Description

Thunderbird Entertainment is one of the more intriguing risk/reward situations I've come across in some time, and represents a high quality business with a strong competitive position, phenomenal management team and hidden optionality with the potential for massive upside, trading at a bargain basement price. The idea has been written up multiple times, and with respect to andrew152, his most recent writeup calling the stock 'a moderate risk/reward' fails to adequately capture the setup and potential asymmetry here.

The thesis is straightforward; Thunderbird is growing their top line 25%+ with a de-risked business model that is cash generative, and has strong relationships with every major streaming platform during a period of time where demand for content has never been higher. Furthermore, Thunderbird is at an inflection point within its business model which should have the effect of driving EBITDA growth and margin expansion over the next few years. Lastly, as a result of their industry position, it would be almost impossible to imagine that this business will not play a large role in the future of content creation over the next few years leading to potential multi-bagger returns for shareholders.

Thunderbird Entertainment can be viewed as a 'pick and shovel' way to play the current wave of demand for content, particularly animated children's content, providing investors with a way to take advantage of the current battle between streaming giants, as well as potentially participate in the hot M&A activity taking place across the film and television industries. Thunderbird is available at a discount price as a microcap (USD $160mm TEV) trading on the Toronto Venture Exchange (as well as US OTC exchange) with limited analyst coverage, somewhat obscure financials that don't fully reflect the earnings power or cash generation of the business (and therefore don't screen well), valuable assets on the balance sheet that have yet to be fully monetized, and low float given high insider ownership. In addition, management does not provide guidance and quarterly calls and presentations up to this point have been underwhelming in terms of communicating the story to investors. As mentioned above, I believe Thunderbird is at an inflection point both within their business and the industry where growth is set to explode moving forward, and additional catalysts such as an potential US up-listing, an M&A deal and potential steps taken to increase the float could materialize, while the strength of the business will continue to shine through. All of this is available at an estimated 4-6x base case 2023 EBITDA.

The Business

Thunderbird Entertainment Group is a Vancouver-based, publicly traded multi-platform entertainment company that creates scripted, unscripted and animated programming for global digital platforms, as well as Canadian and International broadcasters. In other words, they create high quality and award winning content for both TV networks and major streaming platforms. The company has an interesting history discussed more below, and has grown steadily since 2011, evolving from a 150-person studio primarily doing service work to a 700-plus person studio with three locations in Vancouver, LA and Ottawa.

Thunderbird has two divisions, Live Action/Scripted and Animated Content. Within their live action and scripted division, content is produced through their Great Pacific Media arm, and is made up of a combination of production service shows and owned intellectual property (IP) shows. Examples of content from the live action and scripted division includes Kim's Convenience, the popular Canadian sitcom as well as Highway Through Hell, one of the most popular reality shows in Canada, currently filming its 10th season. Within animated content, shows are produced through the Atomic Cartoons arm, and also consist of production service work shows as well as owned IP. Examples of content within Atomic Cartoons include Netflix's Hello Ninja (production service) and Last Kid's On Earth, the owned IP show adopted from author Max Brallier's popular children's book series. In addition to show production, Thunderbird also acquires, licenses and merchandises distribution rights for owned IP.

Within each division, Thunderbird has three different revenue streams consisting of production service work, partnerships and owned IP development. For production service work and partnerships, Thunderbird is hired by a network or streaming service to create and develop a show, and all costs of production are covered by the client on top of a fee paid to Thunderbird. For partnerships, all aspects of a project are outsourced to Thunderbird in exchange for Thunderbird retaining licensing revenue on the back end of that project. When it comes to owned IP, Thunderbird develops a piece of content themselves with full ownership of the IP, which they can then monetize via licensing, consumer products and other avenues of distribution.

Production services/partnership work currently makes up around 60% of revenues and sports 15% EBITDA margins, while owned IP work represents the remaining 40% of revenues but boasts double the EBITDA margins at 30%. In addition to Thunderbird retaining all ownership of their owned IP, this content is preferable to production services/partnership work as it can be re-sold globally into other markets given the long-tail.

An interesting element of studying Thunderbird's business and the industry revealed itself in terms of their industry positioning and competitive advantages. Typically, the movie studio business is a really bad business. With productions requiring cash outlays upfront for the high cost of talent and overhead, and the final product being subject to consumer demand, studios are dependent on ‘home-run’ blockbuster hits to drive ticket sales and licensing/distribution revenues across the world. Thunderbird’s strategy and business model insulate them from the unattractiveness of the movie business, as the company is primarily focused on 'hitting singles', while leaving the potential for a huge IP hit to materialize on its own. As a Vancouver based company, Thunderbird benefits from favorable working capital dynamics in the form of Canadian tax credits, which typically fund around 75% of production costs prior to staffing a show leading to minimal capital outlays upfront. Furthermore, Thunderbird pre-sells every single one of their projects, removing the risk of a ‘flop’ by locking in a guaranteed sale before production begins.

Digging further into these tax credits, Thunderbird works with their distribution partners to receive an allocation of funding for a particular project. Once they receive funding for a project, it unlocks tax credits which can then be leveraged to receive short-term financing for film production from a Canadian bank. With a set budget, timed schedules and partial financing, Thunderbird approaches their U.S. broadcaster to finalize agreements and determine financial participation before greenlighting a project. In return for funding, the broadcaster receives certain rights for sharing costs in the development. Throughout this process, Thunderbird has ensured they can best estimate the input costs, receive financing from a combination of parties, and know the base amount of revenue the project will earn before development. Essentially, Thunderbird works to cover the costs of development before starting a project, and with pre-set financing terms, Thunderbird can continue to develop the production slate and add to their collection of content assets, virtually risk-free. As Thunderbird creates more content, they will grow revenues and brand awareness while enjoying some operating leverage from an internal production team that has been executing at the highest level to date. This model has proven to be scalable, and could be potentially where investors are missing a lot of the value creation taking place as its difficult to understand the complete picture by analyzing the financials alone. This is incredibly different - and good different - from the movie studio business as a whole.

The above dynamic is significant as it de-risks the production side of things and also allows Thunderbird to take on projects not economically viable for US counterparts. While content creation itself has limited barriers to entry, replicating Thunderbird’s competitive positioning would require years of investments in talent, creativity and time, not to mention the reputation that Thunderbird has built as a reliable, high-quality producer of in-demand content. The downside to this model from the standpoint of being a public company is that owned IP project deliveries and revenue recognition can be quite lumpy, leading to non-linear results that can make the business appear less strong than it is. Thunderbird offsets the choppiness of owned IP work with the near-recurring, cash flowing production services work which helps smooth out results until the backlog of owned IP becomes so large that shows are delivered with greater frequency.

A good example of owned IP value creation includes the popular Netflix show Last Kids on Earth, a show created by Thunderbird which has three seasons running in addition to an interactive movie experience. Thunderbird was able to use their industry relationships to secure a meeting with author of Last Kid's, Max Brallier, and optioned the IP for a $10,000 upfront payment. The show is estimated to have brought in $25-30mm of revenues to date, and is currently being followed on by the licensing of various consumer products including toys and video games. Most importantly, the quality of the show and subsequent results have led to Thunderbird becoming a trusted partner to Netflix as well as the other streaming services, a competitive advantage that would be very difficult to replicate.

Today, according to management, Thunderbird's project pipeline and backlog is as full as its ever been given the incredible demand for high quality content, and they currently have over 50 projects in various stages of development, many of which are owned IP shows being distributed on the major streaming platforms such as Netflix, Disney+ and HBO Max.

Background

While the initial version of Thunderbird has roots dating back twenty years, the current version of the company starts around 2011. Since then, as mentioned above, Thunderbird has grown significantly, evolving from a 150-person studio primarily doing service work for content platforms to a 700-plus employee studio with three locations in Vancouver, Los Angeles, and Ottawa.

Thunderbird Entertainment was founded by former President and CEO Tim Gamble with the initial purpose of serving as a venture-capital like business that would help fund film and television productions. A pool of capital was initially put together and the group would invest in other people's ideas and content. For example, content creators would bring Thunderbird ideas with funding, but would need a bridge loan or production money to make the show, and Thunderbird would finance the rest. At some point the group decided to start producing their own content, which came with the aforementioned production development risk, but the turning point for Thunderbird came when Tim Gamble got a call from a director friend who wanted help making a sequel to the original Blade Runner. There was an opportunity to buy out the interests of a partner who didn't want to be involved, so Gamble contacted Lionsgate Studios founder Frank Giustra to help purchase the Blade Runner IP. Giustra agreed, but instead of buying the IP interest outright, Giustra suggested making an investment in Thunderbird as a shareholder, and purchasing the Blade Runner IP as an asset for the company.

The wheels for having Thunderbird acquire and produce valuable IP were set in motion, which also coincided with the growth in streaming services as well as the desire for the major cable networks to create their own platforms as opposed to selling their valuable shows to companies like Netflix. This in turn led to the start of in-house content development by these streaming platforms, but also given the demand, led to Netflix and others having to outsource content production to meet this escalating demand. Following the purchase of Blade Runner IP, in a fortuitous situation for Thunderbird, Australian producer/director Josh Wakely, who had dreams of creating a children's TV series using Beatles music, and had already secured the rights to 50 songs on the Beatles catalog, needed a production company to see his vision through. After embarking on an extensive search to find the right partner, he landed on Tim Gamble and Thunderbird which given the tax credit financing made an otherwise expensive project feasible. So Thunderbird acquired the rights to the project, sold it to Netflix pre-development, and found an animation studio to develop the show. Atomic Cartoons led by current Thunderbird CEO Jen McCarron was chosen, and some time later, Beat Bugs was born. The partnership between early Thunderbird and Atomic went so well, and the work was so good, that Gamble thought it would be in the best interest of Thunderbird to acquire Atomic. Most importantly, the series also cemented the early relationship between Thunderbird and Netflix which continues to bear fruit today. Following Thunderbird's acquisition of Great Pacific Media in 2014, the two divisions were born resulting in the Thunderbird that investors see today. In 2018, Thunderbird went public in via a reverse merger with Golden Secret Ventures, and started trading on the TSX Venture Exchange that year.

Business Strategy

Thunderbird now develops both scripted, unscripted and animated content, with a renewed focus on owned IP, especially within the animated content division. The aim is to build out a world class production studio in addition to an in-house consumer products and licensing arm which will allow Thunderbird to further monetize hit shows with licensing revenues from various consumer products.

With Atomic and the animated content division being the crown jewel of the business, the focus on kid's content and owned IP makes sense as it's both a subscriber acquisition tool and a churn reducer for the various streaming services. The pandemic provided a good example of this as TV, among other things became the babysitter for a lot of working parents. Today, there is an incredible amount of kid's content both available and in production and demand shows no signs of slowing down. According to management, the Kids & Family Division has an animation team of 800 people between 3 locations and is trending towards exceeding 900 people by the end of 2021. Furthermore, in 2015, Thunderbird had 18 bid requests for projects. In 2020, they had 67, and for FY21 they are on track for over 80 bid requests, which averages out roughly two a week.

From the latest call:

"The Kids & Family Division is busier than ever, and our bids and increase tripled year-over-year from January to October 2019 to January to October 2020. We've also added more than 400 crew members to our team on the animation side of the business to keep up with the demand. We are fully booked through 2021 and have visibility well into 2023."

As Thunderbird develops more content, they are developing a collection of valuable IP which remains on the balance sheet as valuable (but hard to quantify) assets. Many of their kids programs in particular have much longer lifespans than the original content amortization periods. As a result, as they grow their library, the business becomes more attractive as an acquisition target for other companies while also creating the option for a valuable tent-pole piece of IP. In addition, with more bid requests flowing in, Thunderbird can dramatically reduce the content acquisition/origination cost which creates somewhat of a flywheel as the company’s ability to produce more quality content will attract even more bid requests and then more talent.

With a strong track record now solidly intact, Thunderbird has earned their great reputation throughout the industry with their quality of their productions and reliability as a content producer. These components are critically important given the significance of trust, value and relationships in the entertainment industry. I'd argue that the barriers to entry to replicate Thunderbird's industry position are incredibly steep. To get to a place where OTT providers trust you with millions of dollars and years of investments in time and creation, you need a great reputation and ability to execute. The pandemic provided a good example of this as during COVID, Thunderbird was able to transition nearly the entire staff to a remote work environment while not missing a beat with their clients, delivering on all commitments to their distribution partners as expected. In addition, with many in person shows and developments being cancelled or delayed, Thunderbird’s focus on animated content allowed their backlog of production work and IP creation to grow year over year. These factors have led to strong relationships with nearly all of the major streaming and content platforms in the media landscape, including HBO Max, Disney, Netflix, and Hulu, among others. These platforms would be hesitant to outsource an important piece of work to upstarts or new studios just to save a few bucks and the relationship with Netflix is paramount as its estimated that they control about 20% of the streaming market today.

Industry insiders have confirmed that your work and ideas are only as good as your relationships at the distribution level. But once that pipeline is opened up and a track record is developed, studios can find themselves in a situation where there is endless demand for new projects with major streaming services. Thunderbird has done exactly that. A strong example would be the Disney relationship. Thunderbird has worked with Disney for many years on various projects. Industry insiders confirmed that there may not be a more difficult client to work with than Disney in terms of Disney's expectations and particularity about their content and characters. This demand for quality is not only ingrained inside of the culture of Atomic Cartoons but has also been delivered on. Quality plus relationships are two very hard to replicate features of Thunderbird's current position.

While animated content and the potential development of a hit piece of owned IP will be a major focus moving forward, Thunderbird will also continue to emphasize service work to maintain their revenue growth and cash flows. This balance is important as it would be difficult for Thunderbird's model to be entirely based around creating owned IP given the long production times as well as occasional lumpy demand. Service work is margin driven and again provides the opportunity for steady cash flow as well as continued relationship building.

Long term, Thunderbird's aim is to have multiple owned IP projects in production with another large chunk of service work related projects in development through 2023. The company's backlog and project pipeline has never been more full, and Thunderbird will continue to expand their footprint in all areas of animation, live-action and factual content. A recent strategic move to build a studio in Los Angeles also bolsters Thunderbird's distribution potential, pre-production business and relationships with industry talent as Netflix and Disney showrunners are now a few doors down from Thunderbird.

Industry Info

As mentioned, Thunderbird’s current development pipeline is robust and growing, indicating the demand for content should provide favorable tailwinds into the foreseeable future. Industry reports estimate global content spend among the major streaming and media platforms to be in excess of $50 billion in 2021 alone (and projected to reach over $70B by 2025) with OTT subscriptions continuing to grow as well. While the growth in service-related work and IP licensing revenues are enough to generate favorable returns moving forward, Thunderbird has been focused on building an in-house consumer products and licensing division so that quality content can be followed up with consumer products leading to more licensing revenue. According to management, these investments in talent and sales should begin to bear fruit in 2023 and beyond.

Today, Thunderbird is constantly being approached by some of the top industry talent, validating this tiny studio’s reputation and opening the doors for the creation of even higher quality content. This is where the flywheel comes into play, because as Thunderbird scales, they will drive more creators to the company, leading to better content, leading to more distribution, leading to further talent and so on. The value chain from a high caliber piece of content lends itself to many winners, and this nonzero sum-ness has led to win-win relationships for Thunderbird and the creators, distributors, actors and end customers. Moving forward, I would have a hard time imagining that Thunderbird will not end up playing a pivotal role in the future of content creation given the secular tailwinds, their competitive positioning, low risk business model and quality content production.

In terms of Thunderbird themselves becoming an acquisition target by a larger studio or content platform, I believe there are several trends that could make that a possibility.

The most significant of those is the transition of viewers from traditional TV to online streaming services and the rise of OTT in general. The rise in streaming services as well as demand for content has attracted interest from all of Apple, Amazon, Netflix, Disney and others, and because the prices for various streaming services are more or less around the same, content will be the ultimate differentiator. This has led to the various platforms aggressively investing and re-investing to create their own original content as well as outsourcing production for other quality shows. More projects are also being completed as joint ventures, as synergies between content creators and distributors become apparent when each can focus on their own expertise. This highly-competitive marketplace where streamers battle it out for market share has created the strong demand for content. While smaller networks and companies in the past simply licensed their content to the streaming services, recent trends point more toward in-house content for each major platform being the focus. In other words, Disney will want Disney content for its streaming services, AT&T will want Warner Media content, HBO will use HBO content, etc. As a result, and while the streaming services continue to look for an edge over each other, the value of content production studios could spike as they turn into juicy acquisition targets.

And that's exactly what's happening.

A number of recent acquisitions within the industry point to the demand for all types of content and anything halfway resembling a 'brand' receiving monster valuations in M&A deals. These deals further highlight the valuation disparity between Thunderbird and many of the potential lesser quality studios. The most egregious example includes Blackstone acquiring a majority stake in Reese Witherspoon's production company Hello Sunshine (with only TWO shows on air and a small handful in production) for $900mm or an estimated 7x revenues. Thunderbird, with its established in-demand IP and enormous project pipeline trades for 1.4x next year's revenues.

If the current environment is a reflection of any sort of trend moving forward, M&A activity will likely push convergence and consolidation among companies to new levels, as merged studios bring together content libraries, capabilities, distribution, and value. It's possible that COVID accelerated the need for M&A as well, as some production halts have put a premium on established and existing content libraries.

Lastly, I think it would be fair to mention Lionsgate Studios at least as a target for where Thunderbird is aiming. It's also applicable given Frank Giustra's involvement. Lionsgate grew from a few hundred thousand in revenues to the world's largest independent film studio with a market cap of over $3.1B. Similar to Lionsgate, if Thunderbird can keep 'hitting singles', building relationships and growing the business, it would be possible for one of their IP owned shows to 'pop' creating tremendous value for shareholders.

Management

Jennifer Twiner-McCarron has served as Thunderbird CEO since 2016, following the acquisition of Atomic Cartoons. Thunderbird named McCarron president in June 2016. She joined Atomic as head of production in 2011 and has served as the lead on projects including Beat Bugs and Last Kids on Earth for Netflix. McCarron was hand-picked and urged by The Board to accept the CEO role in 2018, and since that time period has executed incredibly well. With her extensive background in TV production, distribution and branded content, she is the perfect fit for the role. I think it's rare to find a combination of good business executive, creative talent and operator rolled into one CEO, but I believe that's what exists with McCarron at the helm. I am thrilled to be investing alongside her and believe she is the right person to continue building the culture and lead the business forward. My biggest gripe would be she doesn't own enough stock. However, I view compensation as fair and don't see any egregious stock comp or options being granted, with incentive compensation tied to earnings performance for each division.

Frank Giustra, the aforementioned founder of Lionsgate Entertainment owns over 7.7mm shares or around 12% of the business, and has been involved with Thunderbird for over a decade. I view his presence and involvement as a positive. Lionsgate was founded to capitalize on the growth of the film industry in Canada, and produced low budget, high grossing hits such as American Psycho and Fahrenheit/911. Giustra is also knowledgeable about film and TV production in Canada, as Lionsgate at one time purchased Canada's largest film studio, North Shore Studios, where American producers and film companies came to shoot given the cheaper production costs in Canada. Thunderbird's current strategy relies on the same dynamics including favorable tax credits to fund productions.

I would describe Giustra's day to day involvement as minimal, but at the very least his presence, experience and knowledge could at least help Thunderbird avoid doing stupid things and his breadth of contacts have without a doubt led to some beneficial and lucrative relationships for Thunderbird. The parallels between early Lionsgate and Thunderbird are many, and if anyone knows how to scrap to build a small content and production business with niche, independent content, it would be Frank Guistra. Together, insiders own 30% of the business.

Valuation

Thunderbird isn't the most straightforward valuation exercise that I've done given the timing of show production and deliveries can cause results to be lumpy, but recurring service work has helped smooth results a bit and I believe there is enough here to at least lightly project revenues / EBITDA moving forward given past growth rates. Management doesn't provide formal guidance, only guideposts, and I actually believe this business would be better suited to report results once or twice per year as there is a lot of noise in quarterly results. As a result, both revenues and cash flow could look choppy moving forward, but the company has valuable content assets building on the balance sheet that can accrue to shareholders in the form of increased licensing deals / revenue.

Although Thunderbird can drive value as a standalone business, the company has been exploring accretive M&A opportunities which would contribute meaningfully to the bottom line, creative talent pool and IP catalog. Outside of that, as mentioned, I could imagine a scenario in which Thunderbird themselves become a strategic acquisition target given their relationships with major streamers, built in creative talent, cost effective operations, and huge project pipeline. In addition, two of the company’s largest shareholders have been involved for over a decade, and large shareholders in a low float, thinly traded microcap would need an avenue for exit which the public markets may not provide. Moving forward, increased IR efforts and continued execution should drive more eyes to the business and its attractiveness.

In a bull case scenario, I've estimated 30-35% growth in revenues through 2023 along with flat 20% EBITDA margins on the back of 30%+ growth in EBITDA due to COVID related project demand hitting the income statement as well as the continued shift from service work to higher margin owned IP. This would result in the company generating nearly $40mm in EBITDA by 2023, quite significant for a $160mm TEV business.

Bull Case

In the more conservative base case scenario, I estimate declining revenue growth rates below 30% as well as flat EBITDA for next year followed by an increase in revenues and EBITDA for FY23 on the back of new show deliveries and again increasing development of owned IP. In this scenario, I have EBITDA margins declining by 15% through 2023, a scenario I view as unlikely. This this scenario with a below market multiple of 11x 2023 EBITDA shares could still be worth greater than 100% of the current price.

Base Case

My bear case is highlighted by a severe decline in revenue growth rates as well as EBITDA margins on the back of a failed transition to an owned IP mix shift as well as elevated costs weighing on EBITDA margins. Using an incredibly conservative multiple of 8.5x 2023E EBITDA here I still arrive at a share price higher than the current valuation. The bear case assumes a complete deterioration of the business including none of the positive scenarios laid out above playing out. In other words, I believe a lot would have to go wrong for investors to lose money at the current price, indicating the attractive risk/reward here.

Bear Case

Notes

*EBITDA has historically converted to free cash flow at a decent clip, but the use of and timing of interim production financing (tax credits) payback makes FCF conversion lumpy year to year. 

*Not included in my valuation is the upside from any tent-pole IP being developed

*Not included in my valuation is any potential M&A deal where Thunderbird acquires a production company

*Consumer products and licensing buildout and associated revenues aren't included as part of the valuation

*They also don't disclose certain metrics including project completion data, service work 'churn' (how many old service projects roll off and are replaced by new ones), unit economics surrounding show delivery / cost and a breakout of costs of production.

I believe investor downside is protected by the strong balance sheet, cash flows, relationships with major streamers and the two largest shareholders who as mentioned, may need an avenue for exit or liquidation at some point. As noted, in an incredibly pessimistic scenario where revenue growth rates decline, EBITDA margins continue to deteriorate and the market is unwilling to assign a full multiple to the business, I still estimate a stock price higher than the current valuation. In addition, there is a significant amount of optionality here in the form of potential hit IP and M&A that aren't currently being factored in to my valuation. I'm optimistic about the setup here and positive risk/reward skew.

Risks / Mitigants

No data from the streamers - could affect licensing / distribution sales - every show distributed through a streamer provides a global audience for brand building and licensing opportunities

Management does something stupid - to date, there has been no evidence of this, and the current group is aligned with shareholders via stock and option ownership

Will never get a full multiple due to lack of 'tent-pole' - mitigated for reasons discussed above, with the optionality that a tent-pole is developed within the next few years

Hit shows or talent leaves - Thunderbird is acquiring and retaining talent while growing as opposed to the other way around

Tax incentives dry up or go away due to limited payback / revenue share - countries such as Canada are incentivized to deliver tax credits for job creation as well as fostering creative talent relationships within their own country

Consumer product buildout flops - this part of the strategy is not factored into my valuation and would only add to the top and bottom line in the form of high margin licensing revenues

M&A window dries up - for the reasons stated above I believe Thunderbird can continue to drive value as a standalone business

Catalyst

Growth

M&A

Acquisition target

Tentpole development

Consumer products ramp