Shawn Malcolm is an investment advisor in ScotiaMcLeod’s North Toronto Office.

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When several Canadian film and television production companies went public in the last few years, there was substantial investor appetite for these new issues; however many investors took a ‘show me’ approach, electing to sit on the sidelines until the market forces of supply and demand pegged a true value on these shares.

Now that sufficient time has elapsed to evaluate the earnings and market behavior, I thought it might be interesting to gauge the investor sentiment towards these public companies and the industry as a whole.

Overall, the industry has proven that it has great potential. On the whole, earnings show an upward trend and shareholder value is being created.

All of the public entertainment companies are considered small cap stocks, and are not likely to be a core portfolio holding. They are viewed as being susceptible to volatility, therefore they must exhibit strong growth potential to justify the added risk.

The investment community attaches great importance to quarterly earnings. If a company disappoints, it quickly falls out of favor and will not recover until evidence of a turnaround surfaces.

Before looking at the market climate, I will give you a recap of the earnings and stock behavior of Canada’s entertainment pubcos.

Nelvana

Nelvana stock has been strong on the heels of the Aug. 10 announcement that Boston-based mutual fund giant, Fidelity Management and Research, had accumulated 10.03% of the outstanding common shares. Nelvana’s 1995 second-quarter results, released on Aug. 24, showed a marked decline in revenue compared to the 1994 second quarter, yet the stock is trading at $20 5/8 to $21, not far off its 52-week high of $21 7/8.

Nelvana is Canada’s largest producer of animated television programs, and recently announced the acquisition of Windlight Studios. Windlight specializes in computer animation software. Nelvana is viewed as being a leader in the computer animation process, and the market has warmed up to this growth story.

Cinar

Cinar Films has been another strong performer. Since May 1995, the stock has gone from us$7 to a high of us$12 3/4 on nasdaq ( the u.s. over-the-counter market).

On July 13, Cinar released its second-quarter results. Revenue stood at $11,147,000 compared to $8,360,000 for the 1994 second quarter, an increase of 33%. At the same time, net income increased 23%.

The Fidelity Canadian Growth Company Fund held a position in Cinar as of July 31. Cinar stock has been strong due to its improving fundamentals and a warm reception from u.s investors.

Alliance

Alliance Communications turned in an impressive first quarter on June 30. Revenue was up 98% year-over-year, however earnings per share growth was limited due to equity losses related to its 55% investment in the Showcase specialty television operation.

Revenues in the production segment were up 300% year-over-year, while revenues in the domestic distribution segment increased 200%, due to the video release of Mask and Dumb and Dumber. Revenue growth in the distribution segment should be aided in the second quarter of 1996 when Pulp Fiction is released.

So why has the stock declined from $17 in mid-June to the $14 level? One explanation is that the bid to acquire the entertainment assets of Labatt fell through. Liquidity should be enhanced if the Class B non-voting shares are listed on nasdaq as planned.

Atlantis

Shares in Atlantis Communications fell off in the month of August as the company released its second-quarter results. Although revenue more than doubled, net income was down dramatically.

The company said its higher revenues reflect the delivery of several episodes of high-budget series initiated in 1994. It explained the low earnings are a result of the high-budget episodes having lower than usual margins. Hence, revenues were disproportionate to earnings.

Atlantis also announced that it expects earnings for the year to be below expectations, and it forecasts a loss in the third quarter. On the bright side, the company foresees an improvement in the fourth quarter and is taking steps to reduce costs.

Malofilm

One of the more illiquid stocks in this sector is that of Malofilm Communications. Malofilm’s third-quarter earnings were released on Aug. 16 and showed an 82% increase in net earnings and 70% revenue growth. These results were largely attributed to the release of several popular movies in the rental market including Forrest Gump, Drop Zone and Highlander III.

Megatoon Entertainment Group, a wholly owned subsidiary engaged in the development of interactive multimedia products, contributed nearly $1 million in sales. Megatoon, acquired by Malofilm in May, has successfully launched Megatoon Station, an online service and Internet access provider in the Quebec City region.

Megatoon is also in the process of developing proprietary communications software for the Internet, and has given Malofilm the distinction of being one of Canada’s few public companies to have a full-service Internet operation.

The stock has traded in the $5 range since its debut on the tse, and was virtually unaffected by the earnings report.

Paragon

Another illiquid stock is that of Paragon Entertainment. The stock is currently trading in the $1.30 to $1.50 range after the release of their first-quarter and year-end financial results.

Paragon has not garnered as much investor interest, however, revenue is growing and the company has announced some promising developments such as a new joint-venture initiative into animation with Ottawa animation house Lacewood Productions, the reactivation of u.k.-based HandMade Films, and targeted growth of the company’s film inventories and its international distribution network.

On Sept. 14, Paragon reported that chairman and ceo Jon Slan had purchased an additional 350,000 shares of the company, representing 2.7% of the outstanding common shares.

Investors usually find comfort in knowing that a director is willing to buy more shares at current prices. They also like to hear of aggressive growth targets. Perhaps these new developments will generate some interest.

Investor sentiment

In general, the industry has posted promising earnings, however earnings alone do not explain share prices. There are a host of other considerations, including investor sentiment. Thus far in 1995, it is quite clear that investor sentiment has been focused on the high-tech sector and the cyclical resource-based companies.

However, we all know that the key to successful investing is diversification. Entertainment companies have a low correlation to most sectors of the market and are non-cyclical. They can reduce the overall risk of a portfolio while adding potential for capital gains.

Investor sentiment towards the entertainment sector has been mixed thus far. As in most industries, there are companies that lead the pack, and those that follow. Evidence of this is the relative illiquidity of some of the stocks. Trading is thin in all of these companies, with the exception of Cinar and Nelvana. Investors look for companies that have developed a proprietary technology or have a strong market niche. In short, there has to be potential for growing earnings.

Investors are well aware of the promise that this junior industry holds, however they are also aware of the comparative risk. Entertainment companies, as opposed to high-tech or resource-based companies, have few hard assets and earnings are not as easy to ascertain.