DHX Media (GM:DHXMF) is a children's entertainment company that has added significant value through strategic acquisitions within the last two years. They produce television shows, own a library of content rights, and license merchandise based on their content and characters. Most recently they have announced an acquisition of the Family Channel and various Disney channels in Canada from Bell (BCE).
Family Channel Deal
This Family deal is hugely accretive. DHX paid 6.3X last twelve month adjusted EBITDA for the acquisition. They paid cash, much of which will be borrowed on a term loan from RBC. As the adjusted EBITDA yield of the transaction is nearly 16%, vastly in excess of their likely interest costs, a significant portion of the earnings will flow directly to the DHX bottom line. Paying for the acquisition entirely in cash keeps dilution to a minimum, and is appropriate as the company's leverage ratio will be only 3.6X EBITDA, reasonable considering the quality of the existing assets.
The Family assets are also high quality, making a 6.3X multiple cheap even before synergy is considered. Revenue growth over the past 3 years has been 7% annually, and EBITDA up 4% annually. This cash flow stream is also extremely durable, as the Family Channel has a CRTC category A "must carry" license. That means that all pay television packages in Canada must include the channel. The business has an annuity like profile as Family Channel is not advertising supported, but collects monthly fees from subscribers via their TV provider. This makes it insensitive to economic downturn. The acquired channels are biggest children's TV business in Canada, so they already benefit from scale, and will shortly benefit from production synergy.
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Source: DHX Corporate Presentation
The Family Deal has massive potential for synergy. The 4 channels purchased are large consumers of children's content, and the existing DHX assets produce children's content. Additionally, the CRTC requires Canadian content to be used, so DHX will be able to replace existing Canadian content with their own content. This has the benefit of providing additional exposure to their new shows and to their library content. This additional exposure increases the long-term value of their content by increasing its visibility for foreign sales and creating demand for merchandise based on the shows. DHX indicated on their conference call that they expect to add 1-2 of their own shows per year to their new channel line-up. This additional revenue to their content business adds significant value to the deal, over and above their bargain purchase price.
The Family deal was underpriced because Bell had to sell for competition bureau reasons, and the CRTC will prefer the business going to a Canadian content company as opposed to another large broadcaster. Because DHX does not own an existing broadcaster, they will face no competition issues, making it a clean sale for Bell. This regulatory situation deeply reduced the potential pool of buyers for Bell, explaining the bargain purchase multiple of 6.3X. Bell just purchased Family as part of its purchase of Astral, where it paid a 10X EBITDA multiple. At a 10X multiple, the acquired assets would be worth $270 million, or an additional $100 million more than DHX paid for them.
Other DHX Assets
The company's brands are long life assets; as such, its earnings are understated because they amortize their content, when that content is actually getting more valuable due to digital rights. That makes EBITDA a more representative valuation metric for the business. Content and TV businesses in Canada are typically valued in an EBITDA range of 10-12X.
However, children's content is much more valuable than adult focused content. You get a new batch of consumers every few years, so its new to the audience again, making it more valuable in re-runs. It also translates better across cultures (as an example, they pre-sold their new series "Looped" in Germany before production even started).
Additionally, there are much greater opportunities for merchandising and licensing revenue from children's content. Not many adults are going to buy a NCIS lunch box or backpack, but the Teletubbies have a whole line toys and books and other paraphernalia. DHX does not manufacture these items themselves, rather they licence their brands to third parties. The resulting revenue is extremely high margin, and adds huge value to their content properties. As the company grows the number of brands they control, they will be able to negotiate more lucrative and further reaching licensing deals.
The company owns a number of top tier brands, including Arthur, Caillou, Teletubbies, Yo Gabba Gabba, and Paddington Bear. A list of content assets is here. Their second-tier brands are especially likely to benefit from additional exposure from company controlled linear distribution. They also benefit from digital distribution, as revenue can be generated through digital distribution as "shelf space" on platforms such as Netflix (NFLX) is essentially unlimited.
Valuation
The company has consistently been able to purchase assets in the 5-6X range, with two large content acquisitions in the last two years, and now a large distribution acquisition. That justifies their current pro-forma EV/EBITDA ratio of approximately 13.5X, which is higher than typical for Canadian content and media assets. However, the profitable growth from revenue synergies, the long life of children's assets, and the potential for more accretive acquisitions by a disciplined management team justify the higher valuation. 15X EBITDA would not be an unreasonable target, for near term upside to approximately $5.70 per share. The ongoing growth in EBITDA supports share price growth from that level in the future.
DHX Media is a best in class business trading at a valuation reasonable for its quality, which should reward investors in the years to come with its excellent margins and returns on equity. The company is a prime beneficiary of the regulatory situation in Canada for television content, and will be a beneficiary of the move to digital distribution as the value of its content increases. Because they have guaranteed distribution and do not significantly depend on advertising, digital distribution would have to result in cord cutting to affect DHX, lower hours watched is not enough to hurt their revenue. And the additional value to digital distribution is significant to their large library of older programming.
The company's shares also trade on the Toronto Stock Exchange under the symbol DHX, where approximately a half million shares per day trade. That should be sufficient liquidity for the vast majority of investors, but it should be noted that the company has a market capitalization of only $573 million, which is small for its industry. This gives the company a long growth runway, but also exposes it to more risk than its larger rivals. The company reports in Canadian dollars, and all values in this article are in that currency.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in GM:DHXMF over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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