Description

Point.360 is a provider of a variety of advertising distribution, media post-production, reformatting, and archival services to clients in the advertising, television, and motion picture industries. Last posted on VIC by logan884 in March 2005, the stock has languished on a revenue decline as PTSX continues to exit lower-margin legacy businesses in favor of higher-demand areas. Now at four-year lows, it currently trades at extremely cheap levels of EV/EBITDA while experiencing heavy and consistent insider buying. As an important catalyst going forward, PTSX has recently completed adding significant new capacity for high-definition remastering services, a specialized higher-margin area that will enjoy growing rather than declining demand as government mandates increase HDTV market penetration over the next decade. For those who are interested by the attractive valuation but still hesitant on the overall business, PTSX’s extreme undervaluation compared to a publicly-traded competitor now creates an additional possibility for a long/short pair trade.

With a current market capitalization of under $17 million, an investment in PTSX shares represents an enterprise value to EBITDA ratio of just 3.42. While current sentiment is sharply negative and already prices in a large decline in EBITDA going forward, the presence of heavy insider buying coupled with improving future prospects in high-definition and digital services creates support for the contrarian thesis. In an important confirmation of the attractive valuation, Point.360 CEO Haig S. Bagerdjian has personally purchased nearly 500,000 PTSX shares over the past two year period, paying as much as $3.73. Adding to an already substantial position including 1.4 million shares bought directly from the outgoing former CEO during 2002, Bagerdjian now owns over a third of the company. As the largest shareholder, the CEO has expressed frustration at the low valuation, but has stated that he believes pricing compression is coming to an end and they are seeing the beginnings of margin expansion with growth in their high-definition mastering and distribution markets.

The closest comparable publicly-traded firm is DG Fastchannel (NASDAQ: DGIT), a small-cap advertising distribution firm serving newspaper and radio markets as well as television. DGIT is not a perfect comp due to its absence from the post-production and remastering markets, but its digital ad distribution activities are a close match to much of PTSX’s business, and its further involvement with the deeply troubled newspaper advertising market makes its premium valuation highly questionable. DGIT’s 2.11 price-to-sales ratio is nearly eight times Point.360’s P/S of 0.26, while its EV/EBITDA of 10.84 is over 2.5 times the PTSX ratio of 3.42. As logan884 pointed out, Bain Capital expressed interest in acquiring PTSX for $15 per share in 1999, and elimination of post-Sarbanes-Oxley public company costs at this microcap company would create a very significant source of additional free cash flow for a financial or strategic buyer.

The recent revenue decline has been the major contributor to Point.360's low valuation. Modern digital video technologies have enabled some customers to take some older distribution and archival functions in-house, and PTSX has continued a gradual exit from lower-margin legacy film-based businesses in favor of higher-margin services with stronger demand. Admittedly, future EBITDA and earnings are difficult to forecast with precision, and this idea relies on the combination of heavy insider buying, recent expansion into new markets with better demand growth characteristics, and very low current valuations that more than price in a substantial decline.

PTSX provides a diverse variety of media processing, content enhancement, spot distribution, and post-production services, the aggregate demand for which has grown consistently over decades of significant technological change despite many short-term disruptions. In fact, demand in areas such as analog-to-digital transfer, digital video compression, foreign language remastering, digital watermarking, and on-demand electronic queueing and delivery of advertising content to multiple customers may each be poised for significant long-term growth. Most importantly, Federal Communications Commission mandates currently in place are expected to rapidly accelerate market penetration of HDTV technology in the United States over the next decade, providing significant growth opportunities for the company's modern high-definition media center in California – management believes it is significantly ahead of most competitors in this area and is now beginning to see benefits in the form of margin enhancement. In the context of these future catalysts, the presence of heavy and consistent insider buying and very low valuation compared to current fundamentals give PTSX shares an attractive risk/reward.

Catalyst