Description

Vantiva is a small cap special situation, trading at a ~40% discount to NAV with what I believe is good visibility in the discount disappearing over the next ~12 months.  It has a 35% stake in publicly-listed Technicolor Creative Studios (TCHCS FP) that is slated to be sold and upon monetization you are creating the core business at ~2x EV/EBITDA.  All in, if my thesis is correct, I believe we may see the shares returning 67-146% (given potential NAV growth in the interim) over the next 12 months. 

Disclaimer: This report is the work of an investment adviser affiliated with the author. The report is the result of the adviser executing its investment strategy. The adviser holds a position in the security, however there is no assurance that the adviser will continue to hold the investment or make additional investments and will not update the information to reflect future changes in the adviser’s assessment of the investment.

Vantiva, formerly known as Technicolor SA (“TCH”), is the RemainCo of a mini French conglomerate that just spun off its jewel asset, Technicolor Creative Studios (TCHCS FP), a provider of visual effects to Hollywood studios and streaming services.  TCS is the larger of the two entities (with a ~€900 billion market cap and €1.5bn EV) and has the more desirable mix of assets so Vantiva has seen selling pressure since the spin.  Vantiva now carries a sub-€300 million market cap. 

Vantiva has an excellent chairman in Richard Moat, the former CEO of Technicolor who undersaw a large and successful restructuring program at TCH and also previously at eircom (a distressed Irish telecom operator) where he led a multifold increase in equity value.  Vantiva also has key shareholders in Angelo Gordon & Co, Bain Capital Credit, Farallon Capital (35% ownership cumulatively), former owners of the TCH debt and firms that should be focused on maximizing shareholder value.

 I group Vantiva’s assets & liabilities today into three buckets:

• A 35% equity stake in Technicolor Creative Studios, offset by some net debt secured by that stake.  The board has a mandate to dispose of this stake at some point in the next year or so, likely off-market and at a good valuation

• “Core Vantiva” (Connected Home & DVD) – Most of the value in this bucket is from their Connected Home business, which consists mainly of selling broadband gateways to telecom MSOs .  There is also a monopoly DVD manufacturing & replication business here, but given the secularly declining growth prospects this is <15% of this bucket’s value

• Other Liabilities – There is a net pension liability left over from the days when Technicolor was still known as Thomson.  There are also some legacy lawsuits that I conservatively carry at €50 million 

The 35% stake more than offsets the net debt so you are effectively creating “core Vantiva” at ~2x EV / EBITDA.

What’s interesting about this setup is that you have a board that’s highly likely to monetize its equity holding in TCS at some point in the next 12-18 months, so there’s visibility in any “HoldCo discount” today disappearing.  But TCS itself is an attractive, recession-resilient, growing asset that should have a higher share price 12-18 months from now.  So time is on your side to a degree if the company waits longer to monetize.  The NAV could grow to €1.87 in 12 months, which would imply a 59% discount today (or 146% upside to NAV in 12 months).

Core Vantiva

>85% of the value of core Vantiva comes from the “Connected Home” segment, essentially consumer premise equipment for telecom MSOs.  It’s a nearly €2 billion revenue business with ~20% global market share and with a global footprint across North America, Europe, LatAm and AsiaPac.  It’s a low-margin but capital-light business due to its fabless operating model.  

Connected Home’s customers are all cable & telecom operators so demand is typically fairly stable and recession-resilient, excluding the secular trend away from set-top-box video.  Roughly 65% of revenue (and a larger % of EBITDA) comes from broadband where there should be solid market growth over the next few years.  Another 15% of revenue comes from video streaming, primarily Android TV boxes (where they have 45% global market share).  Less than 5% of revenue comes from North America video where cord-cutting pressures should be most acute (highest historical PayTV penetration and highest ARPUs).

The biggest challenge for this company historically has been managing working capital swings and supply chains.  Holders of legacy Technicolor will recall periods from 2017-2019 where the old management team bungled a squeeze and then subsequent correction in DRAM prices, then bungled a shortage in MLCCs, then lost a key NA video customer, then stretched payment terms with suppliers to unsustainable levels. 

All of these issues have been corrected through the Technicolor restructuring and now relationships with its customers (Comcast being the largest) and suppliers (Broadcom the most important) are better than ever, working capital terms are fully normalized and the company is executing well and gaining market share. Our checks on the new CEO of Vantiva, Luis Martinez-Amago have also been very positive.

Over the past two years a shortage in components has led to the company being unable to meet end demand by nearly 20%.  As a result, the company has secured non-cancelable orders from its MSO customers for the next 12 months, providing good visibility into earnings in the near-term. 

I value this segment at 4.5x EV / EBITDA or 8x EV / EBITDA less CapEx.  There are no longer any perfect public comps but precedents have taken place at ~6-8x EV/EBITDA.  Additionally, Commscope attempted to spin off its Home Networks division (similar size to Vantiva but with significantly higher exposure to video vs. broadband) in 2021 for a targeted 8x EV/EBITDA multiple.

While Connected Home is a slow growth asset (mid-to-high single-digit expected revenue growth in broadband gateways offset by declines in video set-top-boxes), there is a real IoT gateway opportunity that has been capitalized on by other CPE players, there could be an interesting consolidation/synergies angle, and in my SOTP I am valuing on a double-digit unlevered FCF yield that implies this is an ex-growth business whereas the company should still deliver growth.

On the consolidation angle, Sagemcom in France is a similar-sized CPE business that has a complementary footprint to Vantiva and may be interested in owning this business.  Commscope is still looking to divest its Home Networks business (also similarly sized) though a combination here would face some anti-trust issues in North America.  Acquisitions in this space historically have driven significant synergies.  While a very crude analysis, I can envision a scenario where $300-$500 million ($0.84-$1.41/share) of value is created for Vantiva shareholders through a merger with Commscope Home Networks.

The other main asset of Vantiva is a DVD manufacturing & replication business for Hollywood studios and video game manufacturers with 90% market share in the U.S.  Despite the obvious secular decline in this business, it is an interesting asset given its strategically located low-cost manufacturing plants and extensive fulfilment & logistics network. The company has already made inroads diversifying into other product categories such as manufacturing & distributing Vinyl discs for the music labels, microfluidics and freight brokerage.  Nevertheless, I don’t give much credit for future growth opportunities and value this asset at a very conservative DCF valuation that implies an EV/EBITDA multiple of only ~1.5x EV/EBITDA. 

The company in its spin-off presentation is guiding to >€140 million for consolidated Vantiva EBITDA for 2022.  However, this is based on a 1.15 EUR exchange rate (0.99 today), and this is a management team that has recently guided quite conservatively around the Connected Home business.  My €165 million EBITDA estimate for 2022 should prove conservative but is 15% ahead of the only sell-side estimate available (Goldman). 

Debt & Other Liabilities

Ahead of the spin-off the company successfully secured separate debt facilities for both Vantiva and TCS amid a tough credit backdrop.  Vantiva has a €375 million debt facility, with €250m of a first-lien term loan from Barclays and €125m second-lien from Angelo Gordon.  Both tranches carry part-cash, part-PIK interest and making the debt service more than manageable even after pension contributions.  Given expectations for the TCS stake to be monetized in the next year and the debt repaid, I don’t view leverage as a concern.  Moreover, covenants are light (4.5x net leverage with a 35% cushion starting June 2023) and the debt is termed out (4 years with a 1-year extension).

Vantiva was also left with a healthy amount of cash, which should be over €200 million by the end of this year.  Given seasonal working cash needs, I use the average cash balance throughout the year for valuation purposes.  This net debt is more than covered by the 35% stake in TCS so the remainder of Vantiva can be viewed as debt-free. 

The company also had a €229 million net pension liability as of June 30th.  The majority of these liabilities are in Germany and German 10-year bund yields have risen by 100bps since June 30th.  I estimate the liability should be below €180 million by the end of the year and declining over time. 

Technicolor Creative Studios

TCS is considered the leader in visual effects (VFX) for film, episodic and advertising content production.  It has 12,000 employees and 20% global share in an oligopolistic market for high-end VFX.  Business characteristics resemble the IT services industry but with higher barriers to entry and more value-added work.  TCS’s competitive advantage stems from its global scale, IP library, low-cost footprint and virtuous cycle between clients and employees– studios want to give the highest-profile projects (e.g. The Lion King) to the company with the top talent and the top talent wants to work for the studio with the highest-profile projects.

The VFX industry has attractive secular growth prospects driven by media companies increasing spend on content and an increasing VFX budget for the average film/show.  TCS compounded revenue 19% organically for the fifteen years up to the COVID pandemic and it is expected to grow its top-line at a double-digit clip for the foreseeable future.

The rise of streaming platforms and new entrants into the content production space (e.g. Apple, Amazon) has led to an increase in the client base for VFX companies.  Our research has pointed to a significant supply/demand imbalance, leading to increasing bargaining power for VFX vendors.  We expect this increased bargaining power to manifest itself in higher margins, either through increased pricing or multi-year agreements with studios/streamers that lead to better utilization.  These dynamics could lead to an upside surprise in margins over the coming years.

The VFX industry is also ripe for a round of consolidation and TCS is in the prime position to take advantage given its scale and public listing.

TCS should finish the year levered 4.0x Net Debt / Covenant-Adjusted EBITDA but should delever quickly as EBITDA grows.

TCS shares are currently trading at 12x EV / 2022E EBITDA and 9x EV / 2023E EBITDA, with EBITDA poised to compound at a mid-teens type rate thereafter.  While there are no pure-play public comps, I’d highlight a few valuation considerations:

• There has been significant interest in the space from private equity with comparable assets trading hands at low-teens EV / EBITDA multiples

• DNEG (a good comp for TCS) recently nearly came public earlier this year via a SPAC for a mid-teens EV/EBITDA multiple.  It also attempted to IPO in 2019 in London for a targeted 12-14x EV/EBITDA valuation, before the deal fell apart on corp gov concerns

• Comparing EV / EBTIDA-CapEx multiples for IT services companies vs. expected growth rates would yield a low-double-digit to low-teens EV/EBITDA multiple for TCS

All in, in 12 months I see TCS trading at ~11.5x EV / 2023E EBITDA, which would imply a ~5.5% NTM normalized FCF yield.  This gets me to a ~€2.50 share price, or 53% higher than where the shares are trading today.  Goldman Sachs recently initiated coverage with a slightly different approach but a similar €2.50 price target. 

Vantiva management have communicated their intention to divest the 35% TCS stake over time, assuming they can get a good valuation.  I expect this sale to take place in blocks and off-market to interested family offices, sovereign wealth funds or P.E. buyers.  While the 35% stake may be a perceived overhang to TCS shares, I don’t expect management to sell via book-builds in the market and I expect sell-side analysts to clarify this point on coming earnings calls.

Because of tax loss carryforwards and other tax mitigation strategies, Vantiva management do not expect there to be any leakage from capital gains taxes.  I expect any proceeds above the debt outstanding to be returned to shareholders, either via special dividends or buybacks.

Brief Technicolor SA (TCH) History

Technicolor was written up on this site back in September of 2017.  The length of the ensuing message thread was unfortunately commensurate with the magnitude of the future share price decline.  Management struggled navigating tricky supply chain issues but also misled investors. A number of board members were replaced by 2019 and the longstanding CEO Frederic Rose was ultimately pushed out by the board at the end of 2019.  The board brought in Richard Moat, a meticulous and financially-driven turnaround executive with previous experience restructuring eir in Ireland under the ownership of distressed HF and PE investors.

Moat’s arrival was a bit too late to protect equity holders.  He identified a €300 million capital hole that he attempted to plug with a rights offering in March of 2020.  The timing wasn’t great just at the start of COVID and the rights offering was never completed.  The VFX business, historically recession-resilient, started to see demand get hit hard as studios ceased all live-action shoots and instead worked through finishing films in their inventory.

The company was ultimately put into Safeguard in 2020 (the French equivalent of a prepackaged bankruptcy), shedding €340 million of debt and undergoing a debt-for-equity swap, diluting existing shareholders by ~90%.  Coming out of this process the new shareholders of the company were mostly distressed debt funds (e.g. Angelo Gordon, Bain Capital Credit, Farallon), BPIFrance and CLOs.  Since then Moat successfully executed on a €325 million cost-cutting program, sold the trademarks business, refinanced the debt and split the company in two.  The VFX business has been steadily recovering (see below) and is nearly back to normalized levels.  Moat is remaining with Vantiva, but in a chairman capacity, while the highly-regarded head of the VFX division, Christian Roberton, is running TCS.

In order to effectuate the spin-off, Technicolor needed to ensure its “distributable reserves” were large enough that the spin wouldn’t put them in a negative equity position under French law.  This led to the company issuing a €300 million mandatory convertible note to increase reserves earlier this year and only spinning off 65% of TCS vs. 100%.

Catalyst

• Earnings beats at Vantiva
• Sales of TCS stake, debt paydown + capital return (buybacks + dividends)