Description

Investment Thesis

On March 28, 2019, Chicken Soup for the Soul Entertainment (CSSE) announced a piece of transformational M&A. Sony Pictures Television reached a deal with CSS Entertainment to form a joint venture under which the latter will have majority ownership of Crackle (to be renamed Crackle Plus). CSS Entertainment expects the Crackle deal to close next month, or in May 2019 at the latest.

This write-up is one of 2 long pieces I’m doing on micro-cap advertising video on demand. It’s a funny coincidence that two companies I followed ended up doing transformational M&A that will essentially double each respective businesses with a few weeks of each other.  

Why does this opportunity exist?

CSSE is clearly a microcap, and exhibits many of the typical market inefficiencies found with this asset class; low liquidity, investment case remains under the radar because the stock is too small to attractive sellside coverage / larger institutional investors. Plus, there is a HIGH degree of ambiguity around what exactly the financials of combined Chicken Soup / Sony Crackle streaming business will look like given that the deal has not closed and management has not given many details. I’m ok with ambiguity so that’s why I tend to focus on micro-caps.

Also, I cannot discount the fact that maybe part of the reason this remains under-the-radar to some value micro-cap investors is that they would never believe that the same company that used to produce the Chicken Soup for the Soul books is now a leading player in the ad supporting streaming television wars.

Brief Overview of Chicken Soup for the Soul Ent.

For the sake of this write-up, I’m choosing to give a deep diver on the streaming media strategy which is core to the thesis. But here is an overview of CSSE pre-deal.

CSS Entertainment, will contribute six of its owned-and-operated ad-supported networks — including Popcornflix and Truli — as well as subscription service Pivotshare to the venture.

Before we get into why the accretive deal with Sony / Crackle sets up the company to become an aggregator of digital networks, first we must do an overview of one of the lesser known, but rapidly growing sectors of the advertising market, advertising video on demand.

Understanding the AVOD Opportunity

Understanding the massive secular tailwinds driving growth in this sub-sector of the streaming media industry, is among the most important thing to understanding the transformational nature of this joint venture to CSSE.

[Note to reader - This This industry overview is central to the investment theses for both CSSE as well as CIDM, so this section is in both write-ups in case you only end up reading one.]

AVOD = Advertising Video on Demand. Much ink has been spilled reporting on the streaming wars currently underway amongst the major SVOD (subscription video on demand) players such as Netflix, Amazon, HBO (etc.). However, after over a decade of rapid growth, the industry’s growthiest days are most certainly behind the SVOD players, as the major services are more likely than not close to market saturation in North America. Netflix’s recent decision to raise prices is a telltale sign that we’re well past the initial land grab phase.   

Somewhat ironically, at the same time there’s a proliferation of even more SVOD services from the major media players with deep pockets and big catalogues who were initially late to the dance are now making up for lost time. In the coming 12 months (or sooner) new services will be launched by Disney, Time Warner, NBCUniversal, among others. Some are calling this “subscription fatigue”.

Variety: Nearly Half of U.S. Consumers Frustrated by Streaming Explosion, Study Finds

Plus, it’s not cheap to carry all these services (the point of cutting the cord was supposed to be saving money, after all), so consumers naturally will have only enough share of wallet for 2 - 3 services. That has driven millions of eyeballs to a new crop of AVOD services which allow viewers to watch free linear television over the web. Advertisers have been pouring money into this format because it has some of the best of both worlds of digital and linear TV.

More investors have taken notice recently when Viacom paid $340M to purchase Pluto TV.

Founded in 2013 and privately backed with $51.8 million in funding to date from investors including Scripps Networks Interactive, Sky and Samsung Venture Investments, Los Angeles-based Pluto TV is an ad-supported, free-to-consumer streaming service, delivering a range of digital channels in the searchable format of a traditional linear TV programming guide.

According to Tuesday’s announcement, Pluto TV is averaging 12 million engaged viewers a month. The Pluto TV app is available across a range of living-room OTT and mobile devices. But the company’s most important distribution end point is smart TVs, where it competes with add-supported platforms like Roku, Xumo and Tubi TV to be the native streaming app folks see when they first turn on their set. About 60% of Pluto TV’s viewing comes from smart TVs.

Roku, for example, says it now has a monthly audience of 27 million for its platform, with many of those users watching the AVOD-based Roku Channel.

“Advertisers have a real opportunity [with AVOD] to make connections with a younger [demo] likely to have higher incomes,” said Anna Bager, EVP of industry initiatives at research firm IAB.

IAB found the largest AVOD audience segment is 18- to 34-year-old adults, including households with kids, that skews male. Nearly three-quarters (73%) of those who regularly stream video say that they watch ad-supported OTT. Moreover, 45% of streamers report they watch ad-supported OTT the most. More than half (52%) of AVOD viewers are cord-cutters or cord-shavers, with 42% citing “convenience/flexibility” and 38% citing “better content” as reasons to watch. Additionally, AVOD viewers spend less time watching cable than SVOD viewers. AVOD viewers report watching more OTT video than they did a year ago.

Magna Predicts US OTT Ad Revenues Will Double By 2020

• Magna said Friday that its 2018 forecast for US OTT ad revenues came in short. The agency predicted OTT ad revenues would hit $2 billion in 2018, but they actually hit $2.7 billion at a 54% year over year growth rate.

• As a result, Magna is revising its OTT ad spend forecast upwards, predicting 39% growth to $3.8 billion in 2019 and 31% growth to $5 billion by 2020.

Now, I would argue a big reason this growth is happening and will continue, is that the independent digital video hardware prodivers have a vested interest in make sure there are viable alternatives to to the major media conglomerates such as Netflix, YouTube (Google) Disney, NBC Universal, etc. Up until now many have become too reliant on Netflix. According to Roku’s reported financials: in 2008, Netflix accounted for 100 percent of Roku’s streaming hours. Now it’s down to a third. Unfortunately, Roku (et al.) don’t make any money from Netflix. So they have been doing all they can to promote a plethora of free ad supported streaming channels; making sure they are given prominent real estate on the smart TV home screen, having the apps of these tiny obscure digital nets pre-installed on devices, etc.

Examples of Top Free Channels

The Roku charts have a good list of the top names in the space; some you may never have heard of: The Roku Channel, Pluto TV, Tubi - Free Movies & TV, Sony Crackle, FilmRise, HappyKids.tv

The AVOD Industry is Ripe for a Roll-Up Strategy

William Rouhana, CSSE’s Chairman and CEO, made an cogent case for consolidation amongst these digital networks on his company’s Q4 earnings call on 3/29/2019. (Emphasis mine)

“First of all, in terms of aggregating and deal size, I think we're looking at what will probably be barbell strategy. There are lots of very small players out there, who we can aggregate, really for very little. And they add increasing audience access to additional content and more real estate, which allows people who are migrating to find us. Over time, we will have to rationalize those various networks, put them together and turn them into a identifiable group of networks where people know what they're getting when they go there. But that's a process that will take place over a period of time. The other end of the barbell is the larger players, who really have to try and figure out where they're going to go next. I think we represent a great potential partner for many of those people. “

“I think the growth will be extremely high just because of the trend. But add to that our strategy of rolling up these smaller networks, which really cannot compete, because there is no way that advertisers can go hundreds of networks placed there advertising.”

To ride this growth wave that should lift the tides of many boats, if you take nothing away from this write-up you should probably buy both Chicken Soup for the Soul Entertainment, Inc. (CSSE), and Cinedigm Corp. (CIDM) because there’s a more than large enough universe of potential acquisition targets for them both to profitably roll-up the industry.

Why Sony Crackle is A Great Asset

If you hadn’t heard of Sony Crackle, you wouldn’t be alone.

Sony and CSSE will each contribute certain assets to establish Crackle Plus. The service is expected to have:

• A combined audience of nearly 10 million monthly active users on its owned and operated networks, as well as millions of additional users from its ad rep business, positioning it as one of the largest AVOD platforms in the U.S.

• Over 38,500 hours of programming

• More than 90 content partnerships

• Over 1.3 billion minutes streamed per month

• An offering of over 100 networks, both ad-supported and subscription-based, including networks owned by Crackle Plus and third-party networks distributed via Pivotshare

Sony’s contributions to the joint venture include Crackle’s U.S. assets including the Crackle brand, its monthly active users and its ad rep business. Sony and the joint venture will also enter into a license agreement for rights to popular TV series and movies from the Sony Pictures Entertainment library.

In addition, New Media Services, a wholly-owned subsidiary of Sony Electronics Inc., will provide the technology back-end services for the newly formed joint venture.

CSSE expects the addition of Crackle to more than double overall revenue (it generated $27.8 million in 2018 sales) and will be a “meaningful” driver to adjusted earnings before interest, taxes, depreciation and amortization (EBITDA). The Crackle contribution to EBITDA will be around 25% of total revenue, execs said.

Valuation

CSS Entertainment is making no cash outlay in the Crackle deal; the value of its pact with Sony isn’t fully clear. Under the terms of the transaction, Sony will receive 4 million five-year warrants to purchase CSS Entertainment stock at various price points; Chicken Soup for the Soul Entertainment said it will release additional info on the transaction in future SEC filings. CSSE plans to run Crackle with a much lower overhead than Sony did, and will have access to certain Sony titles under the JV partnership. In fact, CSSE’s management cited the opportunity to streamline Crackle’s cost structure as what attracted them to the asset. 

According to Variety: “In its due diligence of Sony Crackle, the company found several areas where it can cut costs, according to Rouhana. “There was a lot of cost there,” he said. “We run our businesses differently.”

I will follow-up with a more detailed valuation once the company comes out with more specific projections in the coming weeks. At this point it would be mere speculation to guess. However this is a transformational deal that lets you rise a massive growth wave with a consolidator. 

Catalyst

Closing the deal no later than June 30