A follow up to yesterday’s post….
First, let’s get into more detail on what they really do and to find it we’ll comb the 10-K filing with the sec.
Overview
We develop, produce and distribute new made-for-television movies, mini-series and other television programming worldwide. We are the leading provider of new long-form television content, including domestic made-for-television, or MFT, movies and mini-series. We also selectively produce new episodic series programming for television. In addition to our development, production and distribution of new content, we own an extensive library of existing long-form television content, which we license primarily to broadcast and cable networks worldwide.
Our business is comprised of the licensing of new film production and the licensing of existing content from our film library in territories around the world. Licensing rights in our film library generate contractual accounts receivable. The contractual accounts receivable reflect license agreements we have entered into with third parties for rights to our film content in future periods. The ability to license our library content in this manner provides us with visibility into long-term library cash flow
Made-for-television movies
Our MFT movie franchise focuses on the production of films with dramatic, suspenseful, or more recently, action/thriller storylines which are generally two broadcast hours in length. With production costs of $1.0 to $2.0 million per broadcast hour, our MFT movies limit our financial risk with their short production cycles and pre-sales which typically recoup the majority of our cost of production. In 2007 and 2008 our pre-sales equaled 84% and 70% of our MFT movie production costs, respectively. The decline in pre-sales as a percentage of production costs reflects lower sales activity resulting from the general economic slow down in the second half of the year and our operating decision to provide exploitation windows for programming on ION Media Networks (ION) and/or pay-per-view (PPV), prior to exploitation windows on broadcast or cable networks.
MFT movies are ordered by broadcast and cable networks and have become an integral part of the broadcast strategies of these programmers. Networks license the rights to air films that meet the characteristics of the network’s genre and therefore will appeal to their viewers. In 2008, we delivered multiple MFT movies to the Hallmark Channel, Lifetime, the Sci-Fi Channel and Spike TV. In 2009, we have completed development and have begun production for several MFT movies, which have already been licensed to broadcast and cable networks.
Mini-series
Over the past 20 years, we have shaped the mini-series industry with award winning and highly-rated releases like Lonesome Dove, Gulliver’s Travels, Human Trafficking, Tin Man and Mitch Albom’s The Five People You Meet in Heaven. A mini-series is typically four broadcast hours in length and production costs are approximately $2 to $5 million per broadcast hour of content. Typically, mini-series are ordered by broadcast and cable networks on a picture-by-picture basis. In 2007, we pre-sold more than 100% of our production costs for mini-series. In 2008, the pre-sales were 80% of our production costs for mini-series, reflecting the lower sales activity resulting from the general economic slowdown in the second half of the year and our operating decision to provide exploitation windows for programming on ION as noted above.
Long-form television library
With more than 1,000 titles, comprising over 3,500 broadcast hours of long-form television programming, our library is an important source of contractual cash flow, revenue and growth for our business. Our film library is enhanced each year with the addition of new MFT movies, mini-series and other television programming as their initial licenses expire. These new productions add value to the film library and ensure that it remains current. We believe that the talent and recognizability of the actors and actresses starring in our productions, along with the subject matter, result in our library having a long shelf life. Classic MFT movies and mini-series such as Cleopatra, Alice In Wonderland, Call of the Wild, Dinotopia, Arabian Nights, Merlin, The Odyssey and The Lion in Winter are examples of our library content which have been repeatedly licensed to our customers over the last several years.
Our productions have won 105 Emmy® Awards, 15 Golden Globes Awards and eight Peabody Awards.
Now, put you thinking cap on here. The company’s top customers are the Hallmark channel and Lifetime. What risk is there that they could lose, say the Hallmark account? This why you read the 10-k notes:
On January 12, 2006, HEI Acquisition, LLC acquired all of the membership interests in Hallmark Entertainment from HEH, subject to a Purchase and Sale Agreement (PSA) dated November 29, 2005 (the Acquisition). HEI Acquisition, LLC was immediately merged with and into Hallmark Entertainment and its name was concurrently changed to RHI LLC. RHI LLC’s sole member is Holdings, a limited liability company controlled by affiliates of Kelso. (RHI owns 46% of Kelso…note mine)
The Company acquired Hallmark Entertainment in order for it to execute its business strategy. The purchase price reflects the Company’s assessment that Hallmark Entertainment could be managed more efficiently and profitably when operated independently allowing the Company to refine its business model and production strategy by focusing on the most profitable content rather than volume, broadening and diversifying the type of content that it develops, produces and distributes and exploiting new distribution opportunities.
You know the “Hallmark Original” movies you see on the channel? Yup, they make em’
A 2008 10-Q says it more clearly:
On January 12, 2006, Hallmark Entertainment Holdings, LLC (Hallmark) sold its 100% interest in Hallmark Entertainment, LLC (Hallmark Entertainment) to HEI Acquisition, LLC. HEI Acquisition, LLC was immediately merged with and into Hallmark Entertainment and its name was changed to RHI Entertainment, LLC (RHI LLC or the Predecessor Company). Subsequent to the transaction, RHI LLC’s sole member was RHI Entertainment Holdings, LLC (Holdings), a limited liability company controlled by affiliates of Kelso & Company L.P. (Kelso). RHI LLC is engaged in the development, production and distribution of made-for-television movies, mini-series and other television programming (collectively, Films).
On June 23, 2008, RHI Entertainment, Inc. (RHI Inc. or the Successor Company) completed its initial public offering (the IPO).
But in the words of Apple’s Steve Jobs “wait, there’s more”
The Hallmark Channel is owned by Crown Media Holdings (CRWN). Back to the 10-k:
On October 5, 2006, the Company entered into a definitive agreement with Crown Media to purchase Crown Media Distribution, LLC for $160.0 million (subject to certain accounts receivable adjustments). The assets of Crown Media Distribution, LLC are comprised of a completed film library consisting of approximately 550 titles and approximately 2,400 hours of programming (Crown Film Library) and trade accounts receivable.
So, you know the “Hallmark Hall of Fame” movies? Yup, they own them.From Crown’s recent 10-k
Until we sold our domestic library to RHI Entertainment LLC on December 15, 2006, we licensed our film assets to broadcasters and video distributors (pay television channel providers) who paid a license fee for the right to exhibit or distribute the programming over a certain period of time.
In short, they essentially own the content Hallmark runs on its network. Nice.
But you’ll say, “Todd, they reported a loss last year!!” Back to 10-K
We have incurred net losses in the past largely due to amortization of film production costs, inclusive of impairment charges, and interest expense on our outstanding indebtedness. During the year ended December 31, 2008, a non-cash impairment charge of $59.8 million with respect to goodwill was recorded as the result of our stock price declining significantly to a level implying a market capitalization below our book value.
Without the goodwill charge the company earned NI of $16 million or $1.23 a share.
What about that book value? As of 12/31 it stood at $7.85 a share vs a $1.89 a share stock price today or you could say the company sells at 24% of its book value.
Disclosure (“none” means no position):Will be going long RHI, none
10 replies on “The Case For RHI Entertainment”
As was mentioned on your post yesterday, from an operating stand point this one will scratch their head for a little bit and try to figure out why the hell Klarman bought into this company (and keeps upping his stake!). But after some pretty in depth analysis, it seems that what Klarman sees is what the market doesn’t: that is, their extensive library and the fact that the library offers consistent (indeed, contractual!) with almost zero marginal cost.
The company simply aims to break even or even take a small loss on their current miniseries and made for TV movies so that they can add it to the library. They then market the hell out of it and sell the foreign rights in the same year as when the domestic rights are locked up by a network or cable channel. Once the exclusive period ends with the domestic broadcaster, usually after about a year, they own the IP to go and resell to the SciFi channel, Hallmark, etc. So the production has already been expensed, and is then capable of driving sales of the library, which they do not sell a la carte, but rather sell as a package… ie, if you want access to that great miniseries that got good reviews on NBC last summer then you have to license a whole package of our library to get it. This keeps the library titles from getting stale.
Additionally, their business model seems strategically well-positioned to expand in tough economic times. That’s because they have a great track record of making productions that hit fairly high ratings, and they’re taking all of the “risk” in the production, which frees up working capital for the NBCs of the world and means that they just buy finished product.
The beauty of the model is that the “risk” that RHIE is taking on in producing their movies, etc. is largely limited by the fact that they have already sold domestic rights, and generally presell foreign rights such that the vast majority of the estimated production costs are already secured through contractual revenues. So this isn’t like a big Hollywood studio which will sink 200 Mil into a film and then hope it doesn’t flop. These guys allow the networks to outsource their programming on the cheap, while RHIE won’t take on a project until they’re already contractually guaranteed a certain percentage of the production costs. They’re aiming for bunt singles instead of home runs.
The only albatross is the high debt levels that came about due to past acquisitions. However, I believe this debt isn’t due until 2011 (that’s off the top of my head), and it’s secured by the IP in the film library which was recently valued by the lenders who gave it the thumbs up.
Management’s stated goal is to pay down debt as quickly as possible, while adding new titles to the library to increase its value and make it easier to sell.
Disclosure: I’m long RHIE.
Yep Byron. That is the case. The problem is some of us bought at 4 with that same thesis. You can say that at 2 is twice cheaper. Yes, but I am fully invested.
An important point is that the recent CC was awful. It was not the impairment charge, it was the revenues.
According to their 10Q they should have a favorable seasonality in Q4 so everyone was expecting a nice number. Several analyst were in that conference call, pretty surprising for a small cap. This was their first CC and the revenues were not according expectations. And the excuse was that they were recognized in previous quarters.
Very bad for a recent IPO.
plan, i read this different “Our revenue and operating results are seasonal in nature. A significant portion of the films that we develop, produce and distribute are delivered to the broadcast and cable networks in the second half of each year. Typically, programming for a particular year is ordered either late in the preceding year or in the early portion of the current year. Planning and production takes place during the spring and summer and completed film projects are generally delivered in the third and fourth quarters of each year. As a result, our first, second and third quarters of our fiscal year typically have less revenue than the fourth quarter of such fiscal year. Importantly, the results of one quarter are not necessarily indicative of results for the next or any future quarter.”
because of the long tail order/delivery process, a delay of 2 months on a project can easily push revenues out a quarter.
This is what I commented in GuruFocus in February:
“Reviewing the last 10Q, the amortization of film costs is 34.3M while the Net Loss was -7.2M. The maintenance CAPEX should be very low while investing 60M in new content.
Therefore it looks like a significant FCF positive company (27.1M per quarter), with stable revenues and growth potential. The main risk is their debt 569M with the first maturity in 2013.
The market cap is 48.7M therefore de EV is 618M for an estimated FCF/EV yield of 17.5%. Looks pretty good.”
Content is king. Libraries have a history of being underappreciated (Ted Turner buying MGM library, or Eisner with Disney). They can be leveraged at low cost in several formats, several countries, and generate merchandise revenue (remember Star Wars?)
And in this case this guys have a low cost, low risk way of financing it. What is not to like about it.
PD: Byron, the first maturity is 2013 (Yey!)
Todd, I might be wrong but I still have this feeling that I got suckered and I imagine the feeling of the guys that bought at the IPO.
Check the CC, my recollection is that the excuse was that there was change in seasonality and the revenues were recognized in PREVIOUS quarters, not future ones.
And this was their first financial report and first CC after an IPO! The impairment charge I believe is a non issue. Definitely strange, first 10Q and you come with this surprise, but I did not mind, but it does not affect the thesis or the FCF.
I would not be surprise if there future possibilities to increase my position. This thesis is going to need a couple of years to develop, the concept and model is not so easy to grasp, and people are going to be scared because of the debt.
that would make sense as Q1,2,3 were dramatically higher that last year….
i agree with you in that i will be adding more
Just a follow up about why Q4 was bad in 2008. Typically this is a business that takes on projects in the summer and takes in revenues in Q4.
So in a normal year, we’d expect Q1, Q2, and Q3 to generate fairly stable cash flows from the library revenue, but very little revenue from film production (while having negative cashflow for the production segment due to the costs associated with actually making the movies).
So the analysts were looking for big numbers in Q4. Well then the credit crunch hit, and it sounds like many of their clients were dragging their feet on payment and their accounts receivables spilled over into Q1 of 2009. So my expectation based on management’s comments during the last CC is that we should see higher than “normal” numbers for Q1 since it’s catching the spillover from Q4.
BTW, I’m in at low to mid $3, so unfortunately my timing–up to now, anyways–wasn’t so hot either.
yea…that makes sense on payments.
when do they report Q1?
Interesting valuation in which in a very rare occurrence, I completely disagree with all of you. The problem with this company is a very simple one in my eyes. They are Owner Earnings negative. For several years they have incurred large losses due to "additions to film production costs". $162.85 Million of "additions to film production costs" alone last year. $174.25 Million for 2007, and $155.96 Million for 2006. That's "real" cash being paid folks. That's as much money going out of the business just in that one area than what the market cap of that business even is. Not sure how any of you are missing this important piece of the puzzle but never the less, I believe any increase in value of this company will be due in large part to complete luck. All the best.
BGC,
Today I was discussing this idea with a friend that mostly buys net-nets and is very skeptical of growth stories. He did not buy my explanation and from what you have shared I do not think you are going to buy it either.
Owner's earnings does not work very well with "installed base" business models in their growth phase.
I recommend that you separate the the current library business from the growth business. For the first you can use owner's earnings (where you are not including "additions to film production costs") and the second you can evaluate using ROIC to see if you are creating value above the cost of capital with the growth capex ("additions to film production costs")