There are some notable exceptions, but movie sequels tend to be worse than the originals. And after a disappointing 2016, Village Roadshow’s latest result appears to follow this pattern, albeit only just (see Table 1).
The company’s net debt is particularly concerning. Having grown steadily in recent years, net debt is now 3.3 times earnings before interest, tax, depreciation and amortisation (or EBITDA).
Debt too high
Interim dividend cancelled & growth investment slowed
Asset sales also being considered
Management deems this ‘unacceptable’ and has sensibly cancelled the interim dividend (with the oft-promised special dividend presumably even further away now). The company will also reduce its growth investments and consider asset sales.
All these moves make sense. In fact, despite its admirable policy to become more shareholder friendly in recent years, we’d prefer dividends to remain off the menu until debt becomes much more reasonable.
With the business considering selling assets, let’s update our sum-of-the-parts analysis, beginning with the company’s Theme Park business.
The tragedy at competitor Ardent Leisure’s nearby Dreamworld also had an impact on Village’s Gold Coast parks and its Wet‘n'Wild park in Sydney. Attendance at its Gold Coast parks fell 8.4% from the day after the accident at Dreamworld to early February 2017 but has been so far largely offset by the company recognising deferred revenue on yearly memberships.
In any case, we’d expect attendance to normalise over the medium term as safety concerns abate. While theme parks are capital intensive, Village’s Gold Coast parks should continue to benefit from increasing domestic and international tourism, helped by a lower Australian dollar, rising living standards in Asia and airlines adding direct flights between south-east Queensland and various Asian cities.
We estimate that the Theme Parks business can earn around $45m in earnings before interest and tax. Using an EBIT multiple of eight, this values the division at $360m.
Asian expansion and Top Golf
The company’s long-promised Asian expansion is seeing some progress, with Village consulting on the construction of the Wet‘n'Wild park on Hainan Island and Lionsgate Entertainment World on Hengqin Island, both in China. Village will manage these two parks following completion while it continues to develop ‘two major opportunities’ in Asia.
Village will open Australia’s first Topgolf next to Movie World on the Gold Coast in 2018. Players hit golf balls containing microchips which track distance and accuracy and allow you to win points for hitting specific targets, while the facility is also an entertainment destination.
|Six months to Dec||2016||2015|| /(–)
|U'lying EBITDA ($m)||78.4||77.9||1|
|U'lying EBIT ($m)||41.8||42.0||-|
|U'lying NPAT ($m)||19.2||22.0||(13)|
|U'lying EPS (c)||11.9||13.6||(13)|
Management is excited about the ‘outstanding paybacks’ of Topgolf facilities. The concept has been successful enough in the US to attract an investment from private equity giant Providence Equity Partners, so it will be interesting to see if it can transfer this success to Australia and perhaps subsequently to Asia.
So while the Asian expansion proceeds at a glacial pace, it and Topgolf have the potential to be successful investments for Village. The lack of disclosure means any estimate of their value could provide wide of the mark but we’re sticking with $120m for now.
2016’s bumper year of films including Star Wars: The Force Awakens and SPECTRE meant it was going to be difficult to improve on that in 2017 and so it has proved in the first half. As we’ve noted previously, alternative entertainment options and the increasing ability to watch movies outside of cinemas mean cinema attendance is likely to continue its steady decline in coming years.
The company has so far been able to compensate by raising the prices of tickets and also persuading customers to spend more on food and drinks and by choosing its Gold Class and Vmax screens. The company also plans to keep rolling out more screens but we continue to worry that at some point cinema tickets will become too expensive for many to justify the expense.
With estimated normalised EBIT of $60m, we value this business at around $480m.
By contrast, Film Distribution continues to struggle as demand for DVDs plummets in favour of lower-margin digital downloads and video on demand services such as Netflix or Stan.
Despite the government moving to shut down various pirate sites – which the company also thinks will help its Cinema Exhibition business – things look grim for this division.
As with the digitisation of the music business, at some stage the move from analogue to digital will stop driving EBIT lower, but we have no idea when. As such, with earnings expected to continue to fall in coming years, we value this business at just less than $100m.
Even worse, the company’s 50% share in Village Roadshow Entertainment Group (VREG) continues to consume cash without much promise of reversing this trend.
While there is value in VREG’s film library – which is recorded at cost in its books – VREG has required continued cash injections to keep developing films. Ongoing operating losses mean VREG’s negative equity has increased from $802m in 2014 to $1,153m in 2016, which explains why Village Roadshow has written down its equity investment in zero while having to continually contribute more cash over this period.
|Asian business & Topgolf||n/a||120|
|Enterprise value ($m)||1,366|
|Less corporate costs~ ($m)||(300)|
|Less net debt ($m)||(554)|
|Net equity value ($m)||512|
|Value per share ($)||3.16|
Happily, after making another US$5m subordinated debt contribution during the first half, due to managements attempts to reduce debt, Village won’t be making any further contributions to VREG. Offsetting this, however, with VREG yet again renegotiating its corporate debt facility, Village has agreed to defer receiving cash interest on its US$20m subordinated debt holding in VREG.
With VREG likely to need further cash injections to support film development (absent any further selldowns of its film library), this raises further questions over the ultimate value of the preferred equity in VREG, let alone its ordinary equity.
However, it could continue to monetise its film library, potentially produce a hit or even float the business to help pay down debt. So we’ll keep our estimated value of Village’s VREG investment at $160m for now, but note that the dearth of information released by the company means the actual value could be much higher or lower than this.
Finally, using the brand name of Edge Loyalty in Australia and Opia in Europe, USA and Asia, this division focuses on consumer incentive programmes.
While it was temporarily affected by reduced promotional activity arising from Brexit – and the fall in Sterling after the vote – this division has good growth prospects as it expands into the USA and Asia. We’ve used an EBIT multiple of 10 to value it at $150m.
After corporate costs and net debt – which has risen to $554m from $402m 18 months ago – we get an estimated value of around $3.20 per share.
With the cancellation of dividends saving $45m per year (assuming the final dividend is also cancelled), cash savings from reduced growth investments and potential asset sales, net debt could fall relatively quickly – but so could EBIT depending on the asset(s) sold. We’re therefore reducing our Buy price to $3.00 (from $3.50) and our Sell price to $5.50 (from $6). HOLD.