MM2 ASIA LTD. (SGX:1B0)
mm2 Asia - In Need Of Deleveraging
- mm2's 3Q19 net earnings plunged 70% y-o-y, hit by higher than expected interest expense and tax rate.
- Spinoff of cinema business is an option to address high interest expense issue.
- Cut FY19F/FY20F/FY21F earnings by 32%/34%/33%.
- Downgrade to HOLD with lower Target Price of S$0.33.
In need of deleveraging; downgrade to HOLD.
- MM2 ASIA LTD. (SGX:1B0) swung into a net debt position following the acquisition of Cathay Cineplexes for S$230m in November 2017. With the additional debt, interest expense is expected to surge almost 10-fold in FY19, and would impact the bottomline.
- In order to maintain a sustainable and attractive net margin of > 10%, after incorporating the lower-margin cinema business, it would have to deleverage. One option is to spin-off the cinema operation.
- In terms of revenue generation, all segments are still generating double-digit growth, but near term, the steep interest expense will continue to be a drag on earnings.
- Downgrade to HOLD till we have better clarity on its plans to deleverage.
9MFY19 earnings below expectations:
- mm2's 9M19 net earnings of S$12.9m accounted for only 52% of our previous FY19F estimates. The drag was mainly from higher interest expense and higher tax rate.
Where We Differ: Slight difference in valuation peg vs consensus.
- We value the production segment at 16x PE, in line with peers listed in Asia, and P/EBITDA for the cinema. For UNUSUAL LIMITED (SGX:1D1) and VIVIDTHREE HOLDINGS LTD. (SGX:OMK), we value it at current valuation, vs P/E valuation used by consensus.
Potential catalyst: more projects especially in North Asia; successful cinema operation spinoff.
- Upside to earnings would come from more projects, especially in China, where the market is bigger and budgets are much larger. A successful spinoff of the cinema would help the group to resume its earnings growth momentum.
Valuation:
- Downgrade to HOLD, Target Price cut to S$0.33.
- Our sum-of-parts target price is now S$0.33 (prev S$0.50), pegged to 16x FY20F earnings for core business, 5.5x P/EBITDA for cinema business, and current valuation for UnUsUaL and Vividthree.
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.
- Unavailability of good scripts. Lack of good scripts for production may lead to less support from stakeholders.
WHAT’S NEW - 3Q19 net earnings plunged 70% y-o-y to S$2m, hit by higher interest expense and tax rate
3Q19 revenue up 41.3% y-o-y, all key segments registered growth.
- mm2 reported 3Q19 group revenue of S$74.1m, +41.3%. All key segments – core business, cinema, event production and concert promotion and post production, registered revenue growth.
- For 9M19, group revenue accounted for 70% of our FY19F forecast, in line as 4Q is typically a strong quarter for the group mainly due to the Chinese New Year period.
- Furthermore, the bulk of the contribution from the blockbuster “More Than Blue” would also be booked in 4Q19.
Lower gross margin due to reclassification of costs.
- Gross profit was higher at S$29.8m (+27.8% y-o-y, +7.8% q-o-q) but gross margin was slightly lower at 40.2%, vs 46.1% in 3Q18 and 42.5% in 2Q19. This was partly due to the reclassification of direct costs from administrative expenses to cost of sales.
High interest expense and tax rate lead to a steep drop in net profit.
- mm2's 3Q19 net profit of S$2m was down 70% y-o-y and 48% q-o-q. The higher finance expenses was due to additional borrowings and the issuance of medium term note, and convertible bonds and notes. Tax rate for 3Q19 increased to 34%, vs 18% in 3Q18 and 19% for FY18. For 9M19, net profit of S$12.9m accounted for only 52% of our FY19F estimates.
Spinoff of cinema business could be an option to address high interest expense issue.
- mm2 moved into a net debt position following the acquisition of Cathay Cineplexes for S$230m in November 2017, that was financed mainly via debt. mm2 has already repaid S$30m of bank borrowings.
- Meanwhile, the group is looking to lower its cost of borrowing. A spinoff of the cinema business could be an option to address this issue in the long run.
Outlook and Strategy
Vividthree - post production
- VIVIDTHREE HOLDINGS LTD. (SGX:OMK) has launched its maiden Train to Busan VR (TTB VR) tour set in Beijing in December. In October 2018, the group signed a Letter of Intent with a Taiwan Stock Exchange listed company - Bossdom DigiInnovation - granting them territorial rights to host TTB VR tour set exclusively in Taiwan, Hong Kong and Macau, with a second TTB VR tour set expected to be delivered by end of 4QFY2019.
UnUsUaL- event production and concert promotion
- UNUSUAL LIMITED (SGX:1D1) will continue with its plans to expand from event production and concert promotion to ownership of globally appealing shows and other kinds of live entertainment intellectual properties (“IPs”), including “Walking with dinosaurs”, “Apollo”, “Disney on Ice” and “Frozen”. These family entertainment type of shows are more sustainable and would account for about one-third of its portfolio.
- The group would also do more large-scale concerts, whereby margins are generally higher compared to smaller scale productions. It would also look to bring more Canto/Mando pop concerts to Western countries. Western countries are easier targets as compared to matured regions like Taiwan.
Platform business (Cinema) and core production unit
- mm2 continues to enter into slate deals to co-produce high-quality digital and live content with international content distributors in North Asia especially, and also in other regions like Korea. In FY2019 to date, the group has won several awards for its films.
Earnings and Recommendation
Cut earnings; downgrade to HOLD with lower Target Price of S$0.33.
- We have cut FY19F/20F/21F earnings by 32%/34%/33% to account for higher interest expense. We have expected the group to refinance a portion of the debt to reduce the interest expense but that has not happened yet.
- A higher tax rate of 30% is used, vs 19% previously, mainly due to the accounting treatment for the interest expense. Interest payment for the loan for Cathay cinema is treated as a non-deductibility item and is taxable. We have also imputed higher minority interests, in view of the strong project pipeline for UnUsUaL and Vividthree.
- mm2's would have to deleverage in order to maintain a decent net margin.
- Downgrade to HOLD till we have better clarity on plans to deleverage.
Lee Keng LING
DBS Group Research
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https://www.dbsvickers.com/
2019-02-13
SGX Stock
Analyst Report
0.33
DOWN
0.500
