Late last week Cinedigm made the acqui­si­tion of New Video that many (includ­ing R2) have been wait­ing for. Any­one fol­low­ing the story knows that Cinedigm has been expand­ing their exist­ing soft­ware and con­tent busi­nesses to become the cen­tral player in what will be a new oper­a­tional and busi­ness model for the cin­ema indus­try.  The shifts the cen­ter of grav­ity for Cinedigm squarely into dig­i­tal con­tent, dis­tri­b­u­tion and soft­ware and should be a cat­a­lyst for increased investor inter­est and higher valuation.

Acqui­si­tion Highlights

Broad Dis­tri­b­u­tion: New Video (NV) links new con­tent to a broad range of dig­i­tal dis­tri­b­u­tion chan­nels like iTunes, Net­flix, and Ama­zon, and has dis­tri­b­u­tion part­ner­ships to reach to most phys­i­cal retail out­lets. New Video pro­vides 12% of filmed enter­tain­ment con­tent and 4–5% of TV pro­gram­ming con­tent on iTunes.

Big Library: On the con­tent side, New Video has a ros­ter of high qual­ity con­tent rela­tion­ships with play­ers like A&E, Life­time, Tribeca Films, and Major League Base­ball along with over 500 inde­pen­dent con­tent pro­duc­ers. Today, NV has 4,700 films and 400 TV pro­grams in their con­tent library.

Favor­able Terms: Based on expected 2012 sales of $14.1M and $4.1M EBITDA, the pur­chase price repre­sents about 1x sales or 3.4x EBITDA. The NV asset has major strate­gic value, profit mar­gins are attrac­tive and rev­enue growth is likely to accel­er­ate. The com­bi­na­tion makes share­holder value accre­tion appar­ent. The com­pany funded the deal with their bal­ance sheet and a $10M equity offering.

Back­ground

While con­sumers face the same quandary of “what is there to watch?” hun­dreds of con­tent pro­duc­ers strug­gle to find a path for their con­tent to their menu of view­ing choice. Both sides have been frus­trated because there hasn’t been a licens­ing and dis­tri­b­u­tion model that fits between big mar­ket films like the Titanic and ama­teur con­tent on YouTube. This has been a clas­sic “chicken and egg prob­lem” for the indus­try and investors.

In the same way net­work tele­vi­sion and printed pub­lish­ing made it impos­si­ble for most con­tent to ever be seen, the tra­di­tional filmed enter­tain­ment infra­struc­ture only works for con­tent with large poten­tial mar­kets. This leaves an exploitable gap in the mar­ket that has very attrac­tive economics.

Invest­ing in enter­tain­ment prop­er­ties is an exer­cise for cre­ative types, not fund man­agers. How­ever, invest­ing in the infra­struc­ture to cap­ture rents from the licens­ing and dis­tri­b­u­tion of a broad con­tent cat­e­gory is where the high, reli­able returns are. There may only be one invest­ment rule in the con­tent busi­ness that works all the time and it’s to keep costs low. When you have a large bud­get you might get a WALL-E or a John Carter. There’s no way to really know. And all that “suc­cess” might not yield as much profit as a small bud­get film that does well.

Cinedigm now has a large library of exist­ing con­tent and is in a unique posi­tion of offer­ing “real” the­atri­cal re­lease with com­pre­hen­sive ancil­lary dis­tri­b­u­tion to the pro­duc­ers of high qual­ity con­tent. It’s a com­pelling path to mar­ket for these con­tent own­ers. The early results are encour­ag­ing based on the enthu­si­asm for the lat­est an­nounced licensed film, In Our Nature, which was a big hit at the recent SXSW con­fer­ence. For the first time, we have a buzz around upcom­ing film releases com­ing to the mar­ket with­out all the major stu­dio roadblocks.

This should be the cat­a­lyst needed to get cin­e­mas and the­atri­cal venues to appre­ci­ate and embrace the new model. They have been agree­able to it but have had a healthy “where’s the con­tent?” prob­lem. In gen­eral, these folks are not risk tak­ers. For a new con­tent chan­nel to make sense for them there has to be a lot of crowd appeal and regu­lar new releases to pro­vide the impe­tus for cus­tomers to come into the the­ater. The cur­rent slate of films (The Invis­i­ble War, Citadel, In Our Nature) is a huge improve­ment and will expand rapidly as the com­pany builds a bill of releases for 2013 and beyond.

Invest­ment Conclusions

The acqui­si­tion will increase our 2012 rev­enue esti­mate to about $100M and add mate­ri­ally to EBITDA. How­ever, the com­pany will be spend­ing to acquire addi­tional streams of high value con­tent for 2013 and beyond. This means some cur­rent expenses won’t turn into incre­men­tal rev­enue for a year or two. In addi­tion, if the per­for­mance of the New Video unit is strong, addi­tional earn-out pay­ments will add to expenses (but of course funded out of addi­tional EBITDA).

The acqui­si­tion clearly moves the cen­ter of grav­ity at Cinedigm fur­ther into the con­tent space but there is more going on. The com­pany has been mak­ing sub­stan­tial invest­ments in their soft­ware busi­ness and recently hired an exec­u­tive to expand sales and dis­tri­b­u­tion. The soft­ware is the crit­i­cal infra­struc­ture needed to man­age this entire process and Cinedigm is work­ing hard to ensure their lead­ing posi­tion remains unassailable.

One miss­ing piece of the puz­zle we expect to see filled in this year is the ancil­lary rev­enue model for the exhibitor mar­ket. Right now the­aters are just an end-point in the dis­tri­b­u­tion chan­nel, but in the new Cinedigm model they become part of the release and dis­tri­b­u­tion process.

Cinedigm may also be able to get more of the the­ater ser­vic­ing related debt off their bal­ance sheet which would help investors see their core busi­ness and finan­cial struc­ture more clearly.

We will be revis­ing all our num­bers post the March quar­terly announce­ment in a few weeks but believe investors with a long-term view (man­age­ment and insid­ers at Cinedigm own 40% of the equity) should con­sider the cur­rent val­u­a­tion of the com­pany to be low.

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