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A total of 23 films were produced in Portugal in 2011. Ten of those had fewer than 500 viewers. The others typically achieved less than 10,000 and only a couple managed to attract audiences around 20,000. This is a dismal track record by any standard. Why were these pictures unsuccessful?

There are four stages in the innovation process: ideas, insights, invention and innovation. Everyone has ideas. If you share your idea, it may become an insight. If your insight is turned into a product (or service) it becomes an invention. Finally, if that invention is successful in the market, this constitutes innovation.

"Innovation means selling tickets"

Films (or documentaries) are often based on new ideas and insights and original scripts – a product of creativity. In my opinion, the right measure for judging whether a film is innovative (rather than just creative) is public acceptance. If a film is creative and manages to attract large audiences, this constitutes an innovation. Having good reviews is not enough.

Note that the reverse is not necessarily true: public acceptance does not always stem from innovation. Most Hollywood blockbusters are not innovative at all. Instead, they are based on small, incremental variations on a well-known genre. Looking at 2011 global box office results, the top 7 films are sequels.

Back to Portuguese film production, I am willing to accept that at least part of the 23 films produced in 2011 involved some creativity, new insights or original scripts. What prevented these films from reaching larger audiences? I confess that have not seen any of them, but I am willing to take a guess.

The first potential barrier is that Portuguese cinema production is State-financed, to a large extent. Both State and local authorities spend a considerable amount of cash to finance films and promote them. Financing films using public funds has various drawbacks. Among others, a committee has to decide which films are worthy of support. Decision by committee is a known innovation killer.

Another barrier is viewer education. The Portuguese population has a relatively low level of education compared to most European countries and in order to draw audiences, films have to be simple – perhaps too simple. Lack of education acts as a constraint on innovation.

Foreign markets could provide additional audiences but in fact, Portuguese-spoken films do not appear to be easily exportable. Brazilian audiences have to make an effort to understand the language as it is spoken in Portugal.

Hollywood studios are the dominant force in the industry, shaping audience preferences. Hollywood has developed an expertise around simple films, based on familiar genres.

The difficult economic conditions and large State deficit will create additional difficulties. The Government’s budget for 2012 specifically identifies cinema as one of the areas where the State will review its policy. This will almost certainly involve spending cuts.

Is there any way to overcome these barriers?

The obvious choice would be to produce films for mass consumption. However, cinema production and direction is a complex eco-system. It is questionable whether directors working in Portugal are interested in reaching large audiences. In fact, the most successful film of 2011 (in terms of audiences) was João Canijo’s “Sangue do meu sangue“, describing the harsh realities of a family living in a slum in the outskirts of Lisbon. Tough subjects seem to be the norm.

With limited audience acceptance, reduced State budgets and strong competition, the future does not look too good for Portuguese cinema production. Yet it is essential that the industry continues to exist as it encourages pluralism, creativity and diversity.

In a previous post on the subject of transaction multiples, it was argued that lack of information and analysis in the Portuguese press acts as a barrier to innovation. If the media does not report adequately on the value of businesses and no one really understands what a company is worth, is there any incentive to develop a new product, break into a new market or even start your own business?

The latest instalment in this series is the EDP privatisation. We are now used to silly headlines however “Christmas sale: the German, Brazilian and Chinese all want EDP as a present” is hard to beat (source: Jornal I).

Here is a basic question on the privatisation: Are taxpayers getting a fair deal?

There are various ways to determine the value of a company. The media are obsessed about market values however, other methods such as discounted cash flow valuation are more reliable.

A simple way to answer the question without going into the detail of cash flow estimation is to use relative valuation. If you calculate EDP’s value in relative terms and compare it to similar quoted companies, you will gain a better understanding about the offers on the table.

The Enterprise Value (EV) is the sum of a company’s market value and its net debt. EV is a measure of value which can be compared to EBITDA (an approximation of the annual cash flow) and this provides a valuation multiple. So the question is: what is EDP’s EV/EBITDA multiple?

Bloomberg estimates that EDP’s Enterprise Value at current market prices is EUR 28.8 billion and its EV/EBITDA is equal to 7.9x. That should be a good enough approximation.

In the case of the privatisation, acquirers are not offering market prices for the stake being sold. Instead, a premium is being offered, relative to current market prices. The resulting EV/EBITDA taking into account reported offer values is around 8.3x.

How does that compare to EDP’s competitors? These trade at around 6.5x – 7.0x EV/EBITDA so from this perspective, it looks like Portuguese taxpayers are in fact getting a reasonable deal. As a taxpayer, I feel that I am entitled to know whether the company is being sold at a fair price, which appears to be the case.

All the other aspects of the transaction, such as the corporate governance and in particular whether the current CEO will keep his job are analysed with a great amount of detail in the press, but would it not make sense to answer basic questions first?

From the proceeds of the II Congress of the Industry and Economists, which took place in 1957, we learn that “it is crucial that initiatives which are useful to the country’s industrial development, are not constrained in any way, as this would refrain the dynamics of creative enthusiasm” (the translation is my own).

Lesson learned?

Shellfish fisherman in the Algarve.

CMVM, the Portuguese equity market regulator, has recently opened a  public consultation period (which is now over) for proposed changes to the takeover code. At present, the code allows the use of so-called defensive measures during takeovers. In practice, if an acquirer launches a takeover offer for a company quoted on Euronext Lisbon without the prior approval or the company’s core shareholders, chances are that the offer will not be successful. Most quoted companies are controlled either by families or core shareholders, whose rights are protected by shareholder agreements and other locking mechanisms.

The proposal, in short, consists in removing voting rights limitations and defence mechanisms.

It is safe to say that, in larger European exchanges and in the US, shareholders’ rights are respected. Take the UK as an example: if a foreign or UK investor, be it a corporate or an investment fund, decides to launch a credible takeover offer for a company listed on the London Stock Exchange, offers a suitable premium and convinces more than 75% of shareholders to accept the offer, it will achieve control over the target. It is as simple (and powerful) as that.

In Portugal, if an investor launches a public takeover without gaining prior approval from core shareholders, the target’s Board will likely block the offer before it even gets to a stage where other shareholders can vote on it. 

• So far, no one has found a way to convince core shareholders to let go of their control rights over quoted companies.
• It is widely accepted that most Portuguese quoted companies would be taken over by larger, foreign competitors, if such shareholders did not exist.
• Most Portuguese consider that, if foreign competitors acquired the leading Portuguese quoted companies, this would be a disgrace. International investors (investment funds, pension funds) already own the majority of shares of those companies, which makes it hard to understand this belief. Yet most politicians appear to share this view.
• A large number of investors buy equities purely for financial purposes. These investors will usually hold on to a stock for less than a year. Large volumes of equities are also traded as part of derivatives trades.
• The State and the State-owned bank, Caixa Geral de Depósitos, are under increased pressure to sell non-core assets in order to reduce the public deficit.
• A number of companies quoted on Euronext Lisbon are former State-owned companies that were privatised during the 90s.

• The State, directly or indirectly, contributed to create a system in which most quoted companies are controlled by Portuguese core shareholders.
• Some (but not all) of these shareholders depend on the State or State-owned banks for financing. In other cases, the acquisition of the shares was partly debt financed and shareholders will need to reduce their leverage in the short term.

Still, the proposed changes are a step in the right direction. The regulator had to refer to some principles in order to justify this initiative, which is fine by me.

I can understand the reasons why a number of people would oppose these changes – as well as why others will back the reform. One side will defend that the budget needs to be balanced and that the country needs to attract foreign investors. Others will defend the need to preserve the independence of quoted companies and fend off attacks from larger international competitors. The positions of the protagonists will depend on their political allegiances and professional interests.

My view is that the benefits of change are far greater than the disadvantages. Advantages would include improved efficiency: while quoted companies will be more vulnerable to being taken over by larger competitors, this could result in improved management practices as management teams develop competitive advantages in order to retain their independence. Another benefit could be improved access to equity markets, which is crucial at this stage when companies need to deleverage.

(Sources: Youtube/Spark Africa)

Do you know of other examples of affordable innovation? Let me know…

One of the most bewildering facts about the way journalists report acquisitions in Portugal is that price and value multiples are almost never mentioned. I really cannot say for sure why this is the case – there could be several explanations.

One explanation could be that transactions in Portugal are comparatively small and there would be limited interest in the price. But then, why bother reporting at all? Perhaps journalists simply know that, if they were to ask questions about the value of the acquisition, they would not get a straight answer.

Another possibility is that journalists cannot be bothered to calculate an EV/EBITDA multiple. The maths are not challenging… The media sector is going through a difficult phase at present with cost cutting and editorial staff limitations, which may explain why there are rarely in-depth articles about acquisitions.

While multiple analysis has a number of limitations, it allows analysts to draw certain conclusions. The lack of transparency in M&A in Portugal is yet another barrier to entrepreneurship. No-one really understands what a company is or could be worth, so why bother starting a business?

Yet there are positive developments. TTR is a financial information company which focuses on providing proprietary information about global M&A transactions which involve Portuguese and Spanish companies.

Should TTR data make its way into mainstream media in Portugal, this could indirectly act as an incentive to entrepreneurship. However, newspapers and TV stations have given up on actually hiring editors and are happy to use and reuse existing news so this could prove unrealistic.

Do you think that mainstream media and particularly newspapers should focus on acquisition multiples? Or would you find it too technical?