Description

This submission is categorized under "LGF/A US", but also applies to "LGF/B US", increasing $ ADV and borrow.

RECOMMENDATION: SHORT Lions Gate with 40-70% upside driven by 1) untenable leverage, 2) 25%+ misses on OIBDA (EBITDA equivalent), and 3) a failed spin process.

DESCRIPTION: LGF consists of two businesses: (i) Studio (~2/3 of revenue) that produces, distributes, and licenses movies and TV shows and (ii) Starz (~1/3 of revenue), which is an on-demand TV offering that caters to niche audiences.

THESIS 1: LGF has an untenable ~5-6x OIBDA leverage, a content library that doesn’t generate enough cash to de-lever, and accounting that disincents debt paydown. Investors will become frustrated by high and rising leverage, falling reported FCF, and a rising cost of debt

LGF’s studio content has soured and new releases have underperformed (last 2 Rambos lost money, Saw is 2 movies past “Saw the Final Chapter”, the last Hunger Games was released 8 years ago and the newly released prequel is underperforming HSX.com expectations, the last Expendables underperformed, etc.). LGF’s new releases are financed with production loans that LGF now cannot afford to repay and have therefore ballooned to all-time highs (~300% above long-term median). While production loans are non-recourse, management will admit that LGF cannot default on its production loans (and never has) given LGF’s new releases / survival are reliant upon new production loan issuances. Moreover, LGF’s accounting disincents production loan repayment given production loan paydown is treated as a use of FCF, meaning repayment leads to reporting troubling negative FCF for a highly overlevered business. Additionally, LGF has sizable term loan + bond balances from overpaying for Starz and other poor managerial decisions. Therefore, LGF is stuck in a precarious situation in which they have elevated leverage, no path for repayment, and a deteriorating content slate, which will prove increasingly troubling for investors.

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

Desperate to lower leverage and show growth, management gave an overly aggressive guide for LTM 1Q23-LTM 1Q24. To hit the guide, LGF released titles across all of its remaining functional franchises including (i) John Wick, (ii) a John Wick spin TV show, (iii) Expendables, (iv) Saw, and (v) Hunger Games. A box office unit economics analysis indicates that new content releases alone will not be enough to hit the Studio guide. Therefore, to temporarily hit numbers, management was forced to aggressively license content by signing longer-term deals (revenue derived from licensing is recognized immediately irrespective of contract length, so signing a 5-year deal allows more revenue to be pulled forward and recognized than a 2-year deal). This pull-forward led LGF to print revenue / OIBDA numbers that cannot be sustained. Despite LGF’s unsustainable release slate and licensing, St is projecting MSD % revenue and mid-teens % OIBDA growth off the elevated LTM 1Q24 figures, setting LGF up for 20-30% OIBDA misses. As LGF misses, investors will become disappointed and leverage levels will rise, exacerbating investor frustration.

THESIS 3: desperate for a permanent solution to its overleverage and declining content slate, management is attempting a spin that will asset strip at bondholders’ expense. Bondholders have picked up on this, formed a bond group to block the spin, and are succeeding. A failed spin will disappoint bulls, leading to a SoTP valuation that implies 40-60% downside

 To address overleverage and a declining content slate, management is turning to corporate actions to find a permanent solution. Management is attempting to strip the assets of value (the Studio) from LGF, leaving bondholders behind with only the low-quality assets (Starz). This will allow management to pursue a sale of the de-levered Studio post-spin and more value to be captured by Studio equity holders. However, this contemplated spin trips a change in control provision that states the bonds must be refi’d out if “all or substantially all” of the assets change hands given the Studio represents just about all or substantially all of LGF’s FMV. Management is attempting to argue that “all or substantially all” of the BOOK VALUE is not changing hands and so the change in control provision is not triggered, but this argument is a stretch. A bond group has formed to fight management on this and there are data points to indicate that they are winning (management has alluded to concessions, bonds are being repurchased in the pubic markets, the spin has been delayed 3x, etc.). If the bonds have to be refi’d out, the spin destroys shareholder value given the cost of debt for the bonds rises 3x+ from the current 5.5% coupon closer to the bonds’ current mid- to high-teens yield. Therefore, the spin that bulls have been hanging on for may be cancelled entirely.

Even if the spin does occur, it will not create value. A spin will cause enormous reputational damage with creditors for a business with 5-6x leverage and a business model reliant on future borrowing (LGF needs new production loans to survive). Additionally, a successful spin will not create value given it leaves behind unattractive assets with no logical buyers.

The standalone Studio is unattractive given: (i) the Studio is covered in hair via production loans that can’t be repaid and can’t be defaulted on without reputational damage; (ii) LGF’s content has limited value to an acquiror given its niche appeal (R-rated); (iii) LGF has licensed away the content that would have been attractive to the next buyer; (iv) it is cheaper for a potential buyer interested in the content to license from LGF rather than acquire; (v) a buyer will see the Studio is at peak OIBDA; (vi) buyers (PARA, WBD, CMCSA, etc.) are distracted by limited BS capacity, HSR risk, depressed multiples (LGF’s multiple is dilutive), etc.; and (vii) if anyone wanted the Studio, they would have bought it over the past ~3 years when the assets were on sale, debt + equity financing was cheaper, and buyers had more political capital.

Standalone Starz is highly unattractive. If LGF leaves the bonds with Starz, the entity has near-zero equity value given (i) Starz is struggling + losing subs + has uninteresting content; (ii) management is wrong in thinking Starz has a coveted brand given the industry trend is toward deleting brands (per recent actions taken by PARA, WBD, Peacock, Televisa, etc.); (iii) Starz does not produce content, so would-be acquirors are better off licensing the Starz content rather than acquiring Starz itself; and (iv) the guide calls for Starz to license more content from the Studio, degrading Starz’ already limited profitability.

MODEL: (i) FY24 theatrical releases and international licensing perform in line with HSX.com expectations; (ii) FY25 theatrical performance declines with the content slate; (iii) Studio cost structure variability is in line with historicals; (iv) media networks continues on its declining trajectory; (v) television production falls to normalized levels and grows MSD% off its new base. Results in modestly beating FY24 numbers, missing FY25-26 top-line by ~high-teens to mid-20%s, and missing OIBDA by ~30%.

RETURNS: reward case SoTP returns 40-60% downside to the current valuation assuming the spin occurs, Starz trades for 5.0x OIBDA, the Studio trades for 9.0x OIBDA, and LGF redeems the production loans for 75 cents on the dollar. DCF returns 50-70% downside with 14.3x uFCF FY28 exit multiple (8% WACC / 1% terminal growth). Risk case assumes (i) Studio trades for 11x, (ii) Starz for 6x, and (iii) buyer pays LGF for $100mm in Starz synergies; returns ~40% downside to short (~10% chance of risk case occurring)

Catalyst

1) 25%+ misses on St numbers, 2) announcement of failed spin, 3) misses on FCF given untenable leverage, and / or 4) disappointing box office performances for new movie releases