Twelve months ago, controversial producer and distributor of Indian language films, Eros International combined with U.S. mini-major film studio STX Entertainment (or "STX") in a merger of equals. The new company has been named Eros STX Global Corporation (ESGC) or "Eros STX" and hasn't exactly been a success story so far as very much evidenced by the 12-month chart:
Market participants have been eagerly waiting for Eros STX to release audited financial statements for the fiscal year ended March 31, 2021, after the company failed to provide detailed financial results over the past couple of quarters.
While a spokesperson for the Indian subsidiary has denied the allegations, Tuesday's SEC-filing actually lends a lot of credibility to the reports (emphasis added by author):
The Form 12b-25 states that the Company is unable to file its Annual Report on Form 20-F for the fiscal year ended March 31, 2021 by the August 2, 2021 due date, without unreasonable effort or expense, primarily because the Company’s Audit Committee is currently conducting a formal internal review of certain accounting practices and internal controls related to its Eros subsidiaries. Significant revenue from these subsidiaries may not have been appropriately recognized during the fiscal year ended March 31, 2020. Further, a significant portion of the receivables associated with such revenue was valued at zero for the six months ended September 30, 2020, as part of the Company’s preliminary purchase price allocation for the Merger transaction, as reflected in the Form 6-K furnished by the Company on March 31, 2021 (the “Form 6-K”). The Audit Committee has not yet completed the internal review.
Even though the internal review has not been completed, the Company currently expects that substantially all of the intangible assets and goodwill reflected in the Form 6-K are likely to be impaired and that one or more material weaknesses in internal controls over financial reporting are likely to be reported. The Company cannot determine at this time when it will conclude the remaining work necessary to complete the preparation of the financial statements and assessment of its internal controls over financial reporting.
Apparently, the former Eros International has recognized substantial amounts of highly questionable revenue prior to the merger with STX Entertainment - otherwise, there would be no need to impair almost 60% of the company's assets as of September 30, 2020:
Source: Company SEC-Filing
Moreover, the ongoing inability to file audited financial statements has resulted in the company violating covenants governing its £50 million 6.50% UK retail bond, and an aggregate $172.8 million currently outstanding under its asset-backed credit facility with JPMorgan (JPM) and a subordinated mezzanine facility:
The Company is considering its options under various debt arrangements, including the £50 million 6.50% UK retail bond that matures on October 15, 2021, and the requirements to deliver audited financial statements by July 31, 2021.
STX Financing LLC, a subsidiary of the Company, currently has $150.1 million outstanding on the JPMorgan Asset-backed Credit Facility (the “JPM Facility”) that matures on October 7, 2021 and $22.7 million outstanding on a mezzanine facility (the “STX Mezzanine Debt”) that matures on July 7, 2022. Under these arrangements, the Company was required to deliver audited financial statements by July 31, 2021. The Company is currently working with these lenders on several options, including a waiver and extension of this deadline to deliver audited financial statements or paying off the debt. The Company cannot provide any assurances that it will be successful in obtaining any extensions or paying off the debt.
To address the looming debt default, the company has ramped up efforts to monetize basically the entire film library of the former STX Entertainment:
STX Financing has entered into an exclusive negotiation period with a third party to monetize the revenue from 46 films in its library, the proceeds of which would be used to repay both the JPM Facility as well as the STX Mezzanine Debt, which represents the entire debt balance of STX Financing, with additional amounts going to the Company’s balance sheet. If any transaction is agreed to, the Company expects that STX Financing will continue to administer and distribute the 46-film catalog for a fee, and will retain derivative rights to the 46 films, including sequels, remakes and prequels. This transaction is subject to negotiation of definitive documentation, and the Company cannot provide any assurances that it will be successful in completing the transaction.
On a more positive note, the company's majority-owned and Bombay Stock Exchange-listed subsidiary in India, Eros International Media Limited recently managed to refinance $63 million of outstanding debt under the Reserve Bank of India’s resolution framework for COVID-19 related stress policy:
The agreement reduces the annual interest rate on the debts to 9.0% from an average of 14.5% and extends the average maturity so that less than $10 million of the debt matures in the second half of fiscal 2022, with the remainder maturing in fiscal 2023 and 2024.
Judging by the disclosures made in Tuesday's filing, it appears that STX might have been duped by its Indian merger partner, otherwise there would be no need to impair the entire intangible assets and goodwill balances.
With the outcome of the above discussed negotiations unclear and no visible path to address the £50 million UK retail bond, bankruptcy might come into play rather sooner than later.
But even in case Eros STX manages to address the current debt issues, the outlook isn't exactly encouraging with the company's U.S. film library likely to be sold and the value of the Indian business entirely unclear at this point.
Given the tremendous uncertainties, investors should consider selling existing positions.