Halifax programming darling DHX launches strategic review, could be sold

HALIFAX _ Less than five months after scooping up the Peanuts gang of children’s cartoon characters in a blockbuster US$345-million deal, the decision this week by DHX Media Ltd. (TSX:DHX.B) to consider putting itself on the auction block has some speculating the Halifax-based children’s entertainment company may have taken on too much debt.

The surprise decision to launch a review of strategic alternatives came Monday. On Tuesday, the chairman of DHX’s strategic review committee, Donald Wright, distanced the Peanuts acquisition from the review.

“Whenever you purchase something as large as Peanuts it takes a lot of management time and effort to integrate it,” said Wright, president and CEO of The Winnington Capital Group.

“We’re pleased with where we are on the Peanuts integration. We took on some debt but we also have a plan and we’re committed to lowering the leverage ratio over the next couple of years substantially.”

Wright said it’s not unusual for a company like DHX to look at strategic alternatives from time to time, especially in light of the company’s recent drop in revenue and stock value.

DHX posted disappointing financial results last week for fiscal 2017. In the fourth quarter, the company recorded a year-over-year decrease in revenue of more than 15 per cent. The company’s stock price took a hit following the lacklustre results, which included transactional charges related to the Peanuts deal.

“I think it’s fair to say the board looks at the value of our businesses and assets and thinks they’re worth a lot more than the stock price indicates,” Wright said.

David McFadgen, an analyst with Cormark Securities, said the company took on too much debt in acquiring its most recent gang of characters.

“Their financial leverage is very high,” he said, noting that the fourth-quarter results were “quite a bit below expectations.”

As the world’s largest independent owner of children’s content, DHX has positioned itself as a global player with many potential suitors. The company’s impressive library of brands includes Teletubbies, Inspector Gadget and Degrassi.

As for possible buyers, McFadgen said a Canadian suitor is more likely to buy the entire company because a foreign buyer like Netflix would not be able to take advantage of certain tax credits and government incentives.

However, Adam Shine of National Bank Financial says a large U.S. media company could acquire DHX’s library while avoiding its broadcasting assets, given foreign ownership restrictions on Canadian broadcasters.

“We don’t rule out Canadian buyers of DHX, but these are not obvious and leverage is high,” Shine said in an analyst’s note.

An analyst’s note issued by Drew McReynolds with RBC Dominion Securities said the launch of the review was a surprise.

“The company owns a variety of valuable content assets that could be of interest to what appears to be a proliferating pool of potential buyers,” he said. “However, there remains considerable uncertainty with respect to scope, probability, timing and valuation of any potential transaction or transactions.”

Michael Donovan, executive chairman of DHX, said during an earnings call last week that over his 37 years in the business, it’s “never been this positive.”

“It’s getting more and more positive in terms of demand than it was six months ago, and that was breaking new ground,” he said. “We are very … well positioned as the leading independent owner of content in this space.”

The company has said it is poised to take advantage of growing demand from industry giants like Netflix, Disney and others as they look for family-friendly premium content for their video-on-demand services.

Donovan said Netflix’s recent promise to fund $500 million in Canadian production was like “a starting gun” going off for “a whole new arms race.”

As for the company’s poor financial results, he admitted management “took our eye off the ball,” saying the acquisition of the Peanuts and Strawberry Shortcake brands “took really all of management’s time for six months.”