Deals

Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

Peppa Pig, meet Lady Mary. 

Buying Entertainment One, the Canadian film distributor and owner of the Peppa cartoon franchise, would be a tricky deal for ITV -- but potentially worth it. Some of Entertainment One's assets fit oddly with the U.K. broadcaster's strategy and the transaction would be sizeable. But these issues are surmountable.

Shares in Entertainment One rose as much as 20 percent to 191 pence on Thursday after Bloomberg News reported that ITV was mulling a takeover. Entertainment One said no approach had been received.

Entertainment One's a Drama for Investors
Shares have slid from a record high last year after the company raised capital to fund acquisitions

Assume ITV would have to pay a standard 30 percent premium to Entertainment One's undisturbed share price of 158.6 pence. A bid would then value the equity at 881 million pounds ($1.2 billion), against ITV's market capitalization of 9.8 billion pounds.

Adjust for Entertainment One's debt and minority interests, valued by Peel Hunt at roughly 480 million pounds, and a full take-out price would approach 1.4 billion pounds. At about 10 times forward Ebitda, that's within the range of ITV's other recent production acquisitions, the broker notes. 

If Entertainment One can contribute net profit of at least 100 million pounds in its first year after the acquisition -- consistent with current forecasts -- the starting return on investment would be a reasonable 8 percent.

That could rise if ITV can cut Entertainment One's costs or boost its revenue.  ITV's balance sheet is strong -- net debt is below Ebitda -- so it could easily pay all in cash.

While that potential return is tempting, just because ITV can afford the entire purchase doesn't mean it should go ahead. The strategic fit is messy. 

There would be logic in scaling back any purchase by quickly finding buyers for assets that have less obvious strategic value to ITV. Entertainment One's film distribution business doesn't seem to belong in a free-to-air broadcaster.

Doesn't Quite Fit
The vast majority of Entertainment One's sales come from film, which falls outside ITV's strategy
Source: Entertainment One
Year to March 31, 2015

Peppa Pig has been a much-loved kids' character for years, and it's fair to ask how much value is left to be extracted from the franchise. 

Selling these could effectively cut the deal value in half depending on the prices achieved. And ITV would be left with the real strategic prize -- Entertainment One's stake in Mark Gordon, the production house behind critical and commercial hits like Grey’s Anatomy and Criminal Minds.

A more-focused transaction would support ITV's strategy to add TV content with global reach. Even after their jump, Entertainment One's shares are trading at around half their all-time high achieved in July last year.

The Canadian group could put up a fight and argue that a bid from anywhere right now is opportunistic. That may be true, but it may not be enough of a defense against the financial might of ITV. Stay tuned.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Chris Hughes in London at chughes89@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net