In Reel Time

Guy Hands is a chump; or, M&A 101

In 2007, British private equity firm Terra Firma Capital Partners – controlled by one Guy Hands – bought legendary British music company EMI Group for £4 billion ($6.3 billion).  Citigroup played a dual role in the deal, acting both as sell-side advisor and as provider of acquisition financing for Terra Firma.

The deal has been a disaster.  EMI still owes £3 billion in debt to Citigroup.  The company is groaning under the weight of that debt and the continuing carnage in the music industry, declining sales of music CD’s, widespread piracy and growing but less lucrative sales of digital music.  Citigroup would have already foreclosed on the company if Terra Firma had not put over £100 million of additional cash into the company to make required debt payments.

So now Terra Firma is suing Citigroup, claiming that Citi defrauded Terra Firma when Citi’s banker told Guy Hands that Cerberus was also bidding for EMI and Terra Firma would have to top Cerberus’ bid to win the property.  The trial started Monday in New York.

To which I reply, Guy Hands is a chump.

I don’t know the facts.  Citi could have told Terra Firma anything under the sun as far as I am concerned.  But it doesn’t matter.  Guy Hands and the rest of Terra Firma’s management have a fiduciary duty to their investors.  Even without reviewing the EMI purchase agreement, I am quite confident that there are no seller’s representations or warranties that Cerberus wanted to buy EMI.  Cerberus may have bid, or they may not have; but it doesn’t change the fact that Terra Firma should have done its diligence and concluded that they wanted to buy EMI at the price they paid.

David, you breathlessly ask, does that mean you lie to buyers about what is going on in the sales that you are managing for your clients?  No, it doesn’t mean that.  I play hard for my clients but I play fair.  I would not be stupid enough to answer a buyer’s question unless answering it serves my client.  If a bidder asks me what it takes to win, I will answer as authorized by my client.  If that same bidder asks me where competing bidder XYZ is coming in, I will likely tell that bidder to bid like they may not get another chance to acquire the property, because they might not.

And if a master of the universe like Guy Hands thinks that the company I am representing is worth more because a third party wants it, then I probably won’t go out of my way to disabuse him of that party’s interest.  But I won’t lie to him.

Finally, when you read about this trial in the papers, keep in mind that Citigroup provided over $4 billion in debt financing for the transaction.  Yes, they made two fees on the 2007 transaction – both the sell-side advisory fee and the financing fee.  But the profitability of the transaction is at risk because Citi did not successfully syndicate that debt and so stands to lose serious money if EMI can’t pay them back.  That doesn’t sound like the behavior of a bank that thought they were selling Guy Hands a pig in a poke, does it?

I know business is hardball, and Guy Hands is probably suing Citi to pressure them for concessions on the debt financing.  Maybe it will work.  But it’s bullshit.  Man up, Guy, admit (at least to yourself) that you overpaid for EMI, and don’t go looking for someone to blame for your potentially career-wrecking mistake.

Comments, anyone?

The Wall Street Journal has covered this saga well recently, here, here and here.  Subscription required.

2010.41 My last week: ITExpo; Digital Music Forum West: Caltech/MIT Enterprise Forum

Last week I dabbled in a few conferences and then committed to a panel. What did I learn?

At ITExpo in downtown my big takeaway was speed. Evolution. Regulation. The cloud. Opportunities continue to develop at an increasing pace. And the battle of net neutrality continues. Indeed, Hank Hultquist gave a riveting speech on the major issues and regulation that comprise net neutrality issues…from AT&T’s viewpoint.

Panels at the Digital Music Forum West (Roosevelt Hotel) sometimes got confrontational, with the forces for change arguing against those with a vested interest in staying the same. A few later panels were too politically correct and mutually supportive (for my taste). But Rick Alden, SkullCandy’s CEO provided insight and emphasis on branding, which distinguishes how his company operates. Visionary and charismatic (with freebees to hand out) he garnered a lot of questions and a crowd outside the main hall. Best quote? “The best ideas won’t come from sitting behind a desk”.

Later panels on Brands & Music and Touring explored further specific instances of how acts and brands can customize and define themselves. The real message? Define clearly who you are and your audience. Then set yourself apart creatively in that context. And don’t tie your brand to an artist; develop your own broader, richer personality.

The conference highlighted innovation (and spots that lack innovation) within the music industry. As we all know, the music industry was ahead in getting hit with digital change, making mistakes in their response and now in coming up with new ideas to survive and prosper.

The Caltech/MIT Enterprise Forum – From Past Time to Prime Time (on Social Networking) – was where I committed. Kevin DeBre of Stubbs Alderton & Markiles introduced. Mark Suster of GRP and Jay Samit of SVnetwork spoke. You want to hear the message straight? They both deliver that. Mark told us to look outside of walled gardens (if you rely only on Facebook they own your audience – keep your website) as both closed and open systems work. Jay advised entrepreneurs to get between big trends and pick up the crumbs (great imagery).

The panel: Jay, Sean Moriarty (Mayfield Fund currently), Jonathan Strauss (awe.sm) and Andy Wilson (Momentum Ventures), with Mark Suster moderating. The panel offered so many insights; I only have room to list a few. The social capital that you bring to business is critical today. Traditional analytics don’t work in social media…the space is so fragmented; do you want pages views or transactions? Brands need to get where the customers are and realize that their “important” doesn’t matter as much as does their customers’. Individuals now communicate across channels. Local is (still) the great unsolved problem. Women are over-served in the major success stories of the past few years: daily deals, flash sites and social games (take the women away and…). Tigertext effectively erases the record of your digital communications.

My conclusion on the week? I’d prefer not to go to conferences/panels everyday (fun though they can be).

Next up, Digital Hollywood starting October 18. I myself am on a panel on Wednesday, October 20.

2010.49 Media Innovations Summit 2010: 22 points from day one

1. Mark Cuban – in person – is engaging, friendly, brilliant, insightful, knowledgeable and says things that others lack either the insight or courage to say.
2. Be careful what you write about people in blogs because you may once meet them in person. (Scroll down to see my blog on Mark Cuban and Lions Gate).
3. Mark Cuban, “You don’t live in the world that you were born in.”
4. Smaller conferences have some strong advantages – at Media Innovations Summit the panelists mingled freely among the attendees, introduced themselves and watched many of the other panels.
5. A focused theme centered around well reasoned and articulated panels draws your panelists into other sessions and creates an engaging environment.
6. Content providers have to contend with numerous devices; being too dedicated to one (iPad/iPhone apps) cuts you off from that group of consumers without that device (credit to fellow Blackberry devotee Joanne Burns, EVP at 20th Television, Fox, a Keynote speaker, for this and numerous other insights).
7. Okay, one more from Joanne – don’t mirror your content across platforms. Make it engaging and show personality. Adapt to the platform and its potential. Interact. Tell a story.
8. TV everywhere? Define TV.
9. “TV is the best alternative to boredom,” Aaron Spelling via Mark Cuban.
10. Define TV? Define Channel. “What is a channel will change,” Phil Wiser of Sezmi.
11. Sezmi and Boxee are hot.
12. TV everywhere is “a wide open game”. It is rolling out as we speak; but how do you make money from it (hint: trial, error and prayer).
13. In the past, curated content was delivered to consumers; now consumers choose when and on what platform (or they go elsewhere).
14. My favorite quote (if you said it or know who did – email me) is that the service providers need to get past the consumer thinking that there is nothing to watch on TV.
15. Aggregators find ways of getting paid; they help the consumer find things. Now comes further personalization.
16. Consumers care about ease.
17. Fragmentation is only getting worse; the top tier of content (measured by consumption not quality) continues garnering a higher percentage of money and audience. The long tail continues getting longer.
18. Everyone admires Netflix; not everyone likes Netflix.
19. Why did Showtime and HBO develop their own content? Because they paid a lot for studio content, everyone paid a lot for the same studio content and nothing was left to distinguish anyone. So, they created premium content to distinguish themselves. Today (history repeats) and everyone is paying a lot for the same content. Conclusion: paying a lot for the same content doesn’t distinguish you.
20. 3D fills the consumers’ desire to immerse and escape reality.
21. With so much content available (for example 100,000 video clips or more downloaded onto the Internet daily) how do you distinguish yourself? Hint: no one has the full answer yet. If you know, please email me privately.
22. Interactivity? Soon, soon…

My thanks to Bob Gold, of Bob Gold and Associates (PR maven).

2010.37 Imax to partner with Laser Light Engines

IMAX, which specializes in immersive motion picture technologies, recently signed a deal with Laser Light Engines for development of high brightness technology systems exclusively for IMAX digital theatre systems.

Under the terms of the agreement, IMAX will make an equity investment (of undisclosed amount) in Laser Light Engines; who in turn will develop a custom version of its laser light technology for exclusive use in IMAX digital projection systems. Laser Light Engines will also develop custom features to help enhance the IMAX experience. Additionally, LLE’s technology won’t be available to the general market for two years, and to other large format theatre systems for three years.
Laser Light Engines designs, develops and manufactures OEM laser-driven light engines that provide high brightness, long lifetimes, energy efficiency and color control capabilities.
One particular challenge of theatrical 3D is that the viewer’s 3D glasses filter out a significant percentage of the available luminescence as they “trick” the mind’s eye into seeing a 3D image. That means that a brightness that is adequate for 2D viewing is insufficient for 3D exhibition, and many viewers consider 3D movies to be too “dark.” This challenge is the backdrop for IMAX’s interest in LLE.

IMAX screens typically go from floor to ceiling, and extend to the edge of viewers’ peripheral vision, which creates an immersive experience. Their sound system is of exceptionally high quality. The company’s 3D theatres even further increase the viewers’ feeling of immersion. Most IMAX theatres feature a steeply inclined floor which allows each audience member a clear view of the screen.

The deal is subject to due diligence.

IMAX has had a busy year thus far in 2010 – quickly signing up deals to open new theatres around the globe. Most recently, on July 15 they announced an agreement with Lumiere Pavilions, one of the fastest growing private movie exhibition chains in China, to open three new theatres, one a year starting in 2010. This deal brings the total number of IMAX theatres scheduled for operating in China by 2012 to 57. The total number of IMAX signings announced this year is 95, as compared to 35 systems during 2009. And the mix of openings signed spanned the globe with sites to include Japan, the Philippines, Thailand, Singapore, Russia, the Ukraine, Croatia, France, the Netherlands and the UK. They have also expanded an earlier agreement with AMC by adding 15 to 25 more theaters to the original 104 agreed upon.

Inception, which opened on a record 197 IMAX screens over the past weekend, was also the top grossing picture, taking in $60.4 million.

The company will announce earnings on July 29.

2010.34 Update on Sonic Solutions / DivX

As our alert readers already know, on June 1 Sonic Solutions and DivX announced a definitive agreement for Sonic to acquire DivX (see our previous post on this topic).  The point of this post is to give interested readers an update.

Valuation reminder.  Sonic agreed to pay $3.75 in cash and to issue 0.514 Sonic shares for each DivX share.  That represented $9.83 per share to DivX holders on June 1, and the implied enterprise valuation for DivX was $189 million.

Timing is everything.  On the day of the announcement, Sonic’s stock price closed at $11.83, which was up almost 20x from its March 2009 low of $0.60.  However, since the announcement Sonic’s stock price has dropped over 35% to its July 9 closing price of $7.64.  This reduces the per-share value of the offer for DivX to $7.68.  Still a premium to DivX’s June 1 closing price of $6.95, but now only a 10.5% premium.

The S&P 500 closed slightly up today (July 9) vs. its June 1 close, so this is not a market issue more generally.  Nor is there any dramatic news from either Sonic or DivX since the announcement.  To the extent that one can explain short-term trading fluctuations, I think the fallback represents (a) arbitrageurs selling Sonic short and going long DivX to lock in a trading gain on a transaction, and (b) some concern on the part of the market that Sonic is opportunistically using the dramatic run-up in its stock price to execute a stock acquisition.

Updated valuation metrics.  At the July 9 valuation, DivX has an implied transactional enterprise valuation of about $118 million.  This represents a valuation of 1.6x DivX’s LTM revenue and slightly under 13x its LTM EBITDA.

Sonic’s portrayal of the transaction.  Check out this link for a Sonic management presentation at the William Blair Growth Stock Conference in June.

What do the relative stock prices say? As noted above, the current transactional valuation for DivX is $7.68.  DivX’s July 9 closing price was $7.26.  That represents a 5.8% discount to the transaction price.  Sonic and DivX have publicly expressed the expectation that the transaction will close before September 30, so on an annualized basis excluding transaction costs that is a return of over 23%.  Not a bad return, but also a price that suggests the market believes the transaction will close on schedule or close to it.

When do you think the transaction will close?

2010: 30 Lions Gate and MGM to merge? Or, strategies for avoiding a corporate raider

Why this follow up post took so long:

Updates to my last related blog post on Lions Gate:

1. Carl Icahn now owns 31.8% of Lions Gate’s shares. He has an open offer outstanding to buy shares at $7.00 until June 30. Given that the stock closed today at $7.26 he is unlikely to pick up any more shares that haven’t already been tendered. After June 30 he can buy shares in the open market.

2. Icahn has stated that he will wage a proxy fight after June 30.

3. When Icahn’s ownership position rose above 20% Lions Gate’s loan provisions were triggered (terms under which its banks could have called due related debt). The banks raised the change of control threshold to 50% after talks with management.

4. Lions Gate is now rumored to be in merger talks with MGM. At a 31% ownership stake Icahn can likely scuttle any such plan. Given the public information about both companies it’s hard to believe that a Lions Gate/MGM transaction is possible at this time (Icahn’s ownership percentage; MGM’s debt). But never say never…a well funded partner could bid the price up so high that Icahn would be better off taking a profit and tendering his own Lions Gate shares.

5. While Icahn hasn’t won yet his ownership stake causes real problems for Lions Gate management. What no one but Icahn knows for sure is his ultimate goal. Obviously he wants to make a profit. Does he want to actually own Lions Gate? We’ll find out.

6. As far as avoiding a corporate raider – keep watching Lions Gate. They’re clearly listening to strategic advisors and deciding to fight and not fold. Declaring that the price isn’t high enough is a permissible way of saying no and the stock price jumping above the tender offer price makes the argument very defensible. But the jump also indicates that certain traders are expecting Icahn to bid (or buy in the open market) higher. Selling the company or merging with another is another (effective) strategy.

7. I’ll continue posting updates. Thoughts or comments?

One more photo. Where was I?

2010.25 Sonic Solutions to acquire DivX

On June 1, Sonic Solutions and DivX announced a definitive agreement for Sonic to acquire DivX.  Your intrepid bloggers at Hadley Partners wanted to bring you some scoop and prompt commentary on the proposed transaction.

Deal terms / premium

DivX shareholders are to receive $3.75 in cash and 0.514 shares of Sonic stock per DivX share.  Sonic stock closed on June 1 at $11.83, so total per-share consideration at announcement was $9.83.  With DivX’s pre-announcement share price at $6.95, the premium was 41%.  However, Sonic’s stock price dropped 12% in the two days after the announcement, reducing the deal premium to 31%.

Post-transaction, DivX stockholders will hold approximately 35% of the equity of the combined company.

At announcement, the price being paid for DivX’s equity was $325 million.  However, as of March DivX had no debt and over $135 million in cash on its books.  In fact, Sonic is paying less in cash to acquire DivX than the cash it will inherit at closing, so in economic terms this is really an all-stock acquisition.

The transaction is expected to close in September, and is subject to a vote of both companies’ stockholders.  If DivX terminates the transaction under certain circumstances prior to year-end, it is required to pay a termination fee of $8.35 million.

Sonic Solutions

Sonic supports the creation and management of digital media with products, software and services.  It generates the majority of its revenues in its “Roxio Consumer” segment, where its offerings enable consumers to create, manage and share digital media content (data backup, media transfers, DVD burning, etc.).  Sonic bought the Roxio brand name and some of this consumer business in 2004 from what is now remembered as Napster.  The Roxio Consumer segment generated 87% of company revenue and all of its operating profit for the nine months ended March 2010.  These sales come through digital storefronts such as Digital River, distributors such as Ingram Micro and Navarre, and the company’s own website.

Sonic’s second business unit is what it calls its “Premium Content” segment.  Most prominently, Sonic offers digital media solutions that enable major studios and other content producers to render their media in different digital forms.  Historically, this has been primarily DVD authoring tools.  However, this business is evolving rapidly, first toward Blu-ray and ultimately toward digital distribution (streaming, downloading, etc.).  The Premium Content business has recently been shrinking and losing money, but the company is optimistic about its positioning for the digital distribution growth opportunity.

DivX

DivX is a leading provider of digital media encoding and decoding formats and solutions, and also supplies digital rights management (DRM) tools.  Encoding/decoding tools (“codecs”) are proprietary offerings that make the delivery of media, in particular video, more bandwidth-efficient without sacrificing image quality.

Since its inception, DivX has been vying against the likes of Microsoft, Apple, On2 Technologies (recently acquired by Google) and Real Networks to become the industry standard for video compression.  DivX technologies have shipped in over 300 million hardware devices worldwide including digital televisions, DVD and Blu-ray players, game consoles and mobile handsets.  The end game is to make high-quality digital content accessible anywhere, anytime on any device.

The company generates over 90% of its revenue by licensing its technologies to consumer electronics OEMs (70%) or to software vendors that include DivX technologies in their offerings (22%).  The company is also very strong internationally, with less than 20% of its 1999 revenues derived in the U.S.

Business logic / strategic rationale

Both Sonic and DivX operate within a complex value chain where their solutions work best if broadly available.  The value chain involves content creators (both professional and personal), content distributors, consumer electronics/hardware companies, PC/software companies and online and offline retailers.  Both companies license their technologies to key consumer electronics OEM’s as well as content creators and distributors.

As the industry evolves from one dominated by hardware distribution (DVD and Blu-ray discs) to one dominated by digital distribution, Sonic is betting that DivX’s technology strengths, licensing relationships and installed device base can all accelerate Sonic’s momentum.  Direct synergies from a combination are not obvious – the companies have been working together for years, and will continue to work with other partners – but the ability to bring more value to key business partners and licensees should create some benefits.

It is possible that the transaction has an opportunistic element for Sonic as well.  The dramatic rebound in Sonic’s stock in the last year – almost 20x from its low of $0.60 in March 2009 – is arguably ahead of its business, where revenue for fiscal 2010 was down 12% vs. the prior year and the business lost money for the full year (albeit profitable in the March quarter).  DivX’s top line has also been down due to lower consumer electronic sales and related licensing revenues, but its absolute profitability currently exceeds Sonic’s.

The acquisition is intended to enhance Sonic’s recently released RoxioNow content platform, the technology behind the virtual video storefront services that Sonic currently runs for Best Buy, Blockbuster and Lionsgate aimed to provide consumer with access to digital media content from virtually anywhere.  Sonic also bought CinemaNow last year and is offering studio content via that website.

Valuation / Metrics

DivX equity valuation – $325 million

DivX enterprise valuation – $189 million

DivX LTM revenue (March 2010) – $75.2 million

DivX – LTM EBITDA – $9.2 million

TEV / LTM DivX revenue – 2.5x

TEV / LTM DivX EBITDA – 20.6x