Protected: Cityneon Holdings Limited: A Force to be Reckoned with

TICKER: Cityneon (SGX: 5HJ) MARKET CAP: SGD 249.5 Million (As of 4 Dec 2017) MARKET PRICE: SGD 1.02 (As of 4 Dec 2017) P/E RATIO (Trailing twelve months): 37.363 DIVIDEND YIELD: - SECTOR: Entertainment WEBSITE: http://cityneon.net/

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INVESTMENT SUMMARY

• Led by new CEO Ron Tan, ex-producer of the Hi-5 TV series & Hi-5 movie. His interests are aligned with the shareholders as he owns 16.35% of the firm.
• Possesses strong economic moat due to IP rights.
• Earnings jumped 690% in FY2016, with more positive surprises to come
• High margin (20+%) and scalable business (exhibits can go round the globe)
• Potential buy-out by HK-listed Teamway International

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COMPANY PROFILE:

From a small supplier of electrical appliances in 1956, Cityneon has come a long way. Today, it is one of Singapore’s leading brand experience agencies, serving a wide array of customers regionally and internationally. By virtue of their specialised expertise in conceptualising, designing and building creative solutions, they deliver brand experiences in the following:

• Interior Architecture,
• Experiential Environments,
• Events and Exhibitions.

In addition, what’s more attractive to investors is the company’s acquisition of immersive attractions company - Victory Hill Exhibitions Pte Ltd in year 2015. Check out their video here! It focuses on delivering engaging educational and interactive “ready-to-showcase” exhibitions through their exclusive Intellectual Property Rights (“IPR”) such as:

• Marvel Avengers,
• Transformers and
• Jurassic World

See below for an overall picture: Without further ado, let’s jump into the analysis of Cityneon.

1. Business Model & Economic Moat

When you look at Cityneon’s business segments, it is no doubt one that focused solely on setting up of trade events or exhibitions across different environments like museums, events, corporate trade shows and more. However, if we take a closer look, we are able to see a big contrast between Cityneon’s existing traditional businesses versus the IPR acquired in 2015.

Cityneon’s Biz Model	4 Traditional Segments	Intellectual Property Rights (IPS)
Economic Moat	Low (Fragmented Market)	Strong (Intangible IPs)
Profit Margin	Low (Single Digits)	High (20+%)
Project Basis	One-time projects	Recurring Basis
Scalability	Tough to Scale	Easy to Scale

  Here are some of our observations explained in detail: 1) We feel that the building of trade shows and events can often be outsourced to even cheaper fragmented players too. More often than not, these mean that Cityneon is unable to mark up their margins very high (low pricing power) which in turn, signifies a low economic moat. 2) Doing some fact-check on its peers like Kingsmen Creatives Ltd (SGX: 5MZ) and Pico Far East Holdings Limited (HKG: 0752) reveals that net profit margins are low (single-digits) for the traditional businesses. They are around 3% for the former and 7.5% for the latter. 3) The usual design-and-build projects are usually a one-time off events too. Just look at the Interior Architecture projects below. The pain is that the firm always have to go seek out new deals in order to just have profits remained constant for that year. Cont’d below… In contrast, the IPR segment can provide a recurring income basis through its operating model. After production of the exhibition sets consisting of all the Ironman, Hulk figures etc., Cityneon can literally milk it over a long period of time. 4) With decades of experience behind them, Cityneon can still do projects with a bigger scale for the traditional businesses. However, huge project bids like this are less and few and often lead to competitive bidding too. On the other hand, Cityneon can scale up its IPR segment just by constructing more exhibition sets and performing more tours globally (more on this part later). To sum up, the traditional business of Cityneon has been declining over the years as a result of a slowdown in demand for such events. Intensifying competition in the industry has also put a drag on profits, and would likely continue to do so. The acquisition of Victory Hill Exhibitions came at the correct time - bolstering Cityneon’s sales and profit growth for the year 2016. Net profits actually jumped 693% from S$0.9 mil to S$6.7mil. With that, we will zoom more into this growth catalyst.

2. Growth Story

As previously mentioned, the intellectual property rights or “IPR” business is where all the excitement and explosive action lies. Leveraging on their exclusive Intellectual Property Rights (IPR), Cityneon is probably able to build a strong economic moat in the ‘experimental exhibition’ business. We zoom into 5 things you need to know about the IPR segment and the Cityneon’ growth prospects: 1) Stemming the decline in the Traditional business. According to the latest 1HFY2017 results, the revenue of the ‘traditional’ businesses are facing some headwinds but mitigated by the positive contribution from IPR. This is what the CEO Ron Tan has to say (excerpt from annual report 2016): At the same time, we will be re-organising our traditional businesses, strengthening and streamlining them to refine the Group into a more nimble and lean organisation. This will be achieved through several steps such as

• Merging the EX and EV segments to better consolidate resources, facilitate cost savings, and improve operational efficiency.
• Expand the EE business segment organically which had for the year under review bolstered its track record following the effective completion of the multi-million dollar international theme park project in Shanghai.
• For the IA segment, we will consolidate the current 2 divisions into a single team and concentrate on tendering for bigger niche projects such as hotels, service apartments, museums and galleries both locally and overseas to increase our standing.

2) Economies of Scale According to both DBS and KGI research reports, a newly conceptualized exhibition set would typically cost US$5 – 8m and take one year to construct (from R&D to completion). However, subsequent sets cost only about one-third of the original cost per set (S$2 – 4m) and extra 2 – 3 months to construct. This means that Cityneon is able to achieve operational leverage with every subsequent set built without the need for additional R&D costs. Any additional modifications to existing exhibits or construction of new exhibits to keep up to date with the movies would only typically require US$0.1 to 0.2 mil in additional spending. This directly translates to higher margins and allowing them to speed up its expansion plans. 3) Scalable Business Model At this point, you have to know that its wholly-owned subsidiary Victory Hill Exhibitions (VHE)  has both a permanent Marvel Avengers’ set in Las Vegas and a few travelling sets touring the world as we speak. In fact, Cityneon has been able to secure new locations every few months as we speak.

Sourced from prnewswire.com

Sourced from SGX.com

Each travelling set is targeted to only be stationed in any specific city for a limited period of time. The 1^st Marvel Avengers’ exhibition in Singapore Science Centre only lasted from 29 Oct 2016 to 5 Mar 2017, a short 4+ months. Assuming that an exhibition lasts for about 3-4 months, theoretically, a set can be used 2-3 times per year based on a back-to-back schedule. Check it out below:

Sourced from Cityneon, KGI Research

Given the overwhelming demand, we believe that more locations will be announced in future and the construction of more exhibit sets will follow suit. With the hiring of 2 senior-level hires, Cityneon has more capability to produce and create innovative concepts to capture visitors’ interest going forward. 4) Low Risk of Execution Apart from the permanent set in Las Vegas, execution risks is kept to a minimal for the travelling exhibits as the bulk of the risk is borne by the operator. For every location or project, Cityneon earns most of its revenues in the form of fixed licensing fees and a variable portion from royalties. And because VHE is an exhibition producer, it does not promote nor operate the exhibition. Instead, VHE ties up with a local operator to operate the exhibition, receiving from them, a fixed license fee which makes up 90% of VHE’s revenues earned from that exhibition. The remaining portion of the revenue is from ticket sales and merchandise sales. Of which, 20% is the minimum guaranteed amount, which reduces risk of poor visitorship. Lastly, each exhibition set is even insured by the operator for up to US$10 mil. This means that any damages to the travelling sets will be borne by the operator. 5) Riding the movie pipeline bandwagon VHE’s value proposition lies in creating a tangible experience for fans, by bringing characters off movie screens and closer to fans. Thus, the success of VHE’s interactive exhibitions will depend largely on whether there is a healthy pipeline of movies to sustain the continued interest of customers. Luckily, the 3 exclusive IP rights under VHE’s belt has several upcoming new movies:

• Avengers - Avengers Infinity War part 1, Black Panther and Ant-man in 2018; Avengers Infinity War part 2, Captain Marvel and Inhumans in 2019, and yet-to-be-named movies in 2019/2020.
• Transformers - Four more films to be released by 2020, with Transformers 5 slated for release in June 2017
• Jurassic World – Jurassic World: Fallen Kingdom in 2018, one more to be affirmed.

To sum up, these popular movie franchises will bode well for the company. In fact, you can also expect higher visitor ship based on the popularity of the movies too. Let’s move on the financials next.  

3. Financials’ Assessment

Sourced from CityNeon’s AR 2016

The past 5 years hasn’t been a pretty picture for Cityneon. Revenue is fluctuating while profits are languishing over the period of time. However, things are turning around in the latest FY2016 with net profits after tax (NPAT) coming in at S$6.6 mil, a record high compared to all the other years! In fact, you will not notice VHE’s maiden contribution for the year just by observing the revenue numbers. This is because the VHE’s revenue growth is being dragged down by the old traditional business segments. That said, the superior profit margin of VHE managed to pull up the earnings of the company. The positive trend continued into the latest 1H2017 results.

Sourced from Cityneon’s 1H2017 Results

Revenue was up 7.3% to S$49.7 mil and net profits soared 64.1% to S$7.7 mil, already higher than the whole of FY2016 profits! By annualizing the net profits (*2), estimated earnings per share (EPS) for FY2017 is derived to be 0.062. This translates to a P/E ratio of around 16.1x. On the other hand, I performed some of my own calculations (attached in excel file). Based on some rough assessment, I think that the company can even do better going forward especially with the acquisition of the new Jurassic World IP. In fact, my daughter loves dinosaurs and my wife is hell bent on going to such exhibitions if there are any in Singapore. Back to the topic, I assume that net profits may soar through the roof to hit around S$ 23.8 mil and S$ 32.2 mil in FY2017 and FY2018 respectively. Giving it a margin of safety of 50% will yield an EPS of 0.066, deriving a P/E ratio of 15x – a fair deal by any means. We have even excluded any profits from the traditional business too! With that in mind, we look at how the company is faring on its balance sheet and cash flow status. As of 31^st Dec 2016, Cityneon has short term bank loans of S$24.7m and S$ 3.5m loan payable to the ultimate holding company. This is not excessive given that the company has S$23.78m in cash and cash equivalents too. One crucial thing to note is how skewed the company is towards purchasing of property, plant and equipment (PPE). The exhibits require a huge capital expenditure (capex) upfront to construct and thus, the group is recording a big cash outflow of S$29.6m in AR 2016. As such, free cash flow is likely to be negative in the near term. Things may improve once the company reach the equilibrium where the initial batch of products can generate enough cashflow to cover the huge capex and go towards ‘maintenance’ mode – where you only need to alter some parts of the exhibits or add new characters.  

4. Key Management Team

Having just joined the Cityneon family as CEO, Ron Tan brings with him a wealth of experience from heading the operations of Victory Hill Exhibitions Pte. Ltd. (“VHE”), the firm holding on to all the Intellectual Property Rights. A former Singapore government scholar and an alumnus of the prestigious University of Hawaii where Mr. Tan graduated with 4.0 GPA, he has served at various local and multinational firms in senior level positions. And in case you didn’t know, he was the Producer of the Hi-5 TV series and the first Hi-5 movie that was sold and broadcast in more than 200 countries globally. I had the privilege to attend the opening ceremony of the collaboration between Singapore Science Centre and Cityneon. He come across as an amiable and forthright leader as he tells of his story how his mother doesn’t understand what he does for a living and he replied candidly, “I do cartoons for a living”. In addition, Mr Ron Tan is aware of the decline in the traditional business and planning counter-measures such as:

• Merging EX and EV segments to facilitate cost savings
• Expand EE business organically following completion of multi-million dollar theme park project in Shanghai
• Consolidate 2 divisions under IA segment to tender for bigger niche project like service apartments and galleries etc.

Last but not least, CEO Ron Tan has every incentive to get this right as he owns 16.35% of the company (through his vehicles).

5. Risks Revealed

No investment is without risks and the same goes for CityNeon. We look at the whole picture and zoom into some of the risks worth noting:

• Hard to determine earnings as it is highly dependent on number of visitors, especially for the permanent sets in Las Vegas. Visitorship can be affected by many factors like geopolitical risks outside of the management’s control. That said, the likelihood of such events occurring is marginal since the company can just “pack and go” for their travelling sets.
• Possible further rounds of share dilution through share placements as the company requires huge cash outlay to build those interactive sets.
• Due to the nature of the exhibits, any delays/damage during transportation of exhibition sets can impact the reputation of the company and earnings adversely.
• Sustainability of VHE’s business model is dependent on the continuity and additions of IP rights. The inability to renew an existing IP would mean a loss of income for VHE. Failure to renew any IP rights will also cause it to lose any economic moat the firm has built up.

Given the remarkable success of the exhibitions in Singapore, Paris and Las Vegas, we feel that the company is heading in the right direction and managing any risks well. It is also not sitting on its laurels by purchasing the Jurassic World IP rights just a few months ago which will be a boon to earnings in the near term.  

Conclusion: Our Take on Cityneon Holdings

We have tabulated these 5 criteria into something easy on the eyes called: Pentagon Rating™ (see above). To sum up, we feel that Cityneon’s economic moat is well protected by the IP rights secured by the various parties – Marvel Entertainment, Hasbro etc. If Cityneon is able to execute the exhibitions well, the parties will receive a constant stream of royalties (10% of ticket sales). There is little reason why they wouldn’t allow Cityneon to keep doing what is beneficial for them. This exhibition business is complementary to their biz too, and not competing with them in any area. I feel that Cityneon is on the cusp of a strong surge in its financials too. The IPR segment is likely to drag the company out of the doldrums and continue posting record highs in net profits. Don’t forget that Cityneon can continue to secure more IP rights and add a further boost to the earnings. All in all, I believe that Cityneon is in good hands with the CEO Ron Tan being in the helm of the company. With scores of experience under his belt, I am sanguine on the company’s growth prospects going forward.