Company: Alliance EntertainmentTicker: $AENTPrice: $5.3Market Cap: $270.9MEV: $335.3MThanks for reading! Subscribe for free to receive new posts and support my work.Summary:Alliance Entertainment distributes and fulfills physical media including Vinyl, CDs, DVDs, gaming hardware, consumer products/collectibles, movies, and adjacent items via drop shipping and wholesale. While historically a business that grew single digits organically, sales skyrocketed in COVID due to a new console cycle and increased spending. After a sharp drop in FY22, FY23- FY25 experienced low-to-mid single-digit sales decline due to weakness in video game release cycle and consumer products. In response, management cut costs and managed to grow EBITDA from $-17.6m to $37m. Today, the business is poised to inflect back to growth via a strong music release schedule, licensing deals, expansion into the collectibles market, and a favorable multi-year video game cycle outlook. Despite EBITDA increasing ~50% YoY for FY25, FY26 estimates project EBITDA eclipsing that at an ~100% growth rate with revenue returning to growth for the first time in 4 years. As investors digest the incoming margin expansion and return to growth, I believe AENT shares could significantly rerate and trade closer to ~7-8x FY26 EBITDA versus ~5x EBITDA today, presenting 80-100% upside.Company:Alliance Entertainment was founded in the 1990s and has since grown into one of the largest physical media distributors in the country through organic and inorganic growth. Today, they operate under 5 primary categories: Vinyl, CD, Blu-Ray/DVD, video games, and consumer products/collectibles representing 32%, 11.8%, 26.2%, 24%, and 3.5% of revenues in FY2025The company exited 2022 with ~$70m in TTM adj. EBITDA and ~1.4b revenue, only for EBITDA to shrink to -$17.6m and revenue to $1.16b in 2023 as COVID induced spending faded and demand for new console releases shrank. Post de-SPAC, shares dropped to <$1.00 as revenue was in free fall and a quick glance at the top line showed a business in optically secularly declining categories. The topline would continue to show weakness into 2024 with revenues down 5% YoY, but gross margins expanded from 9-12% resulting in the company returning to adjusted EBITDA profitability for FY24. However, with a ~4x leverage ratio and a shrinking topline, shares still traded at a punitive multiple of just 5x NTM EBITDA. Early FY25 the stock rallied as high as $10 for 2 key reasons: signs of topline stabilization coupled with continued cost management. Despite revenues shrinking 3%, management reduced distribution costs by over 20% while expanding margins from 11.7% to 12.8%. Management provided seemingly aggressive targets of 15%+ gross margins and 5% EBITDA margins by end of 2026, but by Q425 (which was reported in September), the company achieved 15.8% gross margins and 5.8% EBITDA margins in a seasonally weak quarter. The strength was due to cost cuts, a decline in promotions, and a paramount deal inked on January 1st where Alliance was to distribute all Blu-Ray and DVD products. This deal would generate an addition of $60-80m in revenue from the existing account (vs currently ~$30-40m in sales), and gross margins in excess of 30% versus traditional DVD distribution margins of 12-13%. The deal began in late Q325 and resulted in margins expanding from 13% to nearly 16% by Q4. Shares have retraced from recent post earnings highs of ~$7.10 to roughly $5.30 brought about by illiquidity and a misunderstanding of the business, however, I believe this presents a compelling buying opportunity for a few reasons.Q4 Gross Margins Illustrate a Go-Forward New Baseline:Despite analyst estimates of 14% gross margins for FY26, management has publicly stated that they believe Q4 was not one off and represents a new baseline for FY26. Napkin math on the reported Paramount deal alone supports a structurally higher gross margin: the account originally represented $40m in sales at 12-13% margins resulting in in midpoint gross profit of $5m. The new deal offers $120m in sales at 30-35%, representing $39m gross profit, or ~$8.5m in incremental gross profit on $20m in incremental revenue. For Q126e, this alone would represent ~2.5% step up in margins YoY. Combined with mix shifting away from gaming which historically has had the lowest margin, cost cuts, lapping promotional activity, and growth in their recently acquired HandMadeByRobots brand which has 40%+ gross margins all point to ~15% margins being replicable.Revenue Decline is Being Misinterpreted as StructuralSales decline in the last 3 years is almost entirely due to industry-wide struggles in the gaming industry and consumer products amidst a shift to cloud-based gaming, a weak console/software release cycle, and weakening collectables demand exiting 2022. Notably, it seems like the worst has already come for gaming sales now that most console makers have shifted to software, and Nintendo is relatively committed to physical media. Additionally, management has indicated the consumer side is poised to grow materially entering this year due to distribution wins and growth in owned brands. Over the past 2 years, gaming and consumer products have declined by 189m in revenue, whereas overall AENT sales have only declined by $95m. The underperformance of these segments has masked continued strength in Vinyl, CDs, and DVDs/BluRay which have grown ~16% over the past 2 years. As gaming and consumer have now reached sustainable revenue baselines and a smaller mix of revenue (~41% in FY23 vs ~28% in FY25), it should become more obvious that AENT was growing ex-consumer products/gaming.A return to Growth is Highly Probable in 2026With gaming revenue set to bottom out in Q1, Alliance has a unique setup were the “dogs” of their business (collectibles/gaming) are poised to return to growth after years of decline and other core segments should benefit from distribution gains, strong content releases, and easy comps from 1H25.· Vinyl: Vinyl’s have CAGRed at ~2.4% over last 2 years due to industry growth and distribution gains. For FY26, management recently won a ~$20m distribution deal from UMG, and Taylor Swifts album release in Q2 should make this segment outperform handedly.· DVDs/Blu-Ray: This segment is poised for significant growth since the Paramount deal went live mid Q3 of 2025, which should add a $20-30M tailwind for both Q1 and Q2. Additionally, industry shifts from legacy DVD formats to 4k and Steelbooks should allow for continued pricing gains in addition to volume growth.· Gaming: Gaming is lapping the last quarter where Microsoft was generous with allocations in Q1, but beyond that comps should be much easier to grow against, especially with the Switch 2 release in June 2025. Furthermore, GTA6 is possibly the most anticipated gaming release of all time and is set to be released in Q4 of this year. GTA5 sold over 200m copies, and while GTA6 sales will be a mix of online and discs, this should still poise gaming for explosive growth exiting FY26.· Consumer Products: Collectibles will be very strong with destocking behind us, new distribution wins, and strong performance by HandMadeByRobots projected by management. They acquired the company at ~5m in sales and have nearly doubled it with plans to grow it to $100m in 2 years.Market and Competition:While the physical media industry has been negatively impacted by modern technology, different categories have been impacted on varying levels. Vinyl has shown growth for the past 10 years and is poised to grow again in 2025. CDs on the other hand are struggling significantly after strong performance in 2024, with sales down double digits YoY. Blu-Ray/DVD have also struggled amidst RedBox shutting down, Target/Best Buy destocking product, and a shift to streaming. However, 4k products have stabilized and grown in the past few years with Steelbooks growing double digits as consumers seek media ownership, higher quality streaming, and collectability. These products have significantly higher price points, meaning that declines in volumes have been offset by price increases with industry showing the lowest decline in 3 years for 25. Industry wide declines in Blu-Ray/DVD/CD have forced consolidation which has provided Alliance with a meaningful tailwind in DVD/Bluray as studios seek to outsource distribution versus traditional in-house distribution models. On the gaming side, game developers have continuously shifted away from hardware in addition to developers like sony/Microsoft emphasizing DTC operations resulting in significant deterioration in the video game segment. New console and game releases in 2026 should allow this segment to return to growth, but in the long-term revenues could be lumpy. Collectibles continue to be a strong industry, but destocking and promotions led to weakness exiting COVID. This segment should return to sustainable double-digit growth as demand has stabilized.Catalysts:Q2 Earnings: A major catalyst for Alliance will be their return to growth, which will occur in Q2 of this year and continue thereafter. Furthermore, Q2 is their seasonally strong quarter as it lines up with the holiday season, and the company is poised to generate nearly ~$30M in FCF and closer to $30M+ adj. EBITDA. Assuming margins/topline hold, this should showcase the new earnings power of the business.M&A: Management has a strong track record for M&A, and now that the company is at a healthy leverage ratio with significant free cash flow, shares could trade higher if investors begin to price growth from M&A as AENT consolidates the industry at lower multiples or diversifies revenues to more exciting end markets.Additional Licensing Deals: The paramount deal alone added ~$25-30M of EBITDA to this business, and management has stated that they are in healthy conversations with other studios who are seeking to do the same thing. According to them, each studio would layer on an additional $50-150M in revenues, and at margins similar to the Paramount deal, this translates to an incremental $15-45M in gross profit overnight. While these aren’t likely to happen in 1H25, I expect to hear more in the back half of this year. Notably, their current partner Paramount has submitted a bid for Warner Bros, which if successful, could allow them to expand their licensing deal to both companies.Price Target:The numbers above reflect a base case. If revenue decline continues and margins disappoint, we could see closer to $55m of adj. EBITDA, whereas an upside case could bring us closer to $80m.As we look at in 2027, the main growth drivers would be M&A, additional licensing deals, GTA6 demand, and continued growth in the collectibles segment. If even a few of these catalysts play out, the company could return to double digit growth in 2027 and begin approaching $100m in EBITDA.Based on my projections for FY26, shares are attractive at ~5x EBITDA, meaning that in a bear case shares have minimal downside, but as investors digest the topline inflection, the stock could trade closer to 7-8x EBITDA in the near term or $9.50-$11.00. In a blue skies scenario where management closes additional paramount sized licensing deals, continues to execute M&A diversifying away from declining categories, and executes well on the GTA6 launch, the multiple could expand closer 9-10x upside EBITDA if investors get excited about growth prospects, or $13.50-$15. Overall, the risk to reward seems very favorable at these prices.Management and Shareholders:Insider ownership is extremely high with the Chairman and CEO together owning 47m shares (~95% of the SO) since nearly all shareholders redeemed for cash upon de-SPAC. Governance has been strong, and management was buying shares in the open market as recently as June. While the float is tight, there are additional ~10m warrants with $11.50 strike prices that expire in February 2028. Management has communicated that they’re working on increasing the stock price to get those exercised and increase the public float, which would meaningfully improve liquidity and allow for index inclusion.Risks:Accelerated Decline in Key Categories: While CDs have shown stability over the past few years, the start to 2025 is concerning and an accelerated decline in this segment would be highly detrimental to Alliance’s topline. The same can be said for DVD/Blu-Rays, where further decline in the category could cause key partners such as Walmart to shrink physical media offerings.Industry Shifts: Alliance operates in end markets that have already been displaced with new technology. While some categories have adapted (Vinyl/Consumer Products), further industry changes could shift these to decline if these segments lose popularity.Delays in Major Releases: The multiple AENT can command over the next 12-24 months will be relatively dependent on the growth rate they can achieve. If GTA6 is delayed as well as console releases, gaming could continue to drag on the top line, and the market is likely to retain the current multiple.Conclusion:At the current valuation of ~5x NTM EBITDA, Alliance isn’t pricing the incoming inflection in topline or margin expansion, despite numerous indicators pointing to the contrary. As investors digest the Q2 print and reprice the stock for growth, I believe shareholders can see significant upside in the next 6 months.Disclosure: The information provided in this article is for informational purposes only and should not be considered investment advice. I hold a position in $AENT at the time of this writing. I may buy or sell at any time without prior notice. The author is not a registered investment advisor and does not provide personalized investment advice.Thanks for reading! Subscribe for free to receive new posts and support my work.