With acquisitions and restructuring which had weighed on performance a thing of past, earnings and cash flow are likely to surge.
Visual effects (VFX) in global media content is surging, with India positioned to capitalise with its offshoring advantages. Prime Focus, a Tier-1 VFX provider to Hollywood with multiple Oscar wins, is uniquely positioned to benefit. Acquisitions and restructurings have weighed on the shares thus far, but with these now behind us, earnings and cashflow should surge. We initiate at Buy with a Rs 150 price target, expecting Ebitda to nearly double by FY20e.
Visual effects in media content is surging, helped by the rising success of VFX heavy movies. Budget outlays for technology services in movies have roughly quadrupled in the past two decades. Similar transitions are now visible in home entertainment too.
Prime Focus is uniquely positioned to capitalise on these trends with its game changing acquisition of Double Negative in 2014, propelling it into Top-4 global VFX provider. Its market share within global Top-10 grossers has doubled in the past five years with marquee projects and several Oscar wins recently underscoring its talent, laying the foundation for even higher engagement with top studios. This bodes well for its creative services business (77% of overall revenue).
With its order book up 4.5x since FY14, we expect revenue to remain buoyant although capacity to deliver has limited growth of late. A better trained and a rising employee base (up 2x in FY14-17) may address this over time, allowing Prime to gain further share and break into home entertainment too. Its ability to offshore to India, which houses two-thirds of its 9,000 employees, provides margin leverage too.
The significant restructurings to support its acquisitive growth have complicated Prime’s holding structure though with multiple investors across its key subsidiaries. Strategic investors hold 57% in the list-co, for example, which in turn owns 73% of the ERP and 82% of the creative business. These have weighed on the balance sheet and cash flow too, with net debt rising to 4.3x Ebitda by FY16.
Initiate at Buy
These now appear to be behind us, though, with net debt falling and revenue and margins rising in the past year. This should bring focus back on the core business where we expect Ebitda to nearly double in FY17-20E.
We initiate at Buy.
Our 12M DCF-based PT of Rs150 implies 24x/17x FY19/20E P/E, in line with India media valuations. Risks. Dependence on key personnel at Double Negative; continued restructurings; poor cash flow conversion.
Prime Focus’ uniqueness lies in its business of providing visual effect and 3D services to Hollywood studios. Its differentiation lies in its positioning as a top-tier provider, with work on marquee global box office hits, VFX Oscar wins in two of the last three years and delivery through an offshore model. Industry trend of higher VFX spend per movie and VFX movies dominating box office are incremental positives. At the same time, acquisition-led strategy and corporate restructurings have impacted margins, complicated the holding structure and increased debt. However, we believe that these changes are now behind the company, with the platform set for growth and margin expansion. We forecast a 16%/23%/27% CAGR for FY17-20E revenue/Ebitda/EPS. Our 12M PT of Rs 150 is based on DCF and implies 24x/17x on FY19/20E EPS.
Top tier provider on VFX and 3D services
The creative services business segment (70% of Ebitda, `250mn revenue +18% y-o-y in trailing 12M) provides VFX and 3D for movies. Acquisition of Double Negative in 2014 was a game changer. According to company’s estimates, it had a 40% market share in VFX/3D for Top-10 Hollywood films in 2016 vs 20% in 2011. Oscar wins in two of the last three years has boosted order book by 80% y-o-y.
Company description: Prime Focus Limited (PFL) is one of the world’s largest independent integrated media services companies. It employs over 9,000 professionals in 15 cities across 4 continents and 6 time zones. It provides end-to-end creative services (visual effects, stereo 3D conversion and animation), technology products & services (Media ERP Suite and Cloud-enabled media services), production services (equipment rental) and post-production services (Digital Intermediate and picture post) to the media and entertainment industry.