CSSEP - Chicken Soup: Should You Drink The Preferreds?

Summary

• Chicken Soup's acquisition of Redbox has been transformative to revenue growth but has saddled the company with a high debt burden.
• Whilst adjusted EBITDA at $9.6 million grew by 97% from the year-ago quarter, net loss and cash flows from operations greatly expanded.
• The Series A preferreds currently offer a yield on cost of 12.34% and are trading at around a 20.9% discount to par.

Chicken Soup for the Soul Entertainment (CSSE) went public in the middle of the summer of 2017 and has built a mixed history since then. The Cos Cob, Connecticut-based firm closed a $50 million stock-for-stock acquisition of Redbox last year to form a business that now includes three advertising-supported video-on-demand streaming services and a network of roughly 34,000 kiosks across the US for DVD rentals. The company creates, acquires and distributes its films and has built up a strong library of original content.

However, its performance has been less than stellar. It's operating in an industry fundamentally led and absolutely dominated by larger firms like Disney ( DIS ), Netflix ( NFLX ) and Amazon ( AMZN ). Whilst there will always be space for niche and smaller players, Chicken Soup's performance as defined by its commons over the last few years has left a lot to be desired.

The company traded broadly flat in the years before the pandemic whose trading boom and eventual bust have left shares down by 48% over the last 12 months. Short interest remains relatively high at 8.56% with the rising Fed funds rates compressing the valuation of high-risk growth stocks to historical lows. Further, Redbox went public on the back of the early pandemic-era SPAC phenomenon whose subsequent end, controversy, and legacy has undoubtedly left Chicken Soup with a higher implied risk.

Revenue Surges But Net Income And Cash Flows Worsen

The deal to acquire Redbox also saw Chicken Soup assume $325 million in debt. This would see its net debt come in at $450.7 million as of the end of its last reported fiscal 2022 third quarter. It would also see quarterly interest payments jump to $7.7 million from $2 million in the prior second quarter. It's important to note that this is set to balloon from fiscal 2025 as the terms of the acquisition meant that the Redbox debt is serviced as interest only for two and a half years post-closing.

The company reported revenue of $72.4 million , up 148.8% over the year-ago period and a beat by $5.69 million on consensus estimates. Adjusted EBITDA came in at $9.6 million, up by 97% from $4.9 million in the year-ago quarter. The Redbox business feeds off a strong box office slate as some movies move from exclusive theatrical release windows to DVDs and streaming platforms. Hence, Chicken Soup expects the business to grow at a healthy clip in 2023 against what is the most stacked post-pandemic annual movie slate.

Net loss of $20.1 million was up from a loss of $16.7 million in the year-ago quarter with cash flows from operations negative at $28.4 million, up from $6.8 million in the year-ago quarter. Hence, with cash and equivalents exiting the fourth quarter at $32.2 million, down from $66.9 million in the year-ago quarter, the company faces a tough near-term future. Management stated they had access to multiple sources of liquidity as they head towards a fiscal 2022 revenue run rate of $500 million with $100 million to $150 million in adjusted EBITDA.

An Opportunity With The Series A Preferreds

Chicken Soup's 9.75% Series A Cumulative Perpetual Preferred Stock (CSSEP) pays out a fixed $2.44 annual coupon for a yield on cost of 12.34%. This coupon is also distributed in monthly installments. It's rare to find preferreds from a non-REIT, nonetheless, one paying out monthly.

The Series A are perpetual which sets holders up for indefinite income payments post their June 27, 2023 redemption date. It's unlikely the company would be able to fund the redemption of the Series A at its redemption date with these financed in 2018 when the Fed funds rate was 1.75% to 2.0%, less than half of its current level.

As they're currently trading at $19.77, a 20.9% discount to par, their yield to call stands at 42.9%. This is high and reflects a unique set of risks aggregated with a macroeconomic environment that's been quickly characterized by high uncertainty and a still lingering specter of a recession even against optimistic forecasts for positive US GDP growth this year.

3,698,318 Series A shares were outstanding as of the end of the third quarter. This has a $92.46 million redemption price and would be far too much of a burden for the current balance sheet to manage and against what's a quarterly dividend payment to holders of the Series A of $2.4 million, around $9.6 million per year. There is no dividend coverage as the company does not generate free cash flows from operations so this is an extremely high-risk play. The preferreds bulls are betting that the underlying operations have enough momentum to sustain their going concern status in perpetuity. Critically, Chicken Soup's financials are in a state of turbulent flux and the preferreds are discounted to reflect that risk. I'm neutral on taking a position until after a few more quarters of growth with Redbox come in.

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