In Reel Time

2010.36 RealD IPO prices at $16, stock closes Friday at $19.50

Following up on our two prior posts on this subject (April 20 and June 30), we now report on the consummation of RealD’s IPO.  Highlights as follows:

• Offering size increased from 10.75 million to 12.5 million shares.  All the incremental shares come from shareholders, so the company sold 6 million shares as previously planned and shareholders sold 6.5 million shares.
• Share price increased.  On June 30, RealD had gone on the road with an estimated price range of $13 – 15 per share.  The IPO priced at $16.  This cannot be considered a shocker, given that the NASDAQ had traded up over 6% month-to-date through Thursday’s close.
• Total offering generated gross proceeds of $200 million, and the company received net proceeds of $82.6 million.  That ought to finance a few more deployments…
• Timing is everything.  Not only did RealD likely benefit from the good performance of the equity market in July, but they priced their offering just before a 261 point decline in the Dow on Friday.
• Strong aftermarket performance.  After pricing at $16 Thursday night, the stock traded as high as $21 in early trading Friday morning before closing at $19.50 per share (up 21.9%).  Aftermarket performance for IPO’s in 2010 has not been generally strong, so this definitely counts as a successful start to RealD’s tenure as a public company.
• Valuation update.  At the mid-point of the June 30 range ($14/share), RealD’s implied valuation was $725 million.  At the actual pricing of $16, the valuation was $828 million.  At the Friday closing price of $19.50, the valuation is a cool $1 billion.
• “Greenshoe” from the shareholders, not the company.  As is typical for an equity offering, the underwriters have received a 30-day option to buy another 15% of the deal – in this case, 1.875 million shares – at the same price per share.  In this offering, the additional shares would come from existing shareholders, not the company.  With the stock price well above $16, it currently looks like a safe bet that the greenshoe will be exercised.
• 3D validated by the public market as a significant growth opportunity, and RealD established as the leading pure-play company in the space.

On behalf of Hadley Partners, congratulations to the founders, management, employees and investors in RealD!  We look forward to continuing to follow the company as friends, bloggers and investment bankers.  One of my friends and former co-workers at BT Alex Brown, Andy Howard, has represented Shamrock Capital on the board of RealD since Shamrock’s investment in the company, so my particular congratulations to Andy.

Have a great weekend, everybody!

2010.33 Carl Icahn now owns close to 38% of Lions Gate shares; Mark Cuban did tender his shares

Carl Icahn now owns almost 38% of Lions Gate’s stock. His offer to buy shares from Lions Gate shareholders ended last Wednesday (June 30). Mark Cuban did tender his shares to Icahn. Thursday he purchased 4.64 million more shares on the open market. With other recent purchases he now owns 44.8 million shares, or almost 38%. Due to Canadian law he can’t buy more shares in the open market (Lions Gate is legally a Canadian company). Icahn has declared that he will wage a proxy fight for control.

Later Thursday Lions Gate management adopted a shareholders rights plan triggered at 38% ownership. In it is a provision which allows shareholders excluding a bidder (for the company) to buy shares at a discount. Previously, trying to fend off Icahn, management had raised the “change of control trigger threshold” from in excess of 20% of shares to in excess of 50%. Last April they attempted to put in place a different poison pill but it was voided by the British Columbia Securities Commission. Icahn has already accumulated enough equity to veto mergers and acquisitions, and he has also tripped a provision which grants $16 million in severance to management should they decide to leave the company (they have assured the board that they will stay and fight Icahn).

Management is using classic hostile takeover defense strategies in an effort to slow Icahn down (looking for alternative transactions or ways of building shareholder value). Recent operating results were also strong which helps support their contention that Icahn’s bid is too low. For example, they have discussed a possible merger with MGM and clearly continue listening to counsel with respect to allowable corporate actions. Hostile takeover law is quite sophisticated and management teams must be careful in their attempts to thwart a potential acquirer, or, if the acquirer can’t be thwarted what steps they must take to maximize shareholder value.

The recent operating results? Lions Gate recently reported adjusted earnings for the fiscal year ended March 31, 2010 of $128 million. Film library revenues were up 15% to $323 million, with television revenues rising 60% to $351 million.

Icahn has taken his battle not only to the shareholders but also to the press. Will he start spending more time in the courts as well? Hostile takeover attempts very often involve costly litigation; under Delaware law it is often the only way for a potential acquirer to scuttle anti-takeover provisions. Icahn must act under Canadian law. Indeed, he has already gotten a Receipt of Approval under The Investment Canada Act, in which he made several commitments to government entities regarding how he would run certain Lions Gate businesses should he gain control.

Icahn wants management to clean up the company’s balance sheet, stop producing independent films and just distribute them, stop trying to acquire other film libraries and cut “absurd” overhead costs. Clearly, some shareholders still aren’t siding with him in this battle. The final tally? We’ll find out.

Note for Tuesday, July 5, Lions Gate shares dropped below $7.00 last Friday and remain there today.

2010.32 RealD gets closer to its IPO

On June 28, RealD filed an amendment to its S-1 registration statement in preparation for its IPO.  This amendment has the kinds of details – the shares to be sold, valuation range, selling shareholders – that suggest the company is ready to take this offering on the road.  I would expect this roadshow to begin asap.

This registration statement amends the company’s filing on April 9, 2010.  Please refer to our previous post on that filing.

Highlights of the amendment are as follows:

• Expected offering size and valuation.  The company is proposing to sell 6 million new shares at a price range of $13-15 per share.  At $14 per share, the offering generates $84 million in gross proceeds ($75 million net).  This is a lot less than some people’s estimates of $200 million based on the April filing, but it certainly does the job.
• At $14 per share, the implied pre-money valuation for the company is $725 million.  That valuation includes the impact of warrants and options granted to employees, key exhibitors and others.
• In addition to the 6 million shares to be sold by the Company, existing shareholders are looking to sell 4.75 million shares.  Most existing shareholders are selling a portion of their holdings – Michael Lewis and Josh Greer (the founders), Shamrock, Pequot and others.
• The company’s March quarter was huge.  RealD did $113 million in gross revenue in the nine months ending December 2009.  Just in the March 2010 quarter, the company’s gross revenue exceeded $76 million.  Avatar was the primary driver of this spike in revenues, which the company warns will not be repeated in the June quarter.
• The company’s rapid deployment continues.  Just between March 26 and June 1, RealD’s deployed screen count increased from 5,321 to 5,966 (up 12%).  The 14,000 screen deployment by Digital Cinema Implementation Partners (discussed in our April RealD post) will represent dramatic growth.  The cost is that the company is forecasting $40 – 50 million of capex in the March 2011 fiscal year.
• Growth creates its own challenges.  For example, the company’s freight and logistics expense grew $16 million in the March 2010 year to handle the logistics of eyewear.  Further, the company forecasts that it will spend $4 – 7 million in the June and September quarters to cover expedited shipping of eyeglasses and to build eyeglass inventory.  The logistics of handling expensive 3D eyewear remain a difficult operational challenge for the company and exhibitors.
• RealD sees continued growth in the 3D movie pipeline.  They estimate that 23 3D movies will be released in 2010 and 33 will be released in 2011.  By comparison, there were 27 3D releases in the entire 2005-2007 three-year period.
• RealD’s board is going Hollywood.  Upon the consummation of the IPO, Frank Biondi Jr., James Cameron and Sherry Lansing are all joining the board.  Biondi has served as CEO of both Universal Studios and Viacom.  James Cameron, of course, is the force behind Titanic and Avatar.  Sherry Lansing is a longtime Hollywood player who was once president of production at 20th Century Fox.
• The company has sharply raised its own estimate of its value.  Remember per our April post that RealD has to account for the warrants it issued to exhibitors by estimating the value of its stock as those warrants vest.  As of March 2010, management estimated the company’s per-share value to be $23.07, up 65% in only three months.  This does create the anomalous situation that RealD is preparing to sell stock to the public at a significant discount (35 – 43%) to the board’s estimate of value.
• Don’t let them confuse you with a stock split!  The company has effected a 3-for-2 stock split since its April filing, so any quick per-share comparisons are risky unless you are clear on whether you are talking pre-split or post.

With the Dow Industrials down 268 points yesterday and 92 points today, perhaps RealD’s biggest near-term worry is the market.  Stay tuned for the roadshow!

2010.24 Going public via a reverse merger; one investment banker’s perspective

A reverse merger into a shell company (a back door IPO) is essentially the acquisition of a non-operating public company by a private company, with the public company surviving. The shareholders of the private company gain control of the public company by merging their company into the public shell and receiving shares in the public shell as their merger consideration. The public company is called a “shell” because there is nothing inside – it’s typically not an operating company at the time of the transaction. The private company shareholders obtain the majority of the shares and board control; the private company’s name is usually adopted.

The process is often marketed as taking only a few weeks (much quicker than a traditional IPO) and avoiding a related lengthy and expensive SEC review – should the shell already be registered with the SEC.

Armand Hammer is generally credited with inventing the reverse merger in the 1950s when he invested in a shell company then merged Occidental Petroleum into it. In 1970 Ted Turner completed a reverse merger with Rice Broadcasting, later named Turner Broadcasting. In our just issued In Reel Time newsletter we discuss Image Metrics’ recent reverse merger transaction and related fundraising – and point out that the company is growing at an impressive rate.

I don’t generally like this form of transaction. Doing an Internet search before writing this post I read a lot of positive articles and I’m skeptical of the authors’ objectivity. Are those web sites listing “liquidity” as a benefit because they are touting reverse mergers? Going to Googlefinance.com I was able to find numerous such companies with an average trading volume of zero shares – hardly liquidity.

To be fair, a reverse merger can be a cheaper and faster way to go public. You can often bundle it with a fund raising, lock up shareholders (so they don’t dump shares into the liquidity you might get) and cash out minority investors who need to sell. Theoretically, you can use the “public” shares as acquisition currency after you complete the transaction. And, if the business performs well you will have a higher price, liquidity and perhaps even an institutional following. In the late 1990’s I worked with Richard Rosenblatt and his company iMall, which he was later able to sell for almost $600 million to Excite@Home. The reverse merger structure worked for him, early on and when iMall was suffering growing pains. But Richard, co-founder of Demand Media and seller of over $1.3 billion in Internet company value, is not your average CEO.

What I’ve seen more often is an increased burden for management from the demands of being public. Below a certain market cap institutions can’t or won’t buy company shares so investment banks aren’t motivated to make a market or initiate research coverage. As a result, shares trade thinly. Financing is tough – the participants in such transactions tend to litter their deals with warrants and dilutive and contingent terms (should the company not meet certain performance criteria). Since the initial “shell” company often failed, a stigma can linger. Unlike with an IPO no large chunk of raised funds necessarily accompanies this route to becoming public (which can justify the increased scrutiny, cost and burden of being public).

Is it the structure that I don’t like or the reality that many companies who use it have few alternatives? Both. I’m a huge believer in taking money when you can…until doing so becomes too cumbersome, dilutive or difficult (for example, high debt burdens that are impossible to meet). But alternative methods are alternative for a reason; they’re often marketed with much hype but don’t deliver as promised. In the right situation (see my examples above) a sophisticated and well counseled management team can benefit from such a transaction. As a lawyer by training – though not current practice – I would counsel that the shareholders’ goals need to be clearly defined and match the transaction structure chosen. A transaction structure should be valued based on whether or not it is used correctly; structure alone is inherently neutral.

Most of all, I have reservations about the promises made to those looking for a solution to the difficult realities of raising money. This structure rarely solves a company’s short term capital needs. Being public – in and of itself – does not ease fundraising woes UNLESS your company performs at an exceptional level. But then, public or not, you’ll be able to raise money.

Please feel free to follow up with me personally for insights more tailored to your own company’s status at jones@hadleypartners.com.

2010.18 RealD files for an IPO

NOTE: this posting was slightly delayed because we were busy last week in connection with NAB.

On April 9, 2010, 3D technology company RealD Inc. filed an S-1 registration statement for an IPO. This is our second post this week on IPO’s. That is some coincidence, but it also reflects the fact that the IPO pipeline is the strongest it has been since before the financial crisis. A select group of entrepreneurs should be paying attention. As a service to our dear readers we thought we would provide summary and perspective on RealD’s filing.

RealD’s business is growing nicely. RealD generates substantially all of its income by enabling 3D viewing of motion pictures in theaters, both installing 3D projection equipment and providing eyeglasses for viewers. As of March 26, 2010, the company had its proprietary technology installed in 5,321 digital theaters. This number is up 152% from 2,108 screens in March 2009. Further, the company is working to install another 4,900 screens pursuant to agreements with existing licensees.

The Company is aligned with Digital Cinema Implementation Partners (DCIP). The three exhibitor co-owners of DCIP – AMC, Cinemark and Regal – are all licensees of RealD. Given that DCIP completed $660 million in financing in March to continue its digital cinema deployment, that roll-out should give RealD a tailwind of new theaters to support. DCIP’s financing will fund the digital deployment of approximately 14,000 screens. RealD’s exhibitors also have penny warrants equal to 8.9% of the Company’s pre-IPO shares – while no individual warrantholder reaches the 5% threshold required for disclosure in the S-1, it is safe to assume that the DCIP owners hold a chunk of these warrants.

The Company has recently valued its equity at $578 million. Other than paying a registration fee to the SEC for aggregate IPO proceeds of up to $200 million, neither the Company nor the underwriters (JPMorgan and Piper Jaffrey) take a view on RealD’s IPO value. However, for accounting purposes the Company is required to value its exhibitor warrants as they vest, because the value of such warrants must be deducted from revenue (as if they were a sales allowance, which in a way they are). In December 2009, the Company estimated the fair value of its common stock to be $21 per share, which suggests a pre-IPO equity valuation of $578 million.

RealD’s business model is a direct play on the commercial success of 3D. RealD is definitely eating its own cooking. By the terms of the majority of its exhibitor deals, RealD buys and installs the necessary equipment at the exhibitor, and then collects a per-attendee fee from the exhibitor. The exhibitor thus takes limited risk (they are giving RealD some exclusivity), while RealD has a business model with some capital intensity (they buy and install the equipment up front) but high margins on incremental revenue. So…

RealD should be marketing its IPO on a terrific March 2010 quarter. Because of RealD’s business model as noted above, the March quarter should be strong. Avatar was released 12/18/2009 and rolled well into Q1, and Alice in Wonderland was released 3/5/2010. Those two smashes alone should give the company continued strong growth.

RealD’s bet on 3D is a slightly different play than, for example, Cinedigm’s (NASDAQ: CIDM) economics on digital cinema. Cinedigm gets a “virtual print fee” from a studio every time it delivers a digital movie file to a screen. Oddly, Cinedigm’s revenue goes up with the velocity of movies delivered, not how long they stay in theaters. So for example, Avatar’s long run in Q1 will modestly depress Cinedigm’s results, while the big Avatar gate will favorably affect RealD’s. That difference works both ways, a quarter of weak releases will probably help CIDM and hurt RLD.

It’s the glasses, stupid. Currently, RealD’s income statement is dominated by eyeglass sales, not exhibitor licensing. For the nine months ended December 2009, gross licensing revenue was $44.4 million while product sales (eyeglasses) were $68.4 million. The licensing business is highly profitable on a stand-alone basis, but the gross margin on eyeglass sales is currently negative (RealD lost $9.2 million on its eyeglass sales).

RealD is handling eyeglasses differently in North America and overseas. In North America, it is receiving a per-admission eyeglasses fee from the exhibitor, and is assuming that eyeglasses last eight weeks for the purposes of amortizing their cost. Overseas, RealD is selling the glasses outright. As anybody who has seen a 3D movie knows, the glasses are a logistical challenge for the exhibitor, and Joe Morgenstern at the Wall Street Journal has written about the quality issues with 3D glasses (subscription required). RealD is working to increase recycling of glasses and generally to reduce their cost. In the long term, this logistical challenge is probably second only to the success of 3D generally in determining the long-term profitability of the company.

3D in the home – just starting. The Company is working to license its 3D technology to consumer electronics manufacturers, and also has 3D technologies on the way which do not require eyeglasses. However, these initiatives do not yet have any impact on the Company’s revenue and near-term prospects. This IPO will be bought and sold largely on the prospects for theatrically released 3D content and RealD’s competitive position.

Stay tuned for updates as the IPO proceeds!