MM2 Asia: The forgotten COVID reopening trade

The last year has created an almost unprecedented environment of winners and losers - distortions of the playing field never seen before. There have been the stay-at-home stocks, the reopening stocks, meme stocks and the inflation trades. Developed markets have been eager to ‘look through’ short-term disruptions and price-in a full recovery. While in some emerging markets the struggling companies have been left behind. Mm2 Asia Ltd. is one of those companies.

As a successful film production, live concerts and events, and leading cinema business in Singapore and across Asia, mm2 has grown revenue from S$38.4 to S$268.7m in the 5-years leading up to COVID:

• The core business of film and content production grew from S$29.8m to S$78.7m over the same period due to the burgeoning demand for local content particularly in the Taiwan and Hong Kong markets.
• The cinema business built a strong position as a leader in Singapore and the third-largest player in Malaysia. Through acquisitions, these grew from S$4.8m to S$101.1m in turnover during the same 5-year period.

During its rapid growth, mm2 had accumulated debts of almost S$342.7m as of March 20 compared to next to nothing, just a few years earlier. The borrowing facilitated growth in the production business to meet demand from content companies and Southeast Asian distribution through the cinema business. The business was just gathering the momentum to reach escape velocity (read as: begin repaying their debts) when COVID hit and led to rolling travel restrictions and a domestic lockdown.

As production sets were shut down across Asia and cinemas closed during Singapore and Malaysia’s lockdowns, revenue fell more than 90% during 1H21 (March – Sept 20). The remainder of 2020 was not much better for mm2 with only limited cinema openings and major operational limitations in the production business.

Between the beginning of 2020 and early 2021, the share price fell 75% and the company was in a semi-distressed state, having announced a deeply discounted and fully-underwritten rights-issue to repay debt obligations.

At its nadir, the share price reached S$0.055 immediately following the rights-issue in April, down 85% from the 2017 high. However, somewhat inline with the expression that its always darkest before dawn, the right-issue was a watershed moment for the company and significantly ‘derisked’ the pathway to recovery.

While near-term revenue was volatile, we took the view that liquidity risks were now behind the company and despite little visibility on earnings, there was a clear plan to realise value through a spin-off of the cinema business which meant investors participating in the April rights issue at $0.065 were effectively getting the fast-growing and profitable production business for free.

The company’s full-year results were released earlier this month and revealed a much stronger financial position following the rights-issue and retirement of the medium-term note, partly helped by better than expected operating results in the Cinema and Film production business.

UOB Kay Hian which recently initiated coverage of the company offered these comments following the full-year results:

(full note available here)

As we’ve seen in Europe and The United States, the reopening of economies is inevitable and living with COVID just a part of life going forward. Asia has been behind in reopening, with the most vulnerable populations and inadequate healthcare systems. Over the weekend, Singapore unexpectedly announced that they’re planning to ditch border restrictions, quarantine requirements under a policy change that would see no goals of zero transmission and us live with COVID like any other endemic disease.

This shift is a major development for mm2, which was still operating with the risk of snap lockdowns that would impact the domestic cinema business in particular, which is now just breaking even. Furthermore, it seems like this will open Singapore as a hub for regional concerts and events, as the company has highlighted on the most recent earnings call.

mm2 still trades at a distressed valuation, however, confirmation of the company’s recently improved performance is likely to be what this stock which has been left behind needs to catch up.

Our report on the company is accessible here.

Company materials and other analysts reports are available on their IR website.

SPINDO: from deep value to rapid growth

The transformation of a little know play on Indonesia’s infrastructure growth

How much do you think the producer of almost half of the steel pipe in Indonesia, the world’s fourth-most populist country, is worth? I doubt many investors would guess that it’s just US$100m, however, that’s the current market cap of The Indonesia Steel Pipe Company (ISSP IJ) or "SPINDO", which produces around 40% of Indonesia’s steel pipe that is used in automotive, energy, building and infrastructure projects.

Despite their significance to the construction of a growing Indonesia, the company is little known even to local investors which sets the stage for this 'value stock' to enter a cycle of rapid earnings growth.

We have closely followed SPINDO since 2018 and our original thesis ‘A Strong Recovery’ published in October 2019 was based on efficiency gains and higher value product mix improving gross margins while restructuring the balance sheet will further drive earnings growth.

While the onset of COVID delayed a transformation that was already underway, the subsequent economic stimulus through infrastructure spending has created a market environment that is accelerating SPINDO’s transformation beyond our original expectations.

Our latest thesis ‘Transformer’ has been updated following the publication of the company’s FY20 results and inaugural conference call earlier in April to reflect the current landscape and positive outlook.

While net margins have already recovered from an FY18 low of 1.1% to 4.7% last year, we expect they will continue growing to 8.4% by FY22 resulting in a 51% earnings CAGR through FY22 based on just 7% volume growth, which is broadly in-line with GDP. That means the current PER of just 8.6x will fall to 3.8x in two years.

Those few investors and local analysts who’re not totally asleep at the wheel seem paralysed by the company’s poor profitability and low growth following the FY16 downturn.

With bumper 1Q21 results just around the corner, FY21 is set to be the year SPINDO investors began to look forward rather than backwards.

Is Treasury Wine Estates a logical fit for Pernod Ricard?

There has been recent speculation that Pernod Ricard is weighing an acquisition of Treasury Wine Estates, which has been caught in the crossfire of an Austral-Chinese trade spat.

In recent years Treasury has adopted a growth strategy that’s focussed on flagship brands leading growth in China, which has dragged them out of the dog days a decade ago, narrowly escaping bids from KKR and TPG in 2014.

Of the company’s $1.0 billion revenue growth since FY12, more than half has come from Asia and accounting for a little under a quarter of total sales in FY20.

However, the revenues from Asia have operating margins that are three times higher than other geographies, giving it an outsized portion of operating profit. So, it’s no wonder the stock has been punished as the company seems to have lost their golden goose.

Management has been scrambling to reallocate Penfolds ‘Bin’ and ‘Icon’ range into other markets (around 600,000 cases) while redirecting contracted fruit supply from the less desirable end of the China portfolio (Particularly Max’s blend and Rawsons Retreat – around 2 million cases) to other brands in the portfolio that they claim is supply-constrained.

Given the premium they were commanding in China, it’s unlikely they can attractively reallocate this volume elsewhere.

As part of Treasury’s strategic rethink, the company have guided that they will need to invest in marketing and distribution capabilities both at home, the US and in Asia ex-China markets. An overlooked and underestimated challenge will be transitioning from marketing an in-demand product ‘that sells’ to one which relies on prowess in distribution to muscle sales of less differentiated products in a more competitive space. To build out this footprint across multiple geographies will be more difficult and unrealistic to achieve under the current COVID travel restrictions.

Conversely, global drinks and spirits businesses are marketing and distribution machines of products that are often differentiated by just a brand alone. Pernod Ricard is a €9bn pa business (trailing only Diageo) of which almost half lies in Asia. However, the company’s wine offering is meagre compared to its spirits portfolio, with reported revenue of just $500m from Jacob’s Creek and Spain’s Campo Viejo the only notable wines brands beyond the Champagnes of Mumm and Perrier-Jouët.

Since wines make up such a small portion of total sales, there are presumably immediate opportunities for cross-selling across all of their markets without meaningful additional marketing spend. The local distributors could move the ‘masstige’ Penfolds and premium brands through the bar and restaurant channel with conceivably little effort.

In the longer-term, it is likely that China will return as a market for Treasury and the Penfolds brands. Either the snap tariffs will be reversed or they will ultimately find another way to market, like developing a suite of Napa products which makes me cringe but is already in the works. Making the most of either would surely be easier for Pernod, who describes China as a "must-win" market for them and has current hopes pinned on cognac, whiskey and vodka.

One can assume their investment in Chinese distribution and advertising would dwarf that of Treasury. As a point of comparison, Pernod has 684 employees in China compared to 126 to Treasury according to Linkedin.

Beyond the near-term flexibility, Pernod’s platform could afford Treasury’s hamstrung business, the most attractive part of the deal from the acquirers perspective would be the potential to cut corporate and marketing costs.

Treasury themselves are targeting $85m pa of corporate and supply-chain savings over the next two years through the restructuring of their US business alone. The $50m of those savings that are expected to be recurring represent less than 10% of the group total SG&A spend of $583m in FY20.

While Treasury’s fruit sourcing and wine-making capabilities will be of a high strategic value to Pernod who have failed to grow their Australian wine business since acquiring Orlando in 1989, I doubt that they will look equally favourably on the in-country marketing teams and support functions that would have a large overlap with their existing operations. Could further third of SG&A costs - around $200m - be saved there?

So, that leaves investors to ponder how much Pernod might be willing to pay for a company of strategic value that would swiftly add A$800-900m in EBITDA (including estimated synergies)...