Interesting............EdEntertainment: A fistful of dollarsA...

Interesting............

Ed

Entertainment: A fistful of dollars
A restructure of Village Roadshow's film business might finally bring some clarity to its affairs and rewards to its worried investors.

By James Thomson
BRW. 18 August 2005



The film and entertainment group Village Roadshow is about to reward its true believers. Although most institutional investors and stockbrokers have shunned the stock because of the complexity and risk profile of its businesses, a small band of supporters have pushed Village's share price up 55% in the past 12 months, to a five-year high of $3. These investors say Village is now easier to understand and the company's executive team, led by chief executive Graham Burke and majority owners Robert and John Kirby, have finally unlocked the profit-making potential of Village's film production business.

Thanks to a restructure of the film production division, Village Roadshow has as much as $310 million to return to shareholders; further profits from the production business, of up to $400 million, are still to come, thanks to films such as Charlie and the Chocolate Factory, starring Johnny Depp (see hit and miss, page 40). Many observers believe Burke and the Kirbys will soon begin the process of privatising the company to keep the film profits for themselves. But that move is far from certain - there is evidence to suggest they have more than $30 million in debts associated with their private holding companies, and reinstating Village's dividend payments could be the perfect way to create the cashflow they need. Either way, the faithful are about to be rewarded.

But all is not rosy for Village. On August 30 it will announce its 2004-05 results and analysts including Douglas Farrell of Deutsche Bank are tipping that the company will record a net profit of $42 million, compared with a net profit of $52 million in 2003-04. Farrell has also forecast that Village will report a profit of just $22 million in 2005-06, hardly the sort of trend to tempt potential investors. Yet Farrell is clearly excited about the stock's performance; he has a "buy" rating and a target price of $3.61, which is 20% above the stock's current price. Farrell is one of the few analysts who even bother to cover the stock. None of the big institutions are on Village's share registry; Barclays Global Investors is the largest institutional shareholder, with a stake of about 5%. Most of the big investors simply gave up on the company after it cancelled its dividend payments in June 2001. Village's market capitalisation shrunk from $1.8 billion in February 1996 to just $297 million in February 2003.

But interest in the company is now growing, thanks to the announcement on July 27 of a restructure of its film production division, Village Roadshow Pictures (VRP). Farrell calls it "one of the more significant [announcements] in the company's recent history". He says it finally provides some evidence of the value locked away in the film production business, which has made a string of highly successful and profitable films - with total box office takings of about $US4.7 billion - but has produced little in the way of returns to Village Roadshow shareholders.

In a complex deal, Village has given the United States film and television company Crescent Entertainment (whose backers include the legendary TV producer Norman Lear, the man behind 1970s sitcoms All in the Family and Maude) an option to acquire 50% of VRP. In return, Crescent will give VRP a $US115-million promissory note with a coupon of 8%, which will be repaid over the short to medium term by VRP (not by Village Roadshow). The net effect of all these transactions is that $200 million in previously locked-away movie profits will flow from VRP to Village Roadshow. When added to the company's cash in the bank, it will provide a handy war chest of about $310 million.


Burke, who declined to be interviewed, said at the time of the announcement that the Crescent deal was a great step forward for the company. "These are our type of guys and together we plan to take Village Roadshow Pictures to new heights," he said. "This is the beginning of not only a new expanded vision for Village Roadshow Pictures but also a whole range of expansion opportunities for the Village Roadshow Group."

The deal was also a relief for analysts such as Matthew Newham, from the financial research and services firm Fat Prophets. The firm first told its subscribers to buy Village's preference shares in late 2002, when they were trading at 73¢ (they are now trading at $2.37) and then advised them to start buying the ordinary shares in July 2003, when they were about $1.20. Newham believes the market has grossly undervalued Village Roadshow, simply because it could not understand the film production division. "Now it is only a matter of time before the company gets re-rated again."

The restructure of VRP should be the catalyst for that revaluation. The fact that Crescent is prepared to pay $US115 million for only an option to buy 50% of VRP shows that the film business is worth at least $300 million, although Deutsche's Douglas Farrell says it could be worth up to $800 million and contain up to $378 million in retained profits. Given that Village's stake in the listed radio company Austereo is worth $420 million and Village's theme-park and film-exhibition businesses are solidly profitable, there is a good case for saying Village Roadshow is worth much more than its market capitalisation of $752 million.

But there is one big question that Newham, Farrell and other Village Roadshow investors want answered: what will Burke and the Kirbys do with the company's $310 million in cash? A big special dividend to reward loyal shareholders might be the most appropriate way to spend the money, but the most likely event is a buyback of the company's preference shares. Newham says: "You have just got to look at how aggressive they have been with buybacks in the past 18 months to two years."

In July 2003, the company launched a $360-million proposal to buy back all its preference shares in an off-market transaction. But institutional investors scuttled the plan, claiming that Village's offer of $1.25 a share was too low. Village responded by launching two on-market preference share buybacks (which did not require shareholder approval) of 140 million preference shares at a cost of $170 million. About the same time, it bought about 23 million ordinary shares at a cost of $45 million. In late 2004, it launched another ordinary-share buyback, scooping up 43 million shares for $94.8 million. There are now 168.4 million ordinary shares and about 108 million preference shares on issue.

The preference shares are something of a burden to the company. Not only do they make the company's financial structure more complex, but Village cannot pay an ordinary dividend without also paying a 3¢ higher preference-share dividend. If Village can clean up the 108 million outstanding preference shares - which will cost about $250 million at their current price - it could start paying dividends on its ordinary shares. "That has always been the best way to do it," says one broker who no longer covers Village. "Get the prefs out of the way and then turn the dividend tap back on."

But some brokers doubt that the Kirby family will readily give up the profits it has amassed in its film production business. Newham believes Village Roadshow will buy back the preference shares and then launch a bid to privatise Village Roadshow. "The Kirby family knows the value of what they are sitting on. The market does not realise it," Newham says.

The privatisation theory is not new, and several of the company's actions could be seen to support it. First, there is the series of buybacks Village has launched over the past two years, which has increased the Kirby family's stake in the company from 47.7% to 63.4%. Second, the company has refused to disclose information about the state of the film business, particularly the size of the profits it has made and its market value. This has helped fuel speculation that there are huge profits locked in the production division that the Kirby family wants to keep to itself. Even the recent deal with Crescent Entertainment has only given analysts a better basis for their "guesstimates", rather than a perfect picture of the division's performance.

The third piece of evidence to support the privatisation theory are accusations that Burke and the Kirbys already run the company like a private business. The extraordinary battle between Village and a former executive, Peter Ziegler, who is suing Village in the Victorian Supreme Court for $76 million in compensation and claimed bonuses for his role in setting up $US900 million in financing for VRP, certainly supports this view. The case has provided an important insight into the extraordinary way Village has been run. The court heard tales of the use of elaborate tax schemes, of executives "sourcing OPM [other people's money] through tax opportunities and other innovative and creative ways" and of budget over-runs that brought Village's film production business to the brink of collapse in 2001. (The case is continuing.)

These are the kind of stories that could emerge if the internal workings of any company were put under the microscope. But the fact that Village did not disclose to the market the problems it was having in Hollywood in 2001 is perceived as a lack of respect for minority shareholders.

Another example of the way the Kirbys and Burke have run the company like a private business is the large salaries, despite the company's recent poor performance. In 2002-03 - the year Village slumped to its first and only loss, of $26 million - Robert and John Kirby received $1.7 million in remuneration, including a $290,000 bonus (Burke took home $1.8 million and a $290,000 bonus). In 2003-04, Robert and John Kirby received $1.8 million and a $298,700 bonus, while Burke got just under $2 million and a $298,700 bonus.

The Kirby family and Burke have repeatedly rejected the privatisation speculation and they are now receiving support from a most unlikely source, the Australian Share-holders Association. Village has been on the association's "watch list" for the past few years because of its erratic performance, but the association's director, Andrew Aitken, has been impressed by the company's recent revival. He scoffs at the privatisation suggestions. "I have asked Robert Kirby these questions directly. I really think that [the media speculation about privatisation] has gone beyond a joke."

Although Aitken's endorsement is impressive, the basis of the Kirby family's opposition to privatisation is likely to be financial. Buying back the 62.3 million ordinary shares the Kirbys do not own will cost about $185 million at the current price of $3, or about $224.9 million at Deutsche Bank's target price of $3.61. "At the end of the day, to undertake such a task would be extremely expensive," Aitken says. Maybe so, but if the retained profits in the film production business are as big as $300-400 million, the privatisation price starts to look more attractive.

What could scuttle or delay any privatisation plans are the substantial debts owed by private companies associated with Burke and the Kirby family to the listed entertainment company Amalgamated Holdings. In February 2003, Amalgamated sold its 34.2% interest in the unlisted Village Roadshow Corporation - the holding company used by Burke and the Kirby family for their investment in the listed Village Roadshow Limited - for $46 million. The stake was purchased by VRC Investment Co, a wholly owned subsidiary of Positive Investments, which is in turn owned (through a series of four holding companies) by the Kirby family and Burke and his family.

Positive Investments paid Amalgamated $20 million on the settlement of the deal and was due to pay the remaining $26 million in February 2006. But late last year, Amalgamated extended the deadline to February 2007, and Positive is now due to pay Amalgamated $28.6 million. As one analyst covering Amal-gamated points out, the Kirby family and Burke will need a source of funds if they are to pay off this debt and another $5.3 million of debt on the Village Roadshow Corporation balance sheet. "Restoring Village's dividend payments would give them the cashflow they need to meet their debts," the analyst says.

Of course, any of these options - a buyback of the preference shares, restoration of the dividends on ordinary shares or the eventual privatisation of the company by the Kirby family - will provide big gains to shareholders.

As Newham points out, the institutions on the share registry now have a better idea of what Village is really worth, and will want a fair price for their shares. "They are not going to let them privatise it cheaply," he says. "The value will have to be recognised. There will be a lot of corporate action from Village in the next 12 months."

But investors who think they can make some easy money buying Village stock should be wary. The company works in a risky industry and its management still needs to win back the trust of the market. Aitken of the Australian Shareholders Association believes Village deserves another chance. "I'm happier now with the company than I was three years ago."

But the sins of the past should not be easily forgotten - the fact remains that Village Roadshow's management has wiped more than $1 billion off the company's market capitalisation in the past decade. Investors need to ask themselves whether they are true believers.

Hit and miss

Willy Wonka has become the unlikely poster boy for the revival of Village Roadshow. The fictional character is the star of Village's hit new movie Charlie and the Chocolate Factory, which opened in the United States on July 15 and has already taken $US206.3 million at the box office. Village's second big movie for the American summer, Dukes of Hazzard, took $US38.5 million in its first week on release in the US (the film had a production budget of $US50 million). These successes are seen as further evidence that Village's hard-to-understand film production division has the potential to produce some big profits for Village investors.

Village entered the film production business in 1998, forming a partnership with the US movie house Warner Bros. The original deal was extended in February 2000, and has resulted in about 40 films. Although there have been some stinkers - including last year's Catwoman and 2002's Adventures of Pluto Nash - there have been some big hits, including Oceans 11 and the hugely successful Matrix trilogy, which took $US1.6 billion at the box office.

JAMES THOMSON

The box-office blues

Village Roadshow's film production business may have captured the imagination of the market, but it is the company's film exhibition and radio divisions that provide most of the group's profits. But there are clouds on the horizon for both divisions.

The exhibition division is expected to produce earnings before interest and tax of about $34 million for 2004-05, or about 22% of Village's total earnings. But the result will be soft. A lack of crowd-pulling movies has reduced cinema attendances over the past six months; Australian box-office revenue was down 11.5% to $397 million in the half-year to June.

The results for 2004-05 from the listed company West Australian Newspapers (WAN) do not bode well for Village's exhibition business. WAN paid $173.5 million for its half of the Hoyts cinema chain in January, but the business contributed only $1.43 million to WAN's net profit for the full year. WAN's chief executive, Ian Law, has described Hoyts' performance as "disappointing with a poor result". He said at the time WAN's results were released: "We are confident that Hoyts will turn out to be a good investment. It is just highly cyclical and dependent on the quality of films."

But exactly when those good films will arrive is not certain. A recent report on the media and entertainment sector, from the accounting firm PricewaterhouseCoopers, forecast that cinema admissions would fall 5.2% to 87 million in calendar 2005. Box-office revenue is tipped to fall 3.3% to $877 million.

Village's radio division is also under pressure. Village owns 60% of the listed radio company Austereo, which has been battling against intense competition from DMG Radio Australia, the owner of the Nova network of FM radio stations. Nova, which chases the 18-40-year-old market that Austereo has usually dominated, has stolen market share and advertisers away from Austero in the past few years, dragging Austereo's profits down from $68 million in 1999-2000 to $42 million in 2003-04.

Although Austereo's share price has had a 32% gain over the past 12 months - largely because of speculation that the company would be a prime takeover target if media-ownership laws change - analysts are nervous about the launch of DMG's second network, Vega, in Sydney and Melbourne. But a radio industry analyst, Bob Peters, says that although Vega will bring more competition to the radio industry, Austereo has a younger demographic and should not lose a big slice of its audience to Vega. "It is probably the best result for Austereo because [Vega] is not competing with its stations. The biggest hits will be taken by the local ABC stations in Sydney and Melbourne."

JAMES THOMSON