Description

I’ll keep this writeup relatively short as LGF has been written already 4 times on VIC and the short thesis was submitted by anonymous.user only 6 months ago when the stock was at $9.60. Since then, the stock is down c. 13%. The risk-reward has completely changed and the investment represents today a timely, asymmetric 12m trade. In a worst case scenario I see zero to 20% downside while in a good case (not blue sky) scenario I see a doubling over the next 12 months.

About Lionsgate

Lionsgate currently operates 2 separate businesses. It has a channel network called Starz, which began as a classic linear cable network which over time converted to a premium DTC business, and a pure play content supplier, Lionsgate Studios.

Lionsgate has more than disappointed and frustrated investors over the last decade - I am yet to find someone that made money on the stock (except for short sellers). It’s hard to list all management mistakes over the years. The most egregious were probably the purchase of Starz in 2017 for $4.4bn and the Board rejecting a rumored bid of $40 from Hasbro, also back in 2017. The company has been (poorly) run by current CEO Jon Feltheimer for over two decades. MHR Fund Management, run by Mark Rachesky, is the largest shareholder with 24m shares out of the c.235m shares outstanding or c. 10% economic interest but representing c. 24% voting interest. The B shares don’t vote.

Starz

Starz Networks includes STARZ  and Lionsgate+. Starz includes the domestic branded premium subscription video services through OTT platforms, on a DTC basis through the Starz App, and through US MVPDs. It generates c. $1.3bn in revenues from c. 20m domestic subscribers. Approximately ⅔ of subs are OTT and ⅓ of subs are linear.

Lionsgate+ represents the OTT distribution business of STARZ branded premium subscription video services outside of the U.S. It includes approximately 5m subs. A large percentage of Starz content (c. ⅔) comes from the Lionsgate Studios. This segment has been the trouble child for Lionsgate since its acquisition. Starz troubles affected the group both financially, because of declining margins and falling linear subscribers, as well as strategically, since the Studios had to adapt content spending with an eye to Starz needs. Starz probably absorbed 75% of management time while representing less than 20% of the company value. In 2023 the company announced a wide restructuring of the segment exiting 7 international territories while effecting cost cutting measures, including curbing some ordered programming. The restructuring efforts succeeded and the segment is now stabilized and cash generative. OIBDA after allocated central costs increased from $81m in FY2023 to $181m in FY2024 and is guided to grow further to $200m in FY2025.

Lionsgate Studios

The Studios represent the crown jewel of the group. It was created over more than two decades of M&A, led by current CEO Jon Feltheimer. The company completed 15 studio/content  acquisitions since 2000, including the most recent one being Entertainment One from Hasbro (not without irony) for $375m.

The business operates as a classic video content one that monetizes it in different ways: Theatrical (cinemas), Television (cable), OTT/SVOD and internationally.

Lionsgate is platform diagnostic and has distribution channels with all large content distributors in the US. It boasts a library of c. 20,000 titles and adds c. 400 new titles to it every year. The library alone generates c. $900m in high margin revenue annually.

While the current library is an impressive business which should by itself cover the current market cap of Lionsgate, it’s fair to say that management has not been a great capital allocator historically. As per below slide from the Separation presentation, Lionsgate spent in the last 2 decades over $17bn in content. The ROI on these investments has been very poor, but it shows the inherent value of the asset.

Studio businesses are notoriously volatile and hard to model in the near term but highly sought after from a strategic perspective. Must-have content is instrumental, especially for SVOD players like Netflix and Amazon Prime, to a) attract and retain customers and, b) differentiate from other offerings in the markets. There has been several transactions in the space and Lionsgate is one of the last remaining independent studios in the market. While we could debate ad nauseam over the relative quality of the Disney Studios, Paramount Studios etc. compared to Lionsgate studios, it is manifestly evident that Lionsgate has produced, and is likely to produce going forward, very high quality content that attracts millions of viewers. Some of their most iconic franchises include Saw, Expendables, John Wick, The Hunger Games, Twilight, Orange is the new black, Mad Men, Highlander.

The Studios generated $466m in OIBDA in 2024 before central costs, up from $410m in FY23. After central costs, total Studios OIBDA grew from $287m in FY23 to $330m in FY24. This is guided in FY25 to grow organically c. 15% and with a $60m contribution from eOne, it should generate $430m in OIBDA this year. Some repricing of contracts expiring in the library in FY26 should push Studios OIBDA closer to $500m in 2 years. Important thing to consider - FY24 results were distorted by the WGA strikes in 2023. In FY2025 there will be some expense catchup with financials to normalize in FY26. From the 10k: “These strikes resulted in temporary shutdowns of production on certain of our television and film programming, which resulted in less new content available for licensing and distribution, lower-than-expected spending for content and marketing costs in fiscal 2024, and reduced revenues in our talent management business due to the delays in productions across the industry.”

Short case

The short case predicated 6 months ago is by now largely debunked. It was articulated over 3 theses:

Thesis 1: Leverage

The short case was predicated on LGF having “an untenable ~5-6x OIBDA leverage, a content library that doesn’t generate enough cash to de-lever”. FY2024 results, the SPAC deal and FY2025 guidance suggest otherwise.

The company ended FY2024 with leverage of 4.2x, but this is distorted by the eOne acquisition. Whether LGF separates or not, net leverage is set to fall to below 3.5x by FY25 (March 2025). Regarding the above commentary about lack of cash flow, LGF generated $397 in operating cash flow in FY24 and $157m in net free cash flow after CAPEX and repayment of production loans. In FY2025, the company (per guidance) will generate c. $50-100m with a lumpy profile. The company will burn c. $200m in H1-25 due to working capital movements connected to content payments, given that actors’ strike pushed lots of projects from FY24 to FY25. There is nothing nefarious about this. In H2-25 the company will generate approximately $250-300m in FCF for total FY2025 free cash flow of close to $50-100m this year. This will improve significantly in FY2026 as there won’t be any large WC moves connected to the FY24 strikes. Furthermore, the SPAC transaction which closed in May 2024 brought net proceeds of close to $300m, which are used to pay down debt. Based on the above and based on EBITDA guidance 2025, the company will have net leverage of close to 3x by FY25 and this will fall sub 3x in FY26. These are leverage ratios which are well within acceptable levels, far from being “untenable”. If one of the overhangs for the stock was leverage, this is clearly no more.

Thesis 2: LGF will miss on OIBDA by 25%+, leading to a de-rating

While the company did indeed de-rate, it had nothing to do with OIBDA miss. In fact, the company has:

1. beat on FY24 results, reporting Studio profits of $466m against guidance of $445m and reporting EBITDA of $518m against guidance of $400-450m. Even factoring the $30m of one-off benefit from exiting international STARZ territories, EBITDA came in 8% above the high end of the guidance

2. Reiterated its FY25 guidance, which was consistent with the messaging given during the separation announcement

The OIBDA miss thesis did not play out to date and I don’t foresee misses in FY25. The stock has derated somewhat, but this is all due to risks related to a potential failed spin.

Thesis 3: failed spin

This is the 3rd part of the thesis which hasn’t yet been debunked but I believe it’s just a question of time. The SPAC transaction was instrumental to 1) reduce leverage and, 2) provide a market value for the Studio to anchor the LION US listing. I see it as a stepping stone towards the full separation which should occur within 6 months, when LGF shareholders will receive their pro rata shares in LION US. Today the Studio business, while legally still part of Lionsgate, trades as a separate entity (LION US) since it was listed in May 2024. Lionsgate (LGF) owns 87.5% of LION and the rest is owned by SPAC and PIPE investors. This was step number 1 towards the separation. There are 2 remaining steps required for the full separation which, since its announcement in 2023, was guided to occur by calendar year end 2024. I still believe we are on track for the full separation occurring by December 2024. More on this below. Once the separation will occur in the next 6 months, all the 3 main bear cases will be debunked. The stock should then be free to re-rate to intrinsic value.

I’d add that over the last couple of quarters, since the separation was announced, Liberty Strategic Capital run by Steve Mnuchin has been buying shares. The latest purchase was recorded this week. The fund now owns 11% of the A shares for c. $80m in invested capital. We suspect they are close to management and wouldn’t be buying if they had any doubts about the separation occurring as per plan.

Separation Agreement - where are we today and where we’re coming from

In order to create value, management started signaling to the street its intention to separate the two businesses. Already in 2021, the company announced its intention to separate the businesses by spinning Starz. In September 2022 the company changed its mind announcing the intention of spinning off the Studio business. Things dragged on for years, frustrating investors in the interim. In July 2023 the company posted a Form 10 in connection to the separation of Starz from the Studios. Just as everyone was expecting the separation to occur at some point in 2023, the company once again surprised investors by announcing in August 2023 the acquisition of Entertainment One from Hasbro. The acquisition was not well received by the market because of a) increased leverage at the Studios to deal with and, b) delay in the separation of at least 6 months until the acquisition closed and, c) some suspicions about the transaction being affected by Studios head Burns which was until very recently on the board of Hasbro. The deal eventually closed in December 2023. Lionsgate was finally setting itself up for a full separation in 2024 but still - after years of promises, changes of plans and delays, very few people believed it would still happen.

Once the Board was finally behind this agreement, there were still 3 key hurdles to overcome:

1. Lionsgate carries substantial debt which could obviously not get repaid. A separation counts for change of control which would make the debt payable. Lionsgate would therefore need to convince debt holders, especially bondholders, to exchange their notes with new ones, some of which will move to the newly formed Lionsgate Studios entity and others would stay behind at Starz

2. Lionsgate has 2 different classes of shares, A and B (non-voting). Since Lionsgate shareholders will receive in distributions their pro-rate Lionsgate Studio shares once the separation is completed, a collapse of A and B shares is therefore required. This will have to go through a shareholder vote

3. In order to facilitate a refinancing, Lionsgate needed to “help” debt holders in the debt separation. They did this on December 22nd 2023 when they announced a transaction with a SPAC that would create LION US as a separately traded public company. The transaction had 3 primary goals:

   1. Create a new listed entity, whose share would then be distributed to Lionsgate Shareholders once the separation will be completed. Lionsgate Studios started trading as a separate company on May 14th 2024

   2. Anchor a valuation floor for the Studio business. This would also help debt holders get their head around leverage from an LTV standpoint

   3. Raise some cash proceeds to reduce leverage ahead of the separation

Lionsgate shareholders now own an approximately 87.3% stake in Lionsgate Studios, while Screaming Eagle public shareholders, founders and PIPE investors now own approximately 5.7%, 0.7% and 6.3% of Lionsgate Studios, respectively. The SPAC transaction anchored Lionsgate Studios valuation at c. 11x EBITDA or $4.6bn. We believe this represents an absolute floor to the Studio valuation and is a discount to fair value which is somewhat justified given a) lack of liquidity in the stock until full separation occur, b) risk for SPAC investors of delays to the separation and, c) time value of money - SPAC transaction was announced c. 1 year before expected separation day.

Regarding the 2 remaining hurdles to close the deal, the first one (share classes collapse) is the easiest and will soon go through a vote once the correct exchange ratio will be agreed upon. Both A and B holders want the separation to happen and there isn’t much variability in the historical premium of A over B. The A shares historically traded at an average 8% premium to the B shares. We suspect the exchange ratio will occur at a premium around the 10% mark.

The last, and more controversial step, is the issuance of new debt at the two different entities. Let’s summarize the Lionsgate debt situation as of 31/03/24. The company had $2,480m in Debt and $314m in cash for total Net Debt of $2,166m:

Lionsgate wants to keep a balanced leverage between the Studios and Starz. In order to do so, management wants to move $1.4bn of net debt from LGF to LION and keep c. $700m with LGF (Starz). LGF closed FY24 with net debt of $2.2bn. Pro-forma for the transaction, this fell to c. $2.1bn by Q1-25 ($300m of SPAC proceeds less c. $200m in negative FCF due to working capital movement related to content spend described above). LGF as a whole should end FY25 with c. $1.8-1.9bn in net debt with strong FCF generation in H2-25. EBITDA FY25 on a consolidated basis should be close to $630m, with $430m from Studios and $200m from Starz, for net debt to EBITDA close to 3x by the end of FY25. While this leverage level should not be a problem whatsoever for credit investors, LGF still needs to refinance c. $1.2bn of debt at the Studios and the term loan at Starz. On May 8th 2024, $389.9m of Senior Notes were moved to Starz by issuing new 5.5% notes to exchange the old Senior Notes maturing in 2029. As a result, there should still be c. $360m of old 5.5% Notes outstanding that have not been exchanged. While there are rumors that excluded bondholders from the exchange are threatening litigation, the reality is that the exchange has occurred and those threats did not materialize. Note that we are talking about only $360m in debt which could probably be refinanced via other forms of debt if the litigation threat becomes real. What is really happening now is that LGF is currently holding normal discussions with creditors to issue new Studio debt as well as new term loan debt at Starz to refinance the current obligations. In the end, this will happen and it’s just a question of pricing. The current Term Loan A effective interest in FY2024 was 7.17% and the Term Loan B was 7.67%. The new debt to be issued may in the end carry a spread 25-50 bps wider, but this is not going to stop the deal. By the end of FY2025, we expect Starz Net Debt of c. $700m and the Studios to carry a Net Debt of c. $1.1-1.2bn.

In conclusion, I believe that the risk of a separation not occurring is low and believe it will take place in the next 6 months. Once the full separation will occur, a natural re-rating will ensue.

Valuation

The entire upside on the trade derives from the Studios business. I don’t have a good view as to where Starz should trade, to be honest. Given its modest size I suspect it would garner little strategic interest. The company will generate c. $200m in EBITDA in FY25 and carry c. $700m in net debt. We could almost ignore Starz altogether. For academic reasons let’s pin a 6x EBITDA multiple which would give us a $500m equity valuation (down from $4.4bn when purchased in 2017!).

Lionsgate value lies in its 87.5% stake in Lionsgate Studios. It is again very hard to come up with a precise number, but here are some considerations:

• Lionsgate traded on average on 14x EBITDA before the Starz acquisition

• All comparable transactions occurred at a valuation well above 15x EBITDA. While we acknowledge that multiple valuations compressed over time, we must also acknowledge that there is tremendous scarcity value here. If Paramount Studios gets sold, Lionsgate Studios will be the last remaining independent studio on the market and should therefore garner a premium valuation due to its scarcity value. The most recent similar size transaction involving MGM and Amazon in 2021 was done at 27x EBITDA or $8.5bn for a Studio business which most would categorize as inferior to Lionsgate.

• During the whole Skydance / Paramount saga, several analysts came out with their estimated valuation ranges for the Studio business of Paramount, with values anywhere between $15bn and $20bn. While it’s very hard to derive a precise multiple given the slightly different nature of Studios as well as the many intercompany revenue streams, that range would represent an EV/Sales of c. 5-6x. Lionsgate Studios generated $3bn in sales in FY2024 and nearly $900m in high margin library revenues. Even applying half of the implied Paramount Studios sales multiple, we’d get an enterprise value of c. $7.5bn.

As mentioned, benchmarking against other transactions is hard and there are many qualitative differences amongst studios and IP libraries. Lionsgate has already licensed most of the content and we don’t have a good view as to when these contracts will come up for renewal. Its focus on R rated content may also garner lower strategic appeal, especially from the likes of Disney. While the above is all true, Lionsgate consistently scores as top 5 content provider amongst OTT streaming platforms:

We value the Studios business at the very low end of all comparable multiples listed above, namely on 14x FY25 EBITDA, which would give us an Enterprise Value of $6bn (14*430). This is equal to an EV / Sales of 2x, which is at the very low end of any past Studio transaction. LION US will have Net Debt of c. $1.2bn by the end of the year, which would imply an equity valuation of c. $4.8bn. 87.5% of $4.8bn is $4.2bn. Adding the $0.5bn from Starz gets us a total Lionsgate fair value of $4.7bn in the next 12 months, which would equal a share price of close to $20, or 100%+ upside from here.

If all else fails and the separation does not occur, we are left with a Studio + Star business (LGF US) trading on c. 6x EBITDA and 3x in leverage with an annoying minority interest. It’s hard to see much downside from here.

Catalyst

Full Separation