, in the past, actually made overtures to take the Company private.  Like many other managers, though, Steel needed liquidity following a difficult year.

Today, at $1.30/shr, you buy NOOF at roughly 3x a depressed earnings number net of the Company's cash.  On an EV/EBITDA basis, NOOF trades at 1x.  It is a forgotten, microcap orphan.  This is obviously an attractive multiple for a stable/growing cash generative business that generates good returns on its invested capital.  The Company's growth initiatives are icing on the cake.

Catalyst

Upside earnings surprises, underlying profitability of Transaction TV becomes apparent as direct-to-consumer initiative spending slows, Production segment gets new orders for series