Mm2 Asia - DBS Research 2017-11-03: Cathay Cinema Acquisition

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MM2 ASIA LTD. 1B0.SI

Mm2 Asia - Cathay Cinema Acquisition

• mm2 Asia Acquiring 100% stake in Cathay Singapore for S$230m or 13.8x EBITDA.
• Cathay is the second largest cinema chain in Singapore, with a market share of 27%.
• Raised earnings for FY18F by 22% and 20% for FY19F.
• Reiterate BUY with higher TP of S$0.73.

Setting the stage for sustainable growth. 

• mm2 would have a stronger presence in the entire value chain of content creation and distribution, upon the completion of the proposed acquisition of Cathay cinema chain, which is expected to be completed by end-November 2017. This acquisition will complement its current cinema operations in Malaysia, and further cement mm2's status as the leader in the media/entertainment industry. 
• With a much larger and stronger scale, mm2 can now enjoy the synergistic benefits from the entire value chain.

Growth supported by core business and UnUsUal; cinemas to build recurring income. 

• We continue to project mm2's EPS to grow at a CAGR of 65% from FY16-FY19, underpinned by growth in productions, expansion into the China market, and contribution from UnUsUal. The cinema arm, on the other hand, helps the group build a recurring income base.

Where we differ: Higher valuation peg vs consensus. 

• We value the production business at 28x PE, in line with peers listed in Asia, vs consensus’ valuation of about 25x. For UnUsUal, we value it at current valuation. For the cinema segment, we use 21x PE valuation peg.

Potential Catalyst: Reaping the fruits of success in North Asia.

• We expect North Asia to contribute > 70% of production revenue from FY18F, up from 36% in FY16 and 56% in FY17.
• Upside to earnings would come from more projects, especially in China where the market is bigger and budgets are much higher.

Valuation

Reiterate BUY, raised TP to S$0.73. 

• Our revised target price, based on sum-of-parts, is now S$0.73, up from S$0.60 previously, with Cathay’s contribution and higher market value for UnUsUal. Reiterate BUY.

Key Risks to Our View

• No long-term financing arrangements for productions. The commencement of each production is dependent on mm2’s ability to secure funding.
• Availability of good scripts. Lack of good scripts for production may lead to less support from stakeholders.

WHAT’S NEW

Cathay cinema acquisition Acquiring 100% stake in Cathay cineplexes business. 

• mm2 Asia is proposing to acquire the entire 100% stake in Cathay Organisation's entire Singapore cinema operations and the "Cathay" brand, for about S$230m, comprising S$15m deposit and the balance to be paid over a 6-month period.
• The purchase consideration works out to 13.8x the aggregate earnings before interest, taxes, depreciation and amortisation (EBITDA) of S$16.7m for the period ended 31 December 2016, higher than the 8-9x EBITDA paid for the cinemas in Malaysia, and also higher than the proposed acquisition of the 50% stake in Golden Village (GV) cinemas of 10.5x that was announced in June this year. The GV deal was called off after mm2 failed to obtain the approval from the owner of the remaining 50% stake.
• The higher EBITDA multiple as compared to the proposed GV acquisition can be justified by the full 100% ownership in Cathay as compared to the 50% ownership in GV. Having full control of the cinema chain allows mm2 to fully reap the synergistic benefits from the entire value chain. As compared to the Malaysia cinemas, cinemas in Singapore generally have better margins and utilisation rates.
• The proposed acquisition is expected to be completed by end of November 2017. The funding arrangement is not finalised yet but we are assuming a 70:30 debt-to-equity financing for the Cathay acquisition, at interest cost of 4% for the debt.
• The cash portion will be mainly from the S$65m proceeds from the recent fund-raising exercises.

Cathay is the second largest in Singapore, with a market share of 27%.

• Cathay Organisation, founded in 1935, is one of the best established cinema operators in Asia and a household name in Singapore. Cathay is Singapore's second largest cinema exhibitor with eight cinemas, 64 screens and 11,569 seats.
• The locations are in both central and heartland areas, namely: Cineleisure Orchard, The Cathay, Causeway Point, AMK Hub, Downtown East, West Mall, JEM, and Parkway Parade. It has a market share of 27% in terms of the number of screens, as compared to the market leader, GV, with 91 screens and market share of 39%. Other cinema operators in Singapore include Shaw, Filmgarde, and WE cinema by Eng Wah. Shaw has about eight cinemas, Filmgarde two and WE, one.

Rationale for acquisition of cinemas:- 

1. Strengthening downstream value chain of film production and distribution. The proposed acquisition of the Cathay cinema chain would further strengthen mm2’s presence in the downstream value chain of film distribution. It would enable mm2 to have better bargaining power in terms of securing distribution titles and screening rights, and complement its Malaysian cinema operations. With a stronger footage in the entire value chain, from creation of content to the distribution of content, mm2 would be able to enjoy synergistic benefits from the entire value chain.
2. Stable and cash business. Cinema operation is a relatively stable business with a 10-year CAGR of 3.5% for cinema attendances, and 8-year CAGR for box office receipts in Singapore. For Malaysian cinemas, the growth rate is higher, at 10% and 14.6% for attendances and box office receipts respectively. Cash is collected upfront, and about 50% of the box office receipts goes to the movie producer.
3. Source of recurring income. Cinema is a long-term investment, with payback period of about four to eight years, depending on location, while depreciation is usually on a 10-year basis. Cinemas are usually operated on a 24/7 basis, with no wastage of resources, unlike the production of movies, which could be affected by weather conditions. Furthermore, going forward, cinemas can also be a crowd puller for malls, to counter the proliferation of online shopping.

Earnings and Recommendation 

Adjust earnings to account for Cathay acquisition. 

• We have revised our forecasts to take into account the acquisition of the Cathay cinema chain in Singapore. We have assumed 70:30 debt-to-equity financing for the Cathay acquisition, at an interest cost of 4% for the debt, to be paid in FY Mar 19F.

Net gearing for FY19F is thus higher at 0.77x, from a net cash position in FY18F.

• Overall, we have raised FY18F earnings by 22%, mainly attributed to the 4-month contribution for Cathay cinema and removing the financing cost for the convertible debt due to early redemption, while FY19F earnings were lifted by 20%, after accounting for the full contribution from Lotus and Cathay cinemas, offset by the full financing cost for the Cathay acquisition. 
• With a much bigger and stronger group as a whole, our target price based on sum-of-parts is now S$0.73, up from S$0.60 previously, after accounting for the Cathay contribution and higher market value for UnUsUal.
• Maintain BUY.

Lee Keng LING DBS Vickers | http://www.dbsvickers.com/ 2017-11-03

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 0.73 Up 0.600