No pain, no gain: Hollywood player could be a star in the making

Showbiz has proved a notoriously difficult area for many small investors. Cash has far too frequently been absorbed with little, if any, reward for those enduring the financial strain. But it would appear that attitudes have changed – at least at the cinema. The film business is now much more cost conscious than in bygone days and with more outlets it is reaping rewards that old-style Hollywood moguls would never have envisaged.

It would be foolish to pretend that film production is no longer a tricky undertaking. But with overheads more strictly controlled – and fiendishly clever financing cushioning exposure – much of the risk has been removed. And cinemas are now only part of the distribution circuit with the proliferation of TV channels, plus the growth of the DVD industry, adding extra sales dimensions.

Seven Arts Pictures is one of the smaller players in this superficially glamorous world. Its shares are traded on Plus at 25.5p, capitalising the producer and distributor at around £6.2m. In the year ended in March, SAP made pre-tax profits of £1.5m. For the current 12 months more than £2m seems likely.

Unlike many more famous names the group does not splash out eye-watering amounts on the films it makes. Around £3m (after tax-breaks) seems to be a typical budget. Yet with tight controls the movies it produces can be profitable fairly quickly and if they should flop at the cinema there is the DVD world and mushrooming TV channels to help the income stream.

SAP also believes in sharing risk. Much of the cash for its productions is provided by third party investors; some in the industry (like distributors) or more remote players including hedge funds and institutions. And, of course, tax shelters (Hungary currently offers the best concessions in Europe) are an important element in any financing exercise.

The group likes to make between two and four films a year; it also distributes output from rival makers, collecting a commission on sales.

Whereas years ago old pictures were discarded – many black and white classics have been lost – nowadays film libraries, providing a flow of films for TV and other outlets, are an increasingly lucrative part of the industry. SAP has a collection of more than 30 pictures and is looking to develop a library of at least 75 in the next few years.

Chairman Peter Hoffman, an experienced Hollywood executive who is happy to leave much of the creativity involved to others while embracing the nuts and bolts of the industry, started the group 13 years ago. It arrived on the stock market in 2004, reversing into an AIM cash shell called Cabouchon. The AIM presence came to an abrupt end earlier this year when, for reasons largely outside its responsibility, it was forced to decamp to Plus.

But it seems underwhelmed by the Plus experience and hopes to return to AIM soon. A cash raising exercise as well as a placing of some 25 per cent of the capital will probably accompany the switch. A number of investors, including a hedge fund, have enjoyed their stay but are now looking to cash in. I understand that the placing is already arranged.

Hoffman and his family are major shareholders with a direct interest in 33 per cent of the capital and probably some influence over another 14 per cent or so. The family is also partly responsible for a £4.4m loan to the company. At 25.5p, the shares are selling at less than four times prospective earnings. Although some investors may regard film companies as unfashionable, such a rating, even allowing for the signalled placing, is exceedingly low. SQC Research reckons the shares should hit 50p within a year and observes: "These shares have been overlooked and offer significant upside".

SAP is worth keeping an eye on. A few months ago, I alighted, with some trepidation, on my first exploration share, an area I had avoided. But Nighthawk Energy is in the money and shows signs of becoming a valuable member of the No Pain, No Gain portfolio. Who knows? I could be tempted into another of my taboo industries and recruit SAP. Certainly the shares hold a fascinating appeal and after joining the oil and gas explorers there is a chance that the portfolio could go to the pictures.