Theatrical agency Reach4Entertainment (LSE:R4E) has been one of my worst tips ever. 81p in 2007 – when the company was called First Artist has become 3.5p today. My former colleagues at a site I shall not mention decided to shoot the dog after interims on 12th September. Unlike them I have spoken to chairman David Stoller and I think they are wrong. And here’s why.
The half calendar year numbers were not impressive. Revenues fell by 13% to £34.3 million but the BITDA loss of £128,000 became a profit of £403,000. Pre-tax losses more than halved from £994,000 to £419,000. But the real issue is the balance sheet.
Debt is £14.8 million and there are two issues: banking support and a final earnout due to the sellers of the New York operation Spotco. The statement reads:
“On 29 June, the Company announced that it was in constructive discussions with vendor of Spot and Company of Manhattan Inc “SpotCo” to renegotiate the settlement of the final earn out payment due from the Company’s acquisition of SpotCo, as detailed in the terms of the acquisition agreement dated 8 August 2008.
Discussions have continued to progress towards a conclusion that is mutually satisfactory. The Directors continue to believe that a favourable outcome will occur. The Company will make further announcements as appropriate. On 23 May 2012, the Company announced that the estimated liability in respect of the total remaining deferred consideration payable had been reduced by $1.927m to $4.112m.
The Company maintains a strong banking relationship with its lenders, Allied Irish Bank and has agreed in principle with AIB (although subject to contract) a set of ratios associated with the financial covenants of the GBP14.8m revolving credit facility. The Directors are pleased with this outcome and are satisfied that these ratios are consistent with the Company’s future anticipated financial performance. “
So this is a binary play. Either Reach cuts a deal with the SpotCo seller and gets the bank to extend its banking facilities in which case we can look at it as a going concern. Or it cannot in which case it is likely that there will be a hugely dilutive fundraise or worse. After my call last night I reckon that Reach is close to announcing a positive resolution on both fronts.
So if it does do that what sort of profits could it make? Needless to say there are no broker forecasts out there so I am pretty much stabbing in the dark here but I flag 3 variables:
1. PLC costs have been slashed since the involuntary departure of former CEO Jeremy Barbera. Stoller clearly regrets bringing him in. Those savings will total close to a million but will not really come through in full until calendar 2013.
2. The core Dewynters business is trading well in London, SpotCo fairly well in NY. This year’s numbers will be second half weighted.
3. A number of new organic initiatives from Stoller are starting to kick in and will again impact 2013 numbers.
So, and I stress that this is a stab in the dark, I would expect a calendar 2012 EBITDA of £1.5 million with interest costs of £650,000). In 2013 I would be looking for £3-4 million. This is nothing like the level Barbera used to promise but it is still a decent enough showing. And at that stage Reach can start to pay down its debt.
What is the stock worth on this upside scenario? It is hard to say as there are no comparator stocks but on an EV/EBITDA multiple of 8 times bottom of the range 2013 forecasts we get a valuation of £24 million. Knock off the debt and you arrive at a value of £10.2 million or 16p a share.
This is a binary bet. Bad news on SpotCo or the banks and you lose pretty much most of 3.5p. Good news on both and you gain 13.5p. My inkling is that it will be good news and on a risk reward basis I certainly would not be selling.
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