Phantom Digital Effects Limited

The signing of the term sheet (assume there is an ongoing contractual negotiations before any formal acquisition) does present some questions / perhaps opportunities as well? I had additional thoughts (speculation) to add

a. The 20%-25% increase in revenues was confusing – I interpreted this as 20-25% on Rs 90-95 crs – so that would imply ¬Rs 20 crs (USD 2.4 mn) – as per the Q3 FY24 call the Rs 135 cr FY25 target included inorganic as well. The exact numbers / valuation multiple are not really critical – the main point is that Phantom is 4-5x larger than Tippett – so at least from a size perspective it is the much larger company buying the smaller one

b. Coming to reputation – without a doubt Tippett has a strong historical track record (winning an Oscar can’t be a bad thing!!). Speculation 1: However, I do see that their 2023 references are far fewer and not as impressive compared to previous years (official announcement https://youtu.be/YtKrGzzLeUg at 2:13) .

c. Speculation 2: Selling a 30 year old business for $4.375 mn would seem to imply something is not working. Combining the 2023 revenue size and track record (and the Hollywood strike?), perhaps Tippett is struggling (with any professional services company, employee cost is 50-60% of revenues and the hollywood strike was 5 months). Based on some scuttlebut, working for VFX companies in developed countries does not seem to be a desirable job (highly demanding clients – Marvel leads the pack, very long working hours -high pressure to turnaround, limited compensation upside – overtime is something being introduced). Could also explain the migration of work to India and the subsequent staff challenges here Phantom Digital Effects Limited – #236 by vikas_sinha

d. Speculation 3: Having a US reputed organisation (with the original brand) could be a way to ensure direct contracting of international work. Some additional scuttlebutt I had done on the VFX industry highlighted that one of the key challenges for more international work to be directly contracted by Indian VFX studios was confidentiality concerns. Since the VFX / Post production work needs to be done on the final rushes, there is a major concern to transfer the files to a new partner offsite in India (piracy and leakage concerns for multi-millions dollar movies is a big worry). This is where Teppitt could fit in (In addition to the point made by Gary Mundelll CEO Teppitt – that jointly they will be able to convince studios that India can do creative work as well – in addition to technical)

It would be very interesting to get management’s thoughts on this / perhaps there will be more details if and when the contract is finalised. Several questions still unanswered

• The term sheet is a bit low on details – e.g. revenues over the last 3 years is not provided

• Is there an option to buy out the remaining 20% and at what price?

• Magnitude of earn out for the management to have them stay on – and for what period (would this give enough of a runway for a new management team to build trust?)

• How will the 20% ownership affect the profitability of the business – assuming all US / Canada work is contracted through the Tippett entity, how does the transfer pricing work or is there a ‘20% tax’ on all revenues. E.g. they talk of hiring 250-300 employees across all geographies – India, Canada and US.

• What is the payment schedule and how will they fund this. Total acquisition cost for 80% is Rs 31 cr. I think they had about Rs 4.8 cr at Q2 FY24. There was still about Rs 13 cr Ayalaan outstanding + cash generated in Q3 and Q4. Seems like they might need some debt assuming this is an all cash deal or they might dilute further if there is stock (hopefully not given the current share price trajectory!!)?

In balance, it seems to me that this is a reasonable step to the North America geographic expansion (and depending on the final contract details – may even be an excellent one). Perhaps they will share more on the actual rationale (rather than me relying on my speculation) in the year end call.

Disc: Invested and continuing to build position size – so likely to be biased. Not financial advice and not a registered SEBI advisor