Description

Investment Thesis

Long AMCX represents an opportunity to own a TV content creator/owner.  I will explain below why being a content owner is paramount in today’s TV industry.  Its modest valuation provides downside protection and my base case represents 50% upside.  I also believe potential M&A could provide further upside in 2019 but that’s not in my price target.

Company Description

AMC Network owns and operates cable television networks including AMC, WE tv, IFC, Sundance TV and BBC America.  Over the last decade, AMC shifted its program to original scripted shows including Breaking Bad, Mad Men and The Walking Dead with great success.  Roughly 63% of revenue is derived from distribution and 37% from advertising.

Why is AMCX mis-priced?

Negative secular trends suggest long-term declines

The change in consumer preferences from pay-tv to streaming services like Netflix and Hulu have created a large and expanding cohort of chord-cutters and chord-nevers.  Investors fear that revenue -  advertising and distribution - will be in permanent decline.

Weak ratings for The Walking Dead

Investors fear that the steep decline in ratings (down 30%) of The Walking Dead franchise would lead to contraction in revenue.  The perception is that revenue growth and earnings growth are limited.

No heir apparent to replace The Walking Dead franchise

While generally garnering favorable viewer reviews, recent new shows such as Preacher, Into the Badlands have failed to grow into a replacement for The Walking Dead.  

The most common topic when I discussed AMCX with other investors is “Why buy now? There is no catalyst. You should wait for the next big hit”.  This is music to my ears.

Industry Overview/Background

It is imperative to know the changes ongoing in TV media in order to have the right context to understand the value of AMCX assets.

Consumer preference has shifted from cable TV to internet streamings services

The streamings services have three advantages over cable TV.  First, streaming services are much cheaper ($80 - 100/ month for Cable TV vs $10-12/month for Netflix).  Second, the content is available anytime and on any devices. Third, users can consume the content entirely without commercials, which makes the experience more enjoyable.  Instead of asking “what’s on TV now?”, consumers are asking “what do I want to watch now?” As such, cable TV is losing subscribers to streaming. Consumers ditching cable TV package are referred to as “chord-cutters” and consumers who never paid for cable TV are referred to as “chord-nevers”.  

The decline of cable TV has been slow and less dramatic than one may expect given the ease of chord-cutting

Cable TV operators have avoided the fatal mistakes of print media, which offers the latest article online for free - paywall is a recent phenomenon - and thus, conditioned internet users to expect “free” articles.  New episodes of popular shows are not available for streaming; they are only available on traditional TV.

Traditional TV operators are fighting back by starting their own streaming service

In response to streaming, Showtime, Starz, and HBO have started their own streaming services.  Disney have decided to pull its content from Netflix, and its bid for 21st Century Fox is to fortify its content library so it can start a streaming service that rivals Netflix.  To differentiate the services vs Netflix, the latest shows are available on content-owner streaming services like HBO i.e. the latest episode of Game of Thrones.

...And by competing on price with skinny bundles

Traditional cable package ($80 -100/month) with 150+ channels is uncompetitive with streaming which costs $10 -12/month.  One widely-cited Nielsen statistic suggests that subscribers only watch 17 channels regardless of the number of channels received.  

Also, cable TV operators learned important lesson from the music industry - they are keenly aware of how Apple Music and Spotify destroyed the concept of “albums” -a bundled collection of a dozen songs.

As such, cable TV operators have started streaming live TV services often referred to as “skinny bundles”.  These are basic TV package with 20 - 50 channels and cost $20 - 40/month. Sling TV, Youtube TV, Philo, Direct TV Now, Playstation Vue are a few examples.  Adoptions have been encouraging.

Who are the losers in chord-cutting?

I will highlight why AMCX is on the winning side by naming the losers and the reasons behind.  The losers are the niche channels that subscribers pay for but do not watch. Remember the average subscriber watches 17 stations, regardless of the number of channels subscribed.

A few example are Outdoor Channel, Military History Channel, RetroPlex, etc.  They share several common traits - weak, reruns dominated programming, niche theme, small viewership, and excluded from ALL skinny bundles.

The winners are owners of premium, highly sought after content.

Desirable, high quality CONTENT IS KING.  Popular, live sports such as NFL, NBA or shows like Game of Thrones are embodiments of premium content.  Winners can stay relevant and thrive by 1) start its own streaming service, 2) charge higher affiliate fees, 3) charge higher content licensing fees.  

In summary, TV ratings is down; advertising revenue is down; cable subscriber is down; these are all secular industry trends and thus AMCX finds itself in the penalty box.  Stock price of $59 implies P/2018 E = 7x; EV/2018 EBITDA = 6.8x; Short interest = 16% per Bloomberg.

My Variant View - AMCX will stay relevant and thrive in this new world of TV Media

Investors have painted AMCX with broad strokes and view as a value trap.  Because of its strong content creation platform and library, I believe its revenue base is more stable than perceived.  It will be acquired as industry participants adapt by consolidating but timing is uncertain. While one may argue what is the right multiple, I have very high confidence that this is not a 7x earnings given the quality of the business and industry tailwinds.

Content licensing revenue has and will continue to benefit from secular industry trends.

In 2007, when Netflix started streaming and Blockbuster was still around, no one aside from Reed Hastings had the vision of what streaming would become.  Hence Netflix and later Amazon were able to license shows at unbelievably low costs in hindsight. What’s changed, and the change is important here, is that traditional content owners are fully aware that licensing shows to streaming services is an act of empowerment to their foes.

Strategically, content owners are responding in two ways.  1) Merging to gain scale - In “M&A Dynamic” below, I will discuss the scarcity value of AMCX assets and the reasons why it would be sold, and 2) Drive a harder bargain in content licensing.

According to RBC, content licensing revenue was $200mm in 2014 (20% of National Distribution Revenue) and $397mm (28%) in 2017, implying 3 yr CAGR of 25.7%.

AMCX content is high quality and sought after, evidenced by

• Bucking industry trend, total subscribers for AMCX is up 1.3% and 2.3% in 2016 and 2017 respectively.  Total industry pay TV lost 1% subscribers.

• Of the 6 skinny bundles, AMCX is included in all but one (not on Hulu Live), reflecting the desirability of its assets.  For context, only SNI was available on 5 skinny bundles.

• Per SNL Kagan and RBC, affiliate fee/sub/month is $1.19, which is low relative to the total bill.  As long as AMCX can produce good content, there is still room for meaningful price increase.

• While ratings is weak, data from Rotten Tomatoes suggest recently produce shows are of the same quality vs 10 years ago when AMCX built its reputation as a content producer with Breaking Bad and Mad Men.

Other Investment Positives

They have bought back 17% of stocks outstanding in 2016 - 17, often at double-digit earnings yield.  The buyback represented 84% of aggregate FCF generated over the same time. I expect the buyback to continue.

M&A Dynamic

Owning high quality content, and more importantly, owning the studio “platform” than can churn out quality content is the new winning formula.

This is the logic behind Disney and Comcast bid for Fox, CBS and Viacom, and AT&T and Time Warner merger.  They need the scale in content to compete.

This has been a busy year for Media investment bankers.  In addition to the aforementioned deals, Scripps was sold to Discovery in 2018 for 11x EBITDA.  This also means a deal for AMCX is unlikely in 2018 as strategic buyers are tied up.

The dynamic is very exciting in 2019

Disney will leave Netflix at the end of 2019.  In addition to Disney, I believe there is space for one, if not two more consolidators - CBS, Comcast, Warner - that could start its own streaming services.  Disney would like to start strong in 2020, evidenced by the timing of their FOX bid, so they will make an acquisition by the latest in 2019.

In my opinion, whoever Disney acquires, it will trigger elevated activities by the other consolidators as no one wants to end up standing in this game of musical chair.  The players without the scale to stand on its own long term - AMCX, LGF and MGM - are all in play.

For reference, AMCX is a dual-class stock and the Dolans control >70% of the voting power.  They sold Cablevision in 2016 to Altice. I am not privy to their thoughts.

Valuation

Base Case

• 12x Normalized FCF/share of $7.35.  Target Price $88; 50% upside.

Key Assumptions

• Revenue growth stabilized at 2% base on 1Q18 LTM revenue

• Adjusted EBITDAR margins of 29% vs 31% 2011-17 avg

• Assume cash programing costs at 35% vs 32.3% 2011 - 17 avg

• Assume cash capex/revenue = 3.3%

• 21% tax rate

• Ignore M&A upside

Downside Case

• 8x Normalized FCF/share of $6.52.  Target Price $52; 11% downside

Key Assumptions

• Revenue growth declined 2% base on 1Q18 LTM revenue

• Adjusted EBITDAR margins of 28%, definition explain below

• Assume cash programing costs at 35%

• Assume cash capex/revenue = 3.5%

• 21% tax rate

Key Definitions

• Adjusted EBITDAR = Revenue - Opex + stock-based comp + operating lease - cash program and carriage fees - SG&A - restructuring expense

• Unlevered FCF = Adj EBITDAR - cash capex

• FCF = Unlevered FCF - cash interest - operating lease - cash tax

• Count all unvested shares and options as outstanding to offset stock-based compensation addback.

Catalyst

Potential M&A in 2019

Revenue growth exceeds expectation