Value Find: New Frontier Media Inc.
Opportunity could be lurking in shares of small-cap New Frontier Media Inc. (Nasdaq: NOOF) after the stock was hammered recently in response to a weak earnings report.
Adult entertainment distributor New Frontier Media chose a bad time to report lackluster results. Amid an already skittish stock market, the small-cap company reported weaker-than-expected fiscal first quarter results on August 8, sending the stock tumbling. After putting together a solid 2006, New Frontier shares have now declined almost 40% year-to-date as investors have grown cautious about the company’s prospects.
While not nearly as well known as Playboy Enterprises, Inc. (NYSE: PLA), Boulder, Colo.-based New Frontier is a leader in the production and distribution of adult themed and general motion picture entertainment. Founded almost a decade ago, the company’s programming is today distributed by virtually every major cable and satellite TV operator via pay-per-view (PPV), video-on-demand (VOD) and emerging technologies like Internet Protocol TV (IPTV). All told, New Frontier’s programming collectively reaches 139 million households.
New Frontier entered the adult themed film production business with the acquisition of MRG Entertainment in February 2006 for $20 million in cash and stock. The MRG deal has expand New Frontier’s portfolio of higher margin, less explicit erotic content. New Frontier has also been able to leverage its existing distribution relationships for distributing MRG Entertainment’s content. It was MRG, though, that was a driver behind New Frontier’s recent weak earnings report.
For the fiscal first quarter ended June 30, 2007, New Frontier reported a decrease in revenue to $12.9 million, from $16.3 million for the same quarter a year ago. Net income declined to $1.5 million, or $0.06 a share, from $3.5 million, or $0.15 a share, a year earlier. After deducting approximately $500,000 worth of what New Frontier believes are extraordinary items, the company still posted a significant decline in year-over-year profitability. New Frontier placed the biggest blame for this decline on a delay in the production of several new MRG films until later in the year. These films are now expected to be delivered in the fiscal second and third quarters.
Even the Pay TV segment, which has historically been New Frontier’s bread-and-butter, reported sub-par results. The Pay TV segment posted revenue of $10.4 million, compared with $12.6 million in the year-ago period. Video-on-demand revenue was flat at $4.6 million, while pay-per-view revenue declined 28% to $5.4 million. New Frontier blamed the decline in revenue at the segment on a change in the license fee structure with one of its major customers, as well as adjustments made for accruals.
While we never like to hear lots of excuses, New Frontier has traditionally posted choppy quarter-to-quarter performance. On an annualized basis, though, the company has demonstrated that it is a solid grower that is quite profitable. For fiscal 2006, New Frontier posted revenue of $63.3 million, up 35%, and net income of $12.3 million, or $0.51 a share, an increase of nearly 9%, from the previous year. Earnings before interest, taxes, depreciation and amortization (EBITDA) rose nearly 22% to $21.3 million.
Starting with the current fiscal year, New Frontier has begun paying out a generous quarterly dividend of $0.12 a share. Prior to this fixed dividend, New Frontier had briefly experimented with paying out a variable dividend based on a percentage of free cash flow. With after-tax earnings of $0.06 a share for its fiscal first quarter, New Frontier clearly fell well short of “covering its dividend” out of internal cash flow last quarter. However, the company says it is confident in its ability to pay its $0.50 a share annual dividend entirely out of this year’s cash flow. New Frontier isn’t providing specific guidance.
With New Frontier shares having declined to the low $6 level, the stock now sports an outsized yield of nearly 8%. While a dividend reduction could eventually be a possibility, New Frontier’s strong balance sheet limits the short term risk of such a move. The company ended last quarter with nearly $24 million in cash on hand, and no debt.
It’s also worth noting that activist hedge fund Steel Partners is the company’s largest shareholder. Last year, Steel Partners made informal buyout overtures to New Frontier and the fund can’t be happy with the stock’s decline. Interestingly, a new CFO, who has a merger and acquisition background, takes over at New Frontier on September 5.
While New Frontier has sputtered recently, given its strong balance sheet, attractive dividend and still solid cash flow, the latest selling in the stock looks overdone. New Frontier may deserve to trade at a discount because of its business focus, but not this large of a discount. The stock looks poised for a decent rebound over the coming months.
Bottom-line, New Frontier looks like a solid “value find” for medium-risk oriented investors.
