Entertainment One — Update 11 December 2015

Entertainment One (eOne) produces and acquires entertainment content rights for exploitation across all consumer media throughout the world. It is one of the largest independent global distributors of films with a multi-territory network covering the UK, Canada, Benelux, the US, Australia and Spain and partner operations elsewhere. It is the leading independent television producer and distributor in Canada, with operations in the US and UK; as well as scripted and non-scripted programming, its Family content includes the UK’s number one pre-school property, Peppa Pig. It also owns North America’s largest independent music label. Its content library is valued at over $1bn and includes over 40,000 film and TV titles, 4,500 hours of TV programming and 45,000 music tracks. eOne is headquartered in Canada and has more than 1,300 employees.

eOne’s portfolio is now tilted towards the higher-growth areas of Family and TV, which will account for c 60% of pro forma EBITDA in FY16, and we forecast strong EBITDA growth over the next few years as the group profits from this improved balance. In FY17, Family will benefit from the extra share of Peppa Pig, where we expect ongoing strong growth as the brand is developed in the US, China and Latin America, and in Television there is a very strong pipeline that includes new commissions from Mark Gordon (MGC). While Film is fairly mature, we forecast that it will become increasingly cash generative and the improved film slate expected next year should mean overall growth for the division despite headwinds from declining DVD sales. Consequently, the cash conversion profile should also improve.

The dilutive impact of October’s 4 for 9 rights issue and the new £285m of senior secured notes mean that much of the EBITDA growth will be absorbed at the EPS level over the next two years and we have downgraded FY17 EPS by 7%. However, eOne’s overall growth profile now looks more durable – we introduce a diluted EPS estimate of 23.1p in FY18 (up 13% on FY17) – and the refinancing puts eOne in a stronger position to continue execute on its successful ‘buy-and-build’ strategy. We forecast net debt to decrease from £328m at September 2015 to £255m at March 2016.

eOne offers investors exposure to a balanced, global entertainment content group, which has consistently executed to strategy. Following recent acquisitions and financing, the balance and structure of the group has improved and the growth profile looks secure. On most metrics the shares look good value; its FY17 P/E and adjusted EV/EBITDA multiples of 7.8x and 6.9x respectively are at a c 50% and c 40% discount to peers.

Our reverse DCF of the current share price implies 2020 EBITDA 30% below management's target to double the size of the group by 2020, suggesting that the market is sceptical. However, we believe it is now in a better position to do so and the recent share price weakness presents a buying opportunity ahead of what looks set to be a stronger FY17.

Results fluctuate with the timing and success of releases, although eOne has a fairly broad portfolio. The shift to digital presents opportunities (SVOD deals) but also challenges (falling DVD sales), although eOne has equal exposure. Its television business would be affected by changes in the Canadian funding environment. It has translation exposure to currency movements, notably the C$ (33% of revenues). Transactional exposure (eg minimum guarantees in US$) is hedged.

Entertainment One (eOne) produces and acquires entertainment content rights in film, TV and music for exploitation across all consumer media platforms throughout the world. It is one of the world’s largest multi-territory distributors of films with market-leading positions1 in the UK, Canada, Benelux, the US, Australia and Spain as well as partner operations elsewhere. In TV eOne is Canada’s largest independent television producer and distributor, it has sizeable operations in the US and international distribution from the UK. As well as producing and acquiring scripted and non-scripted programming, its Family content includes the UK’s number one pre-school property, Peppa Pig. It also owns North America’s largest independent music label, eOne Music.

The group reports across two divisions: Television (which also includes Family and Music) and Film, which we estimate will contribute 58% and 42% of EBITDA respectively in FY16 on a pro forma basis. In FY15, Canada contributed 33% of group revenues, the UK 25%, US 19%, Europe 14% and RoW the balance. eOne is headquartered in Canada and has more than 1,300 employees.

eOne’s executive team is highly experienced, ambitious and well incentivised. CEO Darren Throop has been involved in the entertainment industry for over 20 years. He joined Entertainment One in 1999 and became CEO in 2003. CFO Giles Willits joined its executive board in May 2007 having previously been director of group finance at J Sainsbury. The head of Film, Steve Bertram, joined in September 2014 from DreamWorks, where he led new business development and operations. He has more than 20 years’ experience in the industry, as does the CEO of the Television group, John Morayniss, formerly head of television at Alliance Atlantis. Allan Leighton joined as chairman in March 2014; he has held a very wide range of roles including CEO at ASDA, chairman of Royal Mail and lastminute.com, and non-executive director of British Sky Broadcasting. Detailed biographies are on page 16.

eOne’s mission is ‘to bring the best content in the world by being a true partner to the best creative talent…and the world’s leading distributor through a locally deep, globally connected network’.

The group has an impressive record of growth; over the five years to 2015, revenues and EPS doubled and underlying EBITDA more than trebled (Exhibit 1). Up to 2014, most of the growth was driven from Film, eOne’s original focus. Economies of scale are significant in the film industry and the FY13 acquisition of Alliance Films was transformational for the group. It added 60% to Film division revenues, and the reach and scale it brought has enabled eOne to improve the margins and cash conversion.

In November 2014, eOne unveiled its new strategy, to ‘double the size of the group in the next five years’. We have interpreted this to mean to double EBITDA to c £200m by 2020.

In Film, opportunities remain for geographic expansion and there is some scope for further margin expansion from increasing scale economies and the transition to digital (management targets 100bp over the next three years). However, in its core English-speaking markets, the Film division has reached critical mass and is relatively mature. The emphasis on growth is now on Television, Family and digital, to build a more balanced brand and content business, and to capitalise on the digital-driven structural shift in the entertainment market. Although there are many synergies between eOne’s Film, Television and Family divisions, the growth characteristics are quite distinct (Exhibit 2).

Acquisitions have been an important part of eOne’s growth strategy, supplementing organic growth and enabling the group to tap into scale economies. Since announcing its new strategy, eOne has made two key strategic acquisitions in the TV and Family divisions and is well on its way to achieving its goal. The Film/TV EBITDA mix was 64/36% in FY15 – we are forecasting this to shift to 39/61% by FY18.

MGC: In January 2015, eOne acquired a 51% stake in the US TV and film production company the Mark Gordon Company (MGC). Its content portfolio includes over 40 feature films (including global hits such as Speed and Saving Private Ryan), and eight TV series (including Grey’s Anatomy, Criminal Minds and Ray Donovan). The acquisition has brought to eOne not only scale and content that it can leverage through its international distribution network, but also important relationships with US networks and has considerably raised eOne’s profile internationally. Led by the award-winning producer Mark Gordon, eOne believes the division will also act as a creative hub, helping to attract additional talent and partnerships.

ABD: eOne acquired 70% of ABD (Astley Baker Davies), which controlled the 50% of the Peppa Pig ownership rights that were not already owned by eOne. The deal took eOne’s participation up to 85% from 50% and was a logical next step to ensuring complete brand development and monetisation control over its largest ‘Family’ asset as it enters an important growth phase internationally.

The Film and TV industry increasingly overlap: talent works across both segments and film and TV content may also be distributed through the same channels or platforms. For the consumer, the way that audiences treat film and TV is also becoming blurred – the release of the entire series of House of Cards on Netflix is a good example of this, enabling ‘binge viewing’ of series, akin to watching a film. As Kevin Spacey surmised in his key note speech at the Edinburgh Film Festival in 2013, "the device and length of content is irrelevant…audiences just want stories…and they want the control over how they access those stories".

The major film Studios (‘Majors’) and the large TV Networks operate vertically integrated models and manage their own production and distribution. Smaller independent producers draw on the expertise of independent distributors, like eOne, to manage the exploitation of their content.

Film and TV distribution: Film and TV content can be acquired at festivals around the world (eg at the Cannes Film Festival or MIPCOM for TV), via strategic partnerships with producers, or via sales agents. For film, distributors acquire the rights to exploit a film in certain markets by paying a minimum guarantee (MG) to the producer, prior to production. They recoup this investment by selling across many media channels, including cinema, TV, DVD and digital platforms such as downloading and streaming. Once the investment in content acquisition and P&A (print and advertising) is recouped, distributors may share any profits (or ‘overages’) with the producers. In general it takes around a year for a film distributor to recoup its investment and while rights tend to be bought for periods of 15-25 years, the vast majority of revenues are made in the first release cycle of around three years. For TV distribution/international sales the model is similar, although instead of the distributor paying an MG to the producer, in TV a licence fee is paid by the broadcaster to the producer and there is, of course, no theatrical release.

Production: independent studios such as eOne never begin production of TV and filmed entertainment until a high proportion of the budgeted production costs have been covered. For film, this will come in the form of MGs from distributors as outlined above and potentially also from broadcast pre-sales agreements. TV content tends to be financed by ‘interim production financing’ structures once commitments from broadcasters have been put in place. eOne draws on a number of government-backed schemes in Canada (where it qualifies as a Canadian certified content producer) and elsewhere, to cover a significant share of its production costs. In TV, eOne typically only ‘green-lights’ production once 85% of the production costs have been covered, significantly reducing production risk.

New OTT platforms are taking share of audiences…

The film and TV markets are being disrupted by over-the-top (OTT) services that give consumers the opportunity to stream, catch up and view content on mobile devices. Subscription video-on-demand (SVOD) providers such as Netflix, Hulu Plus and Amazon Prime offer customers a library of films for rental with a stock of TV content across multiple genres, often featuring recurring scripted series. These platforms have grown rapidly and according to Digital TV Research claim c 117m subscribers globally, compared to Pay TV’s 900m, forecast to grow to 249m homes by 2020. In reaction, most traditional Pay platforms and the leading TV channels have launched their own services (eg Sky’s Now TV, ITV Player, HBO Now, CBS All Access, DISH’s Sling TV) and a slate of other companies are also introducing services (Singtel, Sony, Disney, Warner Bros and Samsung). Strategy Analytics predicts that subscriptions from OTT providers such as Netflix and Amazon Prime will generate $55.6bn in revenues by 2019, up from just under $18bn in 2013.

…driving increased demand for TV content…

In Film, the effects are seen in the rapid growth of digital revenues, which is close to offsetting the declines in DVD sales (Exhibit 5). The impact is arguably even more profound in TV. SVOD platforms are priced below traditional Pay TV packages, leading to concerns that subscribers will either churn out or down (‘cord-cutting’), and that the mass audience appeal of leading channels may be diluted if viewers wait to watch premium content over SVOD services. Pay and Free TV operators have to raise their game, which, as well as providing the ‘me too’ services outlined above, means the need to invest in more high-quality programmes. As well as competing for much of this content, the larger SVOD services are also starting to commission original, exclusive programming (House of Cards and Orange is the New Black). This competitive tension is driving demand for high-end TV content, which is being used as a key platform differentiator (Exhibit 6).

…and consolidation in the TV and film markets

Film companies, keen to leverage their extensive distribution networks and gain exposure to the fast growing TV segment, are expanding into TV content production and distribution. However, the shifting sands in the TV market have also been a catalyst for consolidation in the TV production industry; large networks favour companies that can guarantee a steady stream of content and ideas, and global OTT platforms need formats to offer customers across many geographies.

eOne is well positioned in this evolving ecosystem. Its higher-growth and higher-margin Television and Family divisions now account for over one-third of revenues, but more than 60% of EBITDA (FY16e pro forma) and it recently reorganised its international sales division to bring its TV and Film sales under one umbrella to exploit synergies across its large and growing TV network. It has agreements in place with all the key digital channels: Netflix, Google, Amazon Prime, YouTube, Hulu, iTunes and blinkbox, and digital accounts for 23% of its revenues.

eOne has grown its TV operation to create a significant business in both production and sales. It is Canada’s largest TV producer and also has sizeable operations in the US through Mark Gordon (MGC). As well as developing its own content, eOne partners to secure access to third-party content for distribution. Important agreements include its output deal for all original scripted series with the fifth ranking US cable network AMC (to 2017), El Rey and Sundance, which provide a steady stream of content for international distribution, including recurring series such as The Walking Dead, Into the Badlands and Turn. This year it has also put in place first-look deals with producers Mark Ford and Kevin Lopez (Creature Films) and partnerships with award-winning producer Ilana Frank (ICF FILMS). Around half of eOne’s TV content is on seasonal renewals and its library of over 4,500 hours of TV content includes high-profile recurring titles such as Haven (in its sixth season on ABC), Saving Hope (season four), Coldwater Cowboys (season two) and Rookie Blue (sixth Season on ABC), which it sells to over 500 broadcasters in 180 markets.

Capitalising on a strong demand for television content, eOne is increasing investment in TV and this year is targeting over 1,000 half-hours of programmes (from 572 in FY15). It made two small acquisitions mid-2014 to strengthen its non-scripted entertainment: Paperny Entertainment Group for £15.1m and Force Four for £6m. However, the £86.3m acquisition of a 51% stake in MGC in December 2014, an LA-based production company with strong relationships in the US, represents a step change in the business’s development. The acquisition (which is now fully consolidated) has increased the pro forma EBITDA of the TV production and sales business by approximately two-thirds and has significantly improved eOne’s standing in the all-important US market as well as providing access to high-quality content from one of the industry’s most prolific producers.

In the past, MGC delivered production ideas (and rights over them) in return for ‘participation payments’ from its partner, ABC, which would then produce them. Moving forward, the new venture will continue to receive these payments. However, for new productions, it will move to a more classic model, where it produces its own ideas, which eOne will distribute (and monetise) via its international network. This enables a wider development remit (it is no longer restricted to ABC’s target audiences) and will add significantly more leverage for successful shows. To put this in context – the current formats developed by the MGC for ABC (including Grey’s Anatomy, Criminal Minds and Ray Donovan) are worth well over $1bn for ABC, yet we estimate MGC revenues of only $25m in FY14e. Mark Gordon is tied in for seven years and at eOne’s capital markets day (8 October) he shared some of his new ideas. He is currently developing 30 new projects – only a fraction of these will be ultimately be commissioned, but three have already received the green light by major US networks, to be broadcast next year.

The Family division creates, produces, distributes and licenses children’s programming and brands worldwide. Its cartoons are sold to over 500 broadcasters across 180 territories, creating and reinforcing the brands that generate licensing and merchandising royalties. These royalties generate the main profits of the division through the sale of a wide range of products including toys, books, bags, apps and DVDs. EBITDA margins are thus very high – 78% pro forma in H116. Its main asset is ‘Peppa Pig’, which we estimate accounts for c 85-90% of divisional revenues.

Peppa has had phenomenal success: over 200 five-minute programmes of Peppa have been produced since 2004, it is aired by 250 broadcasters and over 800 merchandising licences have been sold this year. Peppa is now the number one pre-school programme in the UK, Spain, Brazil and Mexico, and on the back of Peppa, Family division revenues have increased four-fold over the past four years. While the brand is maturing in some of its early markets, there remains plenty of scope to drive strong growth internationally. Exhibit 9 summarises Peppa’s current penetration and shows that in some of the largest toy markets in the world (US, China, Germany and Japan), its potential is only just starting to be tapped. Management believes Peppa can double retail sales to $2bn by 2020 (from $1bn in 2015, $250m five years ago).

Near term, we see the largest potential in the US where merchandising to date has been deliberately low-key to fully embed the brand. After four years in development, Peppa is now one of the top-rated children’s shows on Nick Jr, aired seven days a week in prime slots, and Forbes named Peppa as one of Google shopping’s top 10 children’s brands in 2014. With ‘pent-up’ demand for merchandise, eOne is ramping-up its US merchandising offerings through Toys R Us, Walmart, Amazon and Target this Christmas, and expects the US growth profile to follow that seen in the UK as the range of merchandise expands during 2016. In Germany and France, eOne plans to start a mass roll-out from spring 2016, while in China, TV broadcasts started on CCTV (state broadcaster) in June 2015, to be followed by a merchandising roll out through Toys R Us.

To fully control the development of Peppa, in October eOne increased its stake in the rights from 50% to 85% via the acquisition of a further 35% stake from its partners ABD for £140.5m. In parallel, ABD has committed to produce a further 52 episodes. The acquisition gives eOne full control over brand development and monetisation, which will allow it to fully align its development with its strategy and other parts of the business, for instance by developing a Peppa Pig film.

In addition, eOne is developing some promising newer formats: it co-owns (with ABD) the rights to Ben and Holly‘s Little Kingdom, which has high ratings in the UK and is gaining traction in Spain, Italy, Germany and the US and where it is expanding merchandising this year to all markets. It has also recently launched PJ Masks (pre-school boys) on Disney Junior in the US, which delivered strong ratings and which will now be rolled out across the Disney Junior Network globally. It is also currently working on new series Winston Steinburger and Sir Dudley Ding Dong, co-produced with Teletoon Canada and ABC3 Australia for broadcast in Australia in January 2016.

eOne Film is one of the industry’s largest independent multi-territory film distributors (‘indie’) with strong market positions in Canada (20% 2 share of box office), the UK (10%), Spain (6%), Benelux (5%), and Australia, as well as distribution partners in France, Germany, Scandinavia, and South Africa. It also owns a sizeable physical distribution business in Canada and the US, and is moving up the value chain with a growing volume of sales and production.

eOne’s core markets cover 15-20% of the global box office. They are mature, but increasingly cash generative with the proportion of revenues derived from high-margin library titles increasing and content investment broadly matching amortisation. eOne’s strategy for growth is to shift upstream (more co-production and production), to control more content intellectual property and to develop new partnerships with creative talent (the ‘Hollywood Reporter’ recently suggested that it might take a stake in Stephen Spielberg’s DreamWorks Studios). It recently launched Momentum Pictures to distribute multi-platform content in the US and globally and it continues to explore acquisition opportunities to expand into new high-growth markets in Europe, Latin America and Asia.

eOne also owns a sizeable physical distribution business in Canada and the US, which handles its own content (film and television DVDs and Blu-ray), and provides distribution and internet fulfilment services for other entertainment companies. We estimate that eOne Distribution’s revenues make up about 25% of the Film division total. In Canada, eOne dominates the non-direct market (ie excluding the studios’ direct sales to major stores such as Walmart). The business is in managed decline due to the shrinking DVD market, but costs are strictly controlled and it remains cash generative. It also provides helpful market intelligence to the wider group.

Following the Alliance Film acquisition in January 2013, which brought key skills and relationships, eOne Features was established, which aims to produce four to six mid-budget ($10-15m) films a year. Being involved in a film’s creation at an earlier stage gives better access to content for more territories, and potentially higher margins. The risk around eOne Features is the same as for the rest of the distribution business as scripts are not ‘green-lit’ unless eOne film, on an arms-length basis, would be prepared to bid for the distribution rights across its five territories. The advantage to eOne is that if all five of its territories are prepared to offer a MG, it is strongly placed to negotiate a position as ‘executive producer’, which makes it an equity partner in a film giving greater exposure to any upside outside its own distribution markets. While this remains a small part of eOne’s overall portfolio of releases, with only a few films a year being production-financed (out of the total of c 210 releases in FY16), it has had notable success with the Insidious franchise. Releases over the last 12 months (Suite Française, The Woman in Black Angel of Death, Insidious: Chapter 3 and Sinister 2) have taken $181m at the global box office to date.

eOne Music is one of the largest independent music labels in North America, covering a broad range of genres from gospel, R&B and contemporary Christian music to classical, rock and metal. It is fairly small in the group context, with estimated revenues of c £38m and EBITDA of £1.5m (both of which fluctuate slightly with the timing of releases). About 70% of sales are digital and despite the ongoing hiatus in the music industry, it has delivered a fairly stable underlying revenue stream over the last few years and is well-positioned in its market.

We expect eOne’s record of strong EBITDA growth to continue, with the dynamic shifting from Film to higher-margin TV and Family. We forecast a three-year CAGR in EBITDA and normalised EPS respectively of 17% and 4%, putting the group on track to deliver on its goal to double the size of the business by 2020 (in EBITDA terms). Forecasts broadly reflect the following dynamics:

H116 results (Exhibit 13) clearly show the benefit of having a more balanced portfolio of content across the group. In a difficult market for film, where many indies are holding back films rather than compete against the ‘tent-pole’ releases from the majors (Jurassic World) in H116, James Bond’s Spectre and Star Wars in H215, eOne grew overall revenues by 2% to £337.1m (+1% pro forma), with strong growth in TV (+77%) and Family (+4%) offsetting a weak film (-14%) performance. EBITDA increased by 43% as the mix moved more towards the higher-margin divisions, including the consolidation of MGC and Peppa Pig (royalty savings from 1 April), but was 5% lower on a pro forma basis. Adjusted EPS increased by 19% to 9.3p (after higher non-controlling interests).

We update forecasts to reflect a stronger TV performance this year and the weaker film slate. While this results in a significant cut to our revenue estimates, the shift in business mix to the higher-margin TV and Family divisions means little change to EBITDA. However, the dilutive impact of last week’s issue of £285m of senior secured notes (detail on page 12) results in a cut to our FY17 EPS estimate by 7%. We also introduce FY18 forecasts.

The 2015 market for independent film has proved to be poor as producers opt to hold back distribution of films rather than try to compete at the cinema with an unprecedentedly strong slate from the majors (Jurassic World, Spectre and Star Wars). eOne released only 96 films to cinema in H116 (vs 134 in H115) and expects 210 for the full year (227 in FY15). Home entertainment, broadcast and digital sales are also weak as the industry suffers from the hangover of a poor release schedule across the industry in 2014. Looking to the second half, with the new Star Wars set to be the largest grossing film in history, eOne again anticipates a soft winter season. However, the flip side of this is that next year should see a considerable pick-up in independent film activity across the industry and, according to CEO Darren Throop, is set to be the biggest theatrical release slate in eOne’s history. This is likely to be offset in part by headwinds in home entertainment (which is fed in part by prior year cinema releases), but overall we expect investment to bounce back to £180m in FY17 (£140m forecast for FY16), driving a return to revenue growth in the division of 7%.

TV production and sales had an excellent first half year. Boosted by the three acquisitions in TV (Paperny, Force Four and MGC), 442 half hours of programmes were acquired or produced, a considerable step up from last year’s 245 (pro forma) and management is targeting over 1,000 for the full year (572 in FY15). Except Rookie Blue, most of its own produced series have been renewed and its international sales division continued to perform very well: The Walking Dead is moving to a seventh season, making it a good contender for syndication, and spin-off Fear the Walking Dead opened very strongly. In distribution, two new series have been commissioned (Into the Badlands for AMC and Hap and Leonard for Sundance) and the group continues to put in place additional partnerships, including a new multi-territory deal with Amazon Instant Video. At its H1 results, Mr Throop stated that it is seeing a huge demand for high-quality programmes.

Management expects to invest £120m in the full year (up from c £103m in FY15) and we expect investment to step-up in FY17 (to c £160m) as it starts to deliver on the development work at MGC (we assume one new series a year is delivered from FY17) and its own strong pipeline. EBITDA margins will see a step increase in the current year (from 11.1% in FY15 to 18.3% in FY16e) as it consolidates the participation payments from MGC (c 80% EBITDA margin), but as MGC transitions to a more classic model we would expect to see a gradual normalisation of the margin over time towards 17% as new production business (higher revenue, lower margin) takes a greater share.

Growth in Family revenues can be lumpy depending on the timing of a roll-out to new markets. 5% revenue growth in H1 should be taken in the context of a difficult basis of comparison (FY15 revenue growth of 71%) and we expect a similar performance in the second half of the year before accelerating again into 2017 as the international roll-outs, particularly in the US, start to contribute. eOne has always acted as principal with regard to Peppa’s distribution, so there was no change to our revenue forecasts when the interest increased from 50% to 85%. Previously it took a distribution fee and recouped its sales and marketing costs before splitting the resultant net profit 50/50 with ABD. The terms of the transaction meant that the royalty savings have been recognised from 1 August 2015 (our Update report of 2 October assumed it would be from October, when the deal completed). As a result, the H116 Family EBITDA margin was 67% (77% pro forma) vs 38% in FY15.

Our assumptions are presented in Exhibit 13, and in full at the back of this report.

Both the film and TV models tend to be cash-negative in the year of release: acquired content is amortised against anticipated revenues, which as a rule of thumb translates to c 65-70% in year one and most of the balance in year two, while the MG and print and advertising costs (P&A) are all expensed on release. Accordingly, in a ‘big year’ for film, or a growth phase, the EBITDA:FCF conversion will be fairly weak. eOne’s film division is relatively mature and consequently free cash conversion has been increasing. TV, on the other hand, continues to expand (ie investment will exceed content amortisation), although with a shorter payback than film. Consequently, across the entire portfolio we would expect to see an improving FCF conversion profile (Exhibit 11, page 10).

In FY16 we forecast total investment in content and production of £260m (£120m TV, £140m Film), down on last year due to the pullback in Film. We expect this to step up again in FY17, with a stronger film slate and the ongoing expansion of the TV division and initial commissions at MGC.

Net debt at 30 September was £328,7m, (including £78.7m of interim production financing). In October, eOne completed a 4 for 9 rights issue, which raised £192m net of expenses. Of this, £140.5m was used to finance the acquisition of ABD, with the remainder providing the business with the flexibility to invest and acquire. This, together with the normal seasonal cash inflow in H216, means that we expect net debt at 31 March 2016 of £255m (March 2015: £314m), leaving FY16e net debt/pro forma EBITDA leverage a comfortable 1.9x. Post the rights issue we forecast net assets to increase to £599m at year end FY16 from £382m at 30 September 2015.

On 11 December, eOne will issue £285m of secured notes (at 6.875%, maturing in December 2022). It also plans to put in place a further £100m revolving credit facility. These facilities are intended to replace those that expire in January 2018 (comprising three loans for £74m and a £232m revolving credit facility with an average cost of c 4.5%). While a higher interest charge, there should be savings in terms of banking fees moving forward as the notes have less restrictive covenants, proving greater flexibility in terms of deployment.

Since the announcement of the ABD deal and accompanying rights issue (which we estimated was 8% dilutive to earnings in FY17), eOne’s share price has come back considerably, providing an excellent opportunity to buy the shares.

Considerable discount to peers: At the time of writing (share price 159p), eOne’s P/Es of 8.0x (FY16) and 7.8x (FY17) are at a 60% and 40% discount to peer averages respectively. Adjusted EV/EBITDA (we proportionately adjust EBITDA for our estimate of the MGC and ADB non-controlling interests) at 8.2x (FY16) and 6.9x (FY17) also compares favourably to the peer averages of 12.9x and 11.4x.

DCF implies slowing growth: To achieve its objective of doubling the size of the business by 2020 (to an EBITDA of c £200m), eOne will need to deliver a 10% CAGR in revenues with margins broadly stable from the pro forma 18% we forecast in the current year. Under this scenario, our DCF returns a value of 284p (assuming a WACC of 10.5% and a perpetuity growth of 2.5% after five years), whereas the current share price (159p) is discounting 2020 EBITDA approximately 30% below target at c £150m, which would be achieved for instance with revenue growth of 3% and EBITDA decreasing by 2.5 percentage points.

Library value: eOne’s library is independently valued by FTI Consulting, historically conducted for banking purposes. Its latest valuation of over $1bn (WACC 8.3%) includes the value of the library from MGC, but does not yet include the additional 35% of Peppa. The valuation also excludes the value of eOne’s extensive distribution network.

Entertainment content: Returns on investment (both for new content and library titles) depend on a variety of factors including audience taste (both for specific titles and for alternative leisure activities) and the strength of consumer spending. Results fluctuate according to the number, timing and popularity of releases. eOne has a broad spread of releases, which gives a portfolio effect but while it is not hit driven, the success or otherwise of some of the bigger titles could influence results.

Shift in delivery mechanisms: DVD sales account for 25% of eOne’s total sales, but are declining at c 10% a year in eOne’s main markets. Digital sales are compensating for this at the EBITDA level, and competition for content by both film and television platform owners is positive. However, eOne’s results may differ from our estimates if DVD markets shrink at a greater or lesser rate than we anticipate and depending on the extent to which eOne can manage the decline and possibly also grow its market share.

Competition: eOne’s competitors include the large and well-funded US film majors. They compete both for content and for talent, but eOne has established strong relationships as a successful new operator over the past eight years.

Other business and financial sensitivities: eOne’s film output agreements accounted for 24% of its film releases in FY15 and it could be affected if the contracts were not renewed or replaced, as might the TV division in respect of the AMC deal, but its strong relationships and growing international spread put it in a strong position. eOne’s television and film production utilises interim production finance and would be affected by any change in availability or cost (but this has not been an issue to date). eOne’s Canadian status allows it to utilise certain government incentive programmes and tax credits to finance a proportion of its production budgets, while its content includes programmes certified as Canadian (or Cancon); hence it would be affected by any change in status or the Canadian regulatory environment, although none is expected. eOne’s strategy includes acquisitions, but risks are mitigated by its clearly defined investment criteria and procedures and management’s depth of experience; past acquisitions have all been successfully integrated.

Currency: As an international business, eOne has some sensitivity to currency movements, both translation and transactional (eg MG guarantees are often denominated in US$). It uses forward contracts for significant transactions where there are highly probable forecasts (mainly MG payments) and there is some natural hedging (matching costs and debt with assets).

Share structure: eOne’s original backer, Marwyn Value Investors sold down its entire stake (26.9%) during 2015 with 9% placed with institutional investors in July and the remaining 17.9% acquired by the Canada Pension Plan in September. This removed a share overhang, with the Canada Pension Plan having a track record of focusing on the long term success of the companies in which it invests.