ChickenSoup Entertainment (NASDAQ:CSSE) raised $30 million in August 2017 via a crowdsourced IPO under the new Reg A+ framework, which has “lower[ed] regulatory hurdles for companies trying to go public”.
The offering was among the more noteworthy of the new Reg A+ IPOs partly because of the well-known brand Chicken Soup for the Soul and partly because of the company’s affiliation with Ashton Kutcher. The company was offering a unique business model, with the CEO stating the company was poised to become "the Netflix for inspirational content." Additionally, CSSE reported strong revenue and earnings growth heading into its IPO.
Despite the alluring headlines, however, our analysis indicates that much of the reported revenue and earnings appear to be derived from a newly formed non-profit organization that seems to exist almost solely to support ChickenSoup. We have uncovered red flags indicating that the true nature of the relationship between CSSE and the non-profit in question – the Boniuk Foundation – may have been under-reported to public investors.
Calling the financial results into further question, late last year, the company reported an accounting change in its quarterly filing that would allow it to book a “gain on bargain purchase”. That same day, the company announced an acquisition that it determined to be a bargain purchase. The accounting change has positioned the company to recognize a $22.2 million paper gain on an acquisition that only cost roughly $5 million. Our review of the acquisition leaves us with doubts about the validity of this supposed gain.
Collectively, we have doubts about the credibility and sustainability of the company’s reported revenue, earnings, and adjusted EBITDA metrics.
We believe investors have been attracted to the Chicken Soup for the Soul brand and to the company’s affiliation with Ashton Kutcher without fully understanding the nature of the associations. Much of the media surrounding the IPO seemed to conflate the relationship between the company, Ashton Kutcher, and the book series (see examples here, here, here, and here). The presentation by the company similarly could be confusing to the average reader as it does not make all the details of the affiliate relationships clear.
When digging into the offering documents, we see that the public entity is actually a subsidiary of a subsidiary that is merely focused on video content and is therefore to receive no proceeds from the parent company's book sales. Also, the business founded by Ashton Kutcher, “A Plus”, is actually a separate entity that public investors have no stake in.
Worse yet, according to the offering documents, the public entity must pay its own affiliates “management services” fees for things like access to its own CEO, and licensing and distribution fees for use of the Chicken Soup brand and for distribution through Kutcher’s A Plus.
The Chairman and CEO of CSSE, William J. Rouhana, Jr. has a controversial history. Rouhana previously served as CEO and Chairman of Winstar Communications, Inc., a formerly NASDAQ-listed technology company that declared Chapter 7 bankruptcy following the bursting of the dotcom bubble and amidst a lawsuit that alleged severe accounting improprieties. The blow-up of Winstar reportedly led to as much as $974 million in investor losses.
Rouhana has voting control over the public company and similarly has control over the ultimate parent, thereby giving him virtually unmitigated control of the entire corporate structure. We have little faith in his ability to create genuine value for shareholders given his track record and all of the foregoing red flags.
A review of the offering circular for CSSE presents the company in a very attractive light. In the summary, the company stated “Since our inception in January 2015, our business has grown rapidly and is profitable.” The summary financials show a young company that has achieved year-over-year revenue growth of 438% has recently turned profitable and has strong profit and EBITDA margins:
On the surface, these numbers appear to be glowingly attractive and on a meteoric growth trajectory. The notes, however, show that a significant portion of that revenue was derived from a single unnamed non-profit foundation that Rouhana advises (note 11, pg F-24):
CSS and the Company have several agreements with the Foundation, on whose advisory board the Company’s chief executive officer sits. One such agreement includes sponsorship by the Foundation for a Saturday morning family television show... For the years ended December 31, 2016 and 2015, the Company recognized revenue of $3,734,884 and $1,431,818, respectively, from this sponsorship.
The Offering Circular identifies the show as being “Hidden Heroes” (page F-13). Rouhana, therefore, sits on the advisory board of a foundation that sponsors the creation of Hidden Heroes – a foundation whose very sponsorship represented about 95% of the CSSE’s 2015 revenue and 46% of the Company’s 2016 revenue.
First, an IRS database search reveals that the Boniuk Foundation was ruled tax exempt in April 2015, suggesting that the organization is new and virtually coincides with the creation of CSSE itself (in January 2015).
Second, rather than being a diversified foundation involved in multiple interests, it appears that the Boniuk Foundation is dedicated largely to sponsoring CSSE, its predecessor entity CSS Productions, and affiliates. The Boniuk Foundation’s 2014 Form 990 filing states that:
[t]he companies [sic] most significant activities include distribution of books to various schools in Harris County TX school book sets and creating a children’s television program.
The document later clarifies that CSSE’s parent entities produce books it distributes, stating that “[a]greement made with ChickenSoup for publishing books for distribution for distribution to Houston independent school district.”
Presumably, Hidden Heroes is the “children’s television program” mentioned in the filing. In sum, it therefore appears that both of its “significant” activities are relating to its role supporting ChickenSoup. In all, the total revenue for the Boniuk Foundation for its 2014 and 2015 fiscal years was a combined $4,870,236, further underscoring that it is not a large, well-diversified foundation. The millions directed toward CSSE clearly represent a substantial portion of the foundation’s donation activity.
Third, rather than Boniuk simply acting as a one-way charitable donor to the company, the 2015 Form 990 filing shows the foundation may have had a two-way interest with CSSE. Specifically, the second to last page of that document reflects that a Class A membership interest in Chicken Soup for the Soul Production, LLC (the predecessor entity to CSSE) was contributed to the entity:
The Offering Circular appears to corroborate that information, stating:
On September 30, 2015, CSS made a charitable donation of 6% of the membership interests it owned in CSS Productions to the Foundation. [emphasis added]
We have a hard time believing that the Boniuk Foundation just simply (I) formed right around the same time CSSE, (II) directed much and potentially the majority of its donations to CSSE and affiliates (III) decided to donate so extensively to CSSE that it comprised the majority of the (for-profit) company’s revenue, then (IV) months later, in an unrelated act of charity and kindness, the company decided to donate 6% of its shares to the foundation. Note that the IRS defines a "charitable contribution" as being "voluntary and is made without getting, or expecting to get, anything of equal value."
If the above weren’t odd enough, the director of the Boniuk Foundation, Milton Boniuk, already has another fairly new and similarly named foundation, the Boniuk Charitable Foundation (“BCF”), which gained tax exempt status in September 2014, less than a year earlier. We were a bit confused as to why Boniuk would need another personal foundation seemingly dedicated to ChickenSoup when he had already recently established a personal foundation.
When we examined BCF, we noticed some parallels to the Boniuk Foundation. Virtually, all of BCF’s assets from its 2014 990 filing consisted of investments in convertible debentures and equity in a company called NanoViricides, Inc. (NNVC), a company which Boniuk has sat as director since May 2013:
Notably, while BCF met its qualifying distribution in 2013 and 2015 by donating a collective $157,000 to Rice University, in 2014 BCF met its qualifying distribution by donating $150,000 to the Boniuk Foundation, which could have been directed right back into CSSE and its affiliates.
Taken all together, in our opinion, the above looks similar to Boniuk making an investment (tax-free) in shares of CSSE rather providing a mere arms-length source of revenue to the business. At the very least, we believe a case can be made that the Boniuk Foundation should be a consolidated entity and therefore eliminate what appear to be inter-company transactions rather than booking them as revenue.
We find CSSE’s relationship to the Boniuk Foundation to be unsettling. We also have our doubts about the sustainability of the arrangement. We emailed CSSE's investor relations and asked the following:
We have not heard back as of this writing. Should we receive a reply from the company, we will update this accordingly.
On November 6, 2017, CSSE announced the acquisition of Screen Media Ventures, LLC which owns (I) content licenses to over 1,200 television shows and films, and (II) Popcornflix, an ad-based over-the-top (OTT) platform that allows users to watch movies and TV shows for free. The purchase price for Screen Media consisted of about $4.9 million in cash (plus transaction costs), 35,000 shares of Class A common stock, and warrants to purchase 50,000 shares of CSSE at $12 per share.
In the 10-Q filed on November 6th - the same day of the Screen Media acquisition announcement - new language appeared that altered the company’s definition of adjusted EBITDA to include “the gain on bargain purchase of subsidiary”. (Note that the previous 10-Q had been filed a mere month earlier on October 2, and no such gain on bargain purchase language appeared.)
In the press release describing the acquisition, the company noted that an appraisal of Screen Media’s assets suggested they were worth $25 million. CSSE touted how the acquisition represented a “significant discount to its appraised value, intrinsic value and replacement cost” of the company, and how it now expected the company’s Q4 2017 adjusted EBITDA to “substantially exceed $10 million.” The press release did not clarify that the upward revision to its adjusted EBITDA could include booking a gain on purchase from the acquisition.
Taking things a step further, a later company press release on January 17 highlighted that CSSE had commissioned a new valuation opinion as part of the transaction and - lo and behold - it determined that the assets were valued yet even higher, at $31.4 million. Additionally, the company made clear that it would recognize the massive gain on purchase in its statement of operations:
Reflecting the excess of the net appraised value of the assets over their purchase price as set forth in the Valuation Opinion, CSS Entertainment will recognize a non-cash gain in its Statement of Operations for the year ended December 31, 2017 of approximately $22.2 million. [emphasis added]
We are uninspired by the company’s subtle accounting methodology change that suddenly allows it to recognize an immediate ~440% gain on purchase. The new accounting implementation could give rise to a splashy “headline” that reports explosive quarterly and annual results, but our review of the acquisition leaves us to believe that such numbers would represent little real value beyond optics.
We emailed CSSE's investor relations and asked them to describe the basis for the adjusted EBITDA methodology change that includes a "gain on bargain purchase" which we believe to be neither reasonable nor sustainable. We have not heard back as of this writing. Should we receive a reply from the company, we will update this accordingly.
Digging down on the acquisition, we examined Screen Media more closely and came away with questions about the credibility of the lofty appraisal results that CSSE had commissioned.
According to Yahoo News, Popcornflix launched in 2011 “offering top Hollywood stars in movies you’ve probably never heard of.” We reviewed the site and confirmed that indeed we have never heard of most of the titles. Our own browsing experience aside, it appears that the site is relatively lightly trafficked. According to Alexa, Popcornflix is ranked as the 32,903rd U.S. site as of this writing and is ranked 50,324th worldwide. In short, Screen Media appears to have been an attempt to compete with other streaming TV services that never gained significant traction.
The financials seem to reflect a business in decline that was teetering on insolvency. According to the audits and press releases found in an amended 8-K, Screen Media had recorded year-over-year net revenue declines for all of the past three years:
Y/Y % Chg
*Estimate from company press releases: "Screen Media generated more than $12 million in net revenue...in 2017." Note that given the language, the 2017 net revenue is lower than in the previous year, but it is unclear by exactly how much.
As of the December 31, 2016, audit, the company had only $2,097 in cash compared to $40,848,131 in current liabilities. As of September 30, 2017, Screen Media had $297,969 in cash compared to $41,471,042 in current liabilities.
Screen Media had at least one professional private equity backer, Alta Communications, per the filings. Despite the professional backing, CSSE made the purchase for roughly the cost of Screen Media’s outstanding bank debt. According to the merger agreement made November 3rd, 2017, bank debt of $4,905,355 was to be paid and terminated as part of the transaction, which corresponds to the $4.9 million in cash paid as part of the offering (net of transaction and closing costs).
Given that the private equity backers seemingly allowed the entity to be acquired for the cost of bank debt plus some modest share-based upside that went to the former CEO, we can’t help but wonder whether the business has the significant value claimed in the appraisal. Had the assets truly been worth over $31 million, wouldn’t a sale process have yielded more than ~$5 million? Furthermore, could there really be that much value unlocked by Screen Media’s combination with CSSE which is itself a fledgling media company? We have a hard time fathoming how CSSE’s line up of relatively obscure TV shows would do much to enhance Screen Media’s line-up of relatively obscure movies and TV shows.
We emailed CSSE's investor relations and asked the following:
"Did Screen Media run a sale process? If so, how many potential buyers were contacted and how many bids were received. If not, why?"
We have not heard back as of this writing. Should we receive a reply from the company, we will update this accordingly.
Aside from our questions around the credibility and sustainability of revenue, earnings and adjusted EBITDA metrics, we have identified other red flags. First, CSSE is the subsidiary of a subsidiary, a highly unusual structure for any public company, let alone a company of such modest size as CSSE:
Per the latest 10-Q, CSSE was originally formed under CSS Productions, LLC. That entity was formed by Chicken Soup for the Soul, LLC, “a publishing and consumer products company” that initiated operations in January 2015. That entity in turn is owned by Chicken Soup for the Soul Holdings, LLC, which is the “ultimate parent” to all of the aforementioned entities.
We find it unsettling that public investors are buried underneath several layers within a complex corporate structure rather than simply having a share of the entire success of the overall business.
Both the “ultimate parent” and the public entity are controlled by the same individual, William Rouhana. Rouhana controls approximately 96.8% of the company’s class B shares which carry 10 votes per share and controls about 70% of CSSE’s entire issued share base as of the most recent 10-Q.
We emailed CSSE's investor relations and asked for explanation on why CSSE was structured as a subsidiary of a subsidiary rather than in a manner where public investors could share in the gains and losses of the entire business. We have not heard back as of this writing. Should we receive a reply from the company, we will update this accordingly.
The shared control is troublesome, especially in light of the mind-boggling number of related party transactions and fees paid between related party entities. A partial rundown of the list, per the 10-Qs and the offering circular (note that some of these fees are overlapping):
We can’t fathom how a small company like CSSE can credibly justify the amount of money circulating to related parties amidst its complex corporate structure.
We emailed CSSE's investor relations and asked for explanation on why the company must pay numerous fees to its affiliates, including for things like access to its own CEO and management team. We have not heard back as of this writing. Should we receive a reply from the company, we will update this accordingly.
We looked into Rouhana’s background as Chairman and CEO of Winstar in order to get a sense of his leadership and management abilities. We found that subsequent to the collapse and bankruptcy of Winstar, a class-action lawsuit was filed against its officers, directors, and its accountant Grant Thornton, alleging severe accounting improprieties and the creation of false revenue. Among other things, the Winstar lawsuit alleged that:
Note that the allegations were never proven in court as Rouhana and the other defendants settled without any admission of wrongdoing. The individual defendants collectively settled for a sum of $25 million according to the settlement agreement (pg 74):
Later in 2013, Grant Thornton paid $10 million to settle their portion of the matter as well.
We find the above to be troubling. Given that Rouhana controls both the private parent entity and the public subsidiary, he may have been in a position to effectively negotiate the related party fees with himself or to exert overwhelming influence in the process.
We emailed CSSE's investor relations and asked who negotiated the fees on behalf of the public entity and the private parent entity. We have not heard back as of this writing. Should we receive a reply from the company, we will update this accordingly.
Giving us yet more cause for concern, CSSE’s auditor appears to have virtually no experience auditing public companies, let alone those with complex structures. The latest 2017 PCAOB report from CSSE’s auditor, Rosenfield & Co PLLC, shows that the firm had audited no public companies during the reported period and had no substantial role in the preparation or furnishing an audit report with respect to a public issuer during the reporting period.
Despite the wholesome sounding name, we believe ChickenSoup Entertainment has all the key hallmarks of a disaster in the making. While we expect the reported numbers to be glowing in the near future, we believe the company is on a road toward inevitable ruin.
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