[Regarding DISK] Up to this point, I wish I had been just a spectator of this circus; instead I have been one of the company clowns. Well, here are my thoughts, including an amateur try to valuate Image Entertainment:
1. Probability of Closing: This deal is almost a perfect example of Knight’s uncertainty so I won’t dare to throw a guesstimate. It could be anything. However, uncertainty is our friend because it scares momentum players and arbitrageurs. I would say that at this moment most of the big shots are long gone.
And what weapon do we have small players have against this uncertainty? Klarman’s golden glove to catch falling knives: margin of safety
2. Margin of Safety: Most people buying DISK do not even know what they are buying. They just see recent sell-offs and use that as a proxy for downside risk.
Since when we value investors trust Mr. Market? Especially since film libraries are assets that time and again are being underestimated by our bipolar partner. P/E ratios lack accounting of the heavy non-cash depreciation and amortization expenses, And M/B ratios usually undervalue the library because it is not marked to market.
At the same time the library has some particularly favorable economics:
- Growth potential across formats and internationally with marginal investments
- Low maintenance CAPEX
- Steady royalty cash flows
In other words, they are the perfect LBO or acquisition target. The only problem is the risky film production. But once you have the rights, no sweat! Buffet likes, or used to like, newspapers. I like film libraries.
I prefer to use equity free cash flow and in this case, EBITDA is a good proxy for FCF because of the low maintenance CAPEX.
