SINGAPORE (Mar 4): Four years ago, mm2 Asia went public to fund its ambition to become a regional media powerhouse. Investors were only too keen to back a scrappy underdog with big dreams. In a few short years, mm2 now has a chain of cinemas, a concert organiser, a visual effects studio and an online video platform. It makes content for East Asia and Southeast Asia, from film to TV and online content. At its peak in June 2017, mm2’s share price was up more than 12-fold from its IPO price of 25 cents.

Naturally, there is pressure to continue to grow. But some investors have lost faith in mm2 ever since the company failed to buy a 50% stake in the local cinema business of Golden Village, the largest cinema chain in Singapore, with a 39% market share. Instead, it acquired the Singapore operations of Cathay Cineplexes, which had a 27% market share, for $230 million, or 13.8 times earnings before interest, taxes, depreciation and amortisation (Ebitda), more than what it paid for the cinemas in Malaysia and what it wanted to pay for the 50% stake in Golden Village cinemas.

So far this year, mm2 has shed 12.5% of its value, closing at 28 cents on Feb 27. Now, observers are worried about the debt incurred from its latest cinema acquisition, whose lower operating margin is a drag on mm2’s overall Ebitda margin. There are calls for the production house to take a long hard look at its cinema business — spin it off, possibly — and deleverage.

Ever since the Cathay acquisition, mm2 has been in a net debt position. Its third-quarter earnings were down 60% y-o-y to $2 million, owing partly to higher finance expenses at $4.3 million and tax related to its acquisition of Cathay. DBS expects net gearing to be 0.77 times in FY2019, as interest expense could surge 10- fold for the period.

DBS analyst Ling Lee Keng says: “To maintain an attractive net margin of more than 10%, it would have to deleverage. One option is to spin off the cinema operations. In terms of revenue generation, all segments are still generating double-digit growth, but in the near term, the steep interest expense will continue to be a drag on earnings.”

For Melvin Ang, mm2 founder and executive chairman, the journey is far from over. Ang says he did not acquire one business after another in the entertainment industry to boost mm2’s share price. “You can’t stop what you are doing because someone doesn’t like [it],” he tells The Edge Singapore. “You have to be rooted and committed [to growing the business]. We don’t flip businesses. We are not in corporate finance.”

 mm2 and its two listed subsidiaries — visual effects studio Vividthree Productions and concert organiser UnUsUaL — are far from what can be called sizeable. UnUsUaL and Vividthree have barely started acquiring intellectual property (IP) rights to boost their pipelines. mm2’s North Asia productions, which make up the bulk of its core business, come with their own risk as the Chinese content market undergoes consolidation and faces regulatory challenges.

If anything, mm2 and its group of companies need to grow its pipeline of projects to mitigate some of the risks. The company does not provide visibility of productions beyond 18 months, nor does it disclose the proportion of series in its pipeline. But since it is debt-laden, acquisitions may not be the best option. Maybank Kim Eng’s analyst Luis Hilado says in an email response: “I believe they intend to go into more partnerships and tie-ups with regional and even global names in terms of IP — not buying content or IP but being a conduit [in a deal]. So, that involves the relationship skills of the management teams rather than a significant capital investment.”

Ang, who has spent more than two decades in the media industry, has always been known as a deal maker. He relinquished his role as CEO in 2017, choosing to focus on courting business partners and investors to grow the company. Whether he can keep the momentum going remains to be seen.

Production core

mm2’s production arm, its original core business, is holding the fort well. The company has signed numerous deals and relationships in the last few years to produce a myriad films in East Asia and Southeast Asia. It has produced and distributed more than 100 films. In the next 18 months, it has between 70 and 80 projects in progress. In 2017, the figure was closer to 50.

And some of its productions have seen success. Its recent Taiwanese romance drama More than Blue grossed NT$32 million ($1.4 million) on its first three days of opening in Taiwan, breaking the box office record for biggest opening for a domestic film last year, according to the Taiwan Film Institute.

mm2’s business depends on its ability to secure investors and funds for its productions. The company is involved in the scripting, casting and editing of films. It earns a production fee for its work and collects a producer bonus of up to 10% of box office receipts for successful movies. It may obtain sponsorship revenue and charge a fee to distribute films. Investors get the remaining box office returns.

About 57% of its production revenue comes from North Asia. mm2 CEO Chang Long Jong had previously said that studios such as mm2 can produce films in Taiwan and Hong Kong to enter the Chinese market. Films from Taiwan and Hong Kong are not considered part of the Chinese government’s quota for foreign films.

mm2 does not break down segmental revenue for quarterly results. In 3Q ended December last year, earnings fell 59% y-o-y to $2 million even as revenue rose 41.3% to $74 million, with all business segments registering growth. In FY2018 ended last March, the core business accounted for 49% of total revenue at $93.6 million, nearly double from the year before. The production arm accounted for 44.5% of gross profit at $40.3 million. This partly boosted the group’s earnings to $26.4 million, up 51% from the year before, as revenue more than doubled to $192 million for the year ended last March.

The Chinese market is precarious, though, according to Stanley Rosen, a film and Chinese politics expert at the University of Southern California. The authorities have been clamping down on celebrities who evade taxes, with the latest casualty being one of China’s most highly paid actresses, Fan Bingbing. Rosen says, “After the tax evasion issue, there is a heightened sense of carefulness in the industry; you just don’t know when you are breaking the law or a contract. For investors who want to invest in Chinese content, the market is getting very complicated.” He adds that productions from Taiwan and Hong Kong are also affected by the state of political relations with China at any given time.

The scale of China’s market — there are about 70,000 screens — adds a layer of complexity. To become a blockbuster, a film has to be carried by the majority of these cinemas. Cinema operators, in turn, are selective on which films to show. They prefer those with heavy marketing muscle already committed by the big studios. “If you are a small-budget studio, it is very hard to get access,” says Rosen.

For its part, mm2 is not betting on the cinema market alone. It is doing more work for over-the-top platform and has been announcing deals for non-China production work, including FOX Networks Group Asia and Netflix in Taiwan.

“When an OTT platform commissions us for a project, it’s a classic B2B sale,” Ang says. “For example, the margin is normally smaller, in view of better visibility of payment milestones.” Production for mm2’s OTT platform currently accounts for less than 20% of all its productions. He expects the slate to account for 40% of future productions.

mm2 is also making bigger-budget productions that may spur more growth for the company. China film production can reach more than US$5 million ($6.7 million) as well. “We just rolled out a package slate for investors to invest in three productions in China, two in Taiwan and one in Hong Kong for US$18 million,” Ang says.

UnUsUaL and Vividthree

mm2 subsidiaries UnUsUal and Vividthree are separately listed, but their growth plans are similar. To drive new growth, both companies will need to increase their bank of IP rights to new shows and themes, but they might need additional capital.

UnUsUaL, the concert production arm, has shows lined up until 2022. Most of them would be family entertainment shows such as Walking with Dinosaurs and Disney on Ice. Leslie Ong, co-founder of UnUsUaL, says, at US$70, tickets for family entertainment shows are cheaper than the US$200 for traditional concerts. Family entertainment shows can run seven or eight times a week, whereas concerts last only a couple of nights. Furthermore, family entertainment shows can sell about 6,000 tickets a show, far more than mid-scale concerts. The Edge Singapore understands that UnUsUal is in talks with partners to confirm more shows for 2022.

More interesting is the company’s IP acquisition growth. On Aug 2 last year, it entered into a non-binding joint venture agreement with Nick Grace Management to produce Apollo. The show is expected to start touring the US for three years. The acquisition was worth $13.5 million. Ong says the IP will last for five years. By owning the IP, UnUsUal has the flexibility to bring the show to different markets, including Asia. “We have a 60:40 profit-sharing split [with Nick Grace Management]. The profit-sharing kicks in only after we recover our capital. We expect to be able to recover our capital in one year, with box office sales of 80%,” Ong says. For the year ended last March, the concert production arm accounted for 24% of revenue at $46.4 million and 20% of gross profit at $17.9 million. UnUsUaL is currently in discussion for more IPs.

The narrative is no different for Vividthree. Co-founder Charles Yeo aims to secure another IP in a year. Last December, the company unveiled its first virtual reality (VR) immersive exhibition, based on the hit Korean zombie movie Train to Busan. The exhibition was held in Beijing and recorded a daily average admission of 200. Each ticket cost more than $30 on average. The content production business has a gross margin of between 45% and 55%. The group signed a letter of intent with Taiwan-based Bossdom DigiInnovation, granting it territorial rights to host a similar VR exhibition in Taiwan, Hong Kong and Macau. The Edge Singapore understands that the group may be setting up more sets in Southeast Asia as well.

Fuelling the future

How would mm2 and its subsidiaries grow? As at Dec 31, 2018, the company held $35.7 million in cash and cash equivalents, and net debt of $215 million; UnUsUaL held cash and cash equivalents of $4.9 million and had net debt of $4.4 million; and Vividthree is debt-free and held cash and cash equivalents of $7 million. Observers say it is likely that the trio will grow through partnerships and be less acquisitive.

“UnUsUaL has talked about getting local production partners, depending on country. That helps spread out work and timeliness but lowers margins because of partial outsourcing and revenue sharing. But the goal is to grow gross profit in absolute terms. Typically, the type of financing for the business models are working capital and short-term,” says Maybank Kim Eng’s Hilado.

He is particularly concerned about the visibility of mm2’s progress in the cinema business. Ang says the cinema business adds value to the group. It has strengthened its network with producers in the region and allows the company to screen its own films, saving on cost and giving the studio more control over its distribution channel. Ang says it is still too early, however, to quantify the value brought to the group by its cinemas.

“Cinema is a mature business; you don’t see huge growth like a 30% jump. We are already changing the way we market content, giving promotions to elderly people. If we co-produce more movies, if we own a bigger network [of cinemas], we can have more bargaining power across [the supply chain],” explains Ang. In FY2018, cinemas recorded Ebitda margin of just 12.3%, lower than the group’s overall Ebitda margin of 33.4%.

For now, analysts are sceptical. DBS’s Ling, who has a “hold” call and a price target of 33 cents on the stock, says: “We have cut FY2019 earnings by 32% and FY2020 earnings by 34% to account for higher interest expense. We have expected the group to refinance a portion of the debt to reduce the interest expense, but that has not happened yet.”

Likewise, Hilado, who has a price target of 34 cents, has cut his earnings estimates, by 48%. While he sees revenue growing 45% to $280 million for FY2019, he expects core profit to fall 15% y-o-y to $22 million because of higher finance costs and tax.

mm2 would do well to map out exactly how the cinema business has improved over time or added value to the group. More importantly, it can strengthen its business case if it grows its portfolio of content significantly, which would mean more partnerships and potential co-ownerships. Investors who want to stay will have to accept the attendant risks.

This story appears in The Edge Singapore (Issue 872, week of March 4) which is on sale now. Subscribe here