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Merlin’s Muddy Puddles and Share Price Wizardry

25 February 2018  |  Oliver Schutzmann, CEO

Anyone driving with children from Dubai to Abu Dhabi will be all too familiar with the notion of “pester power”. Legoland Dubai is well-known, well-marketed and very well-signposted on the Sheikh Zayed Road. It grabs the attention of drivers and their little passengers, tempting them to divert and visit. 

DXB Entertainments, the company that listed on DFM in 2014 and since has lost nearly half of its market value, built Legoland Dubai. But it leaves the operations of Legoland Dubai to another company: Merlin Entertainments.

Merlin, a UK-listed company, also operates global hotspots such as Madam Tussauds - once owned by Dubai International Capital - and Alton Towers in the UK, Gardaland in Italy, and Heide Park in Germany. 

In all, Merlin operates 123 attractions and hotels with around 3500 rooms in 25 countries across four continents, drawing over 60 million annual visitors worldwide. 

In October 2017, Merlin partnered with Entertainment One to bring Peppa Pig attractions and themed accommodation to enter the pre-school kids segment. In November 2017, Merlin announced details of its plans to enter the experienced economy of adventure seekers in partnership with Bear Grylls, the ex-SAS soldier, survivalist and adventurer whose media distribution reaches an estimated 1.2 billion people. 

And last week Merlin hit the headlines in a way that all listed companies should pay attention to.

Merlin’s history as a listed company has been as volatile as one of its own rollercoasters. Listed in November 2013 with a valuation of GBP 3.2 billion
(AED 16 billion), Merlin’s IPO rewarded many years of faith and hard work from its management and private equity backers. Its business model was strong, capitalising on the seeming limitless growth in appetite for visitor attractions and theme parks, it became the second-biggest operator of leisure attractions in the world after Disney.

After two years of healthy business, however, Merlin’s outlook became more troubled. An accident at Alton Towers in 2015 resulted in a GBP 5 million
(AED 26 million) fine for health and safety shortcomings; terrorism incidents in the UK and Europe resulted in a souring of sentiment towards companies that rely on tourism. Finally, the Brexit referendum left Merlin with an uncertain future in Europe. 

A profit warning in October 2017 saw the share price drop 20% in one day and collapse towards its IPO price, and at the end of 2017 Merlin was ejected from the FTSE 100 list of the UK’s largest listed companies.

The company’s share price seemed to be stuck in one of Peppa Pig’s muddy puddles, whereby every trading update became an excuse to sell the stock.

Then, on 19 February 2018, the shares jumped magically by 4% in one trading session. A San Francisco-based activist hedge fund, ValueAct, declared a 5.4% stake in Merlin, placing it right behind Blackrock, Merlin’s largest shareholder at the time. And investors cheered. 

ValueAct has an investment philosophy of long term investments to turn around under-performing companies. It has had success with Rolls Royce, and holds stakes in firms including Sara Lee, Halliburton, and Invensys. ValueAct has also had some bad press, mainly because of its involvement in Valeant, the crisis-ridden pharmaceutical company.

Although the activist has not commented publicly on its Merlin stake, it is likely that ValueAct will seek to rebuild some investor confidence in Merlin through strategic focus and analytical rigour. 

Why is this important for all listed companies?

Because this is a great example of the way in which companies (and investors) can quickly lose sight of the intrinsic value, growth and potential of their business when they hit some speed bumps. The relentless demands of quarterly results and pressure for short-term returns can deafen management and equity investors to the real business of any listed company: to deliver sustainable shareholder value over the long term. 

This intervention by an activist investor is also a good example of how management can succeed in difficult times by being open, transparent and honest about its difficulties, enabling its investor to properly price risk, while
at the same time articulating a credible equity story and future potential that compels an investor to act in such a positive way.

In this example, a new shareholder has seen something in Merlin that other investors have not. While many of Merlin’s challenges appear to be external,
they are not insurmountable, and the internal factors driving its business remain unchanged. Having conducted a forensic examination of the financials, the strategy, the competition, and the business potential, ValueAct must have concluded that, with the right focus and management actions, the future
should be brighter than the market is pricing today. 

For DXB Entertainments, the return to health of one of its key strategic partners should be welcomed. For investors, the lesson is clear: following the herd and taking bad news at face value can be blinding to the long-term prospects of a company. For Merlin, the start of the journey is to learn to look at their business with a new perspective.

And for parents driving along Sheikh Zayed Road, those calls to stop and visit Legoland, and one day in the future, Peppa Pig Land, are going to get a lot louder.