|Shares Out. (in M):||160||P/E||0||0|
|Market Cap (in $M):||3,200||P/FCF||0||0|
|Net Debt (in $M):||536||EBIT||0||0|
Lionsgate is the largest independent, publicly-traded, U.S.-based, film and television production company. Since touching ~$41 per share in Oct. 2015, the stock has fallen roughly 50%, including a 27% drop on Feb. 5, 2016, the day LGF reported disappointing FY Q3 2016 earnings. The stock has been negatively impacted by two consecutive high-profile failures at the domestic box office that were expected to be hits (e.g. G-ds of Egypt; Divergent), and a recent credit downgrade by Moody’s.
The stock has also been hurt because event-driven funds had likely bid up LGF’s stock price in the expectation that LGF was going to merge with STARZ.
On Feb. 4, the day before the 27% stock price decline, LGF updated a 13-D filing, noting that it intended to pursue merger discussions with STARZ (I would refer you to cnm3Ds recent write-up of Starz for a good discussion of the merger logic). Because LGF would likely need to use its equity to finance a good portion of the deal, the decline in the Company’s stock price complicates the financing, creating uncertainty around the deal, leading to selling in LGF stock by funds that have been expecting a merger.
Lastly, investors are concerned that LGF will be unable to replace the revenue and earnings generated from The Hunger Games, one of the most successful film franchises in history. Without a replacement for The Hunger Games, there is worry around LGF’s film business profitability.
The recent events have left LGF trading at an attractive valuation that represents a discount to the value of its assets and a discount to what a strategic buyer would pay for control of the studio.
With a ~160mm shares outstanding, LGF has a market capitalization of $3.1B. Adding net corporate debt of $536mm results an Enterprise Value of ~$3.7B. LGF has ~$800mm of non-core assets, leaving a value of $2.9B for the core film and television business. I value LGF’s television business at $2B, resulting in valuation of ~$1.7B for the film business ($895mm of film obligations and production loans due in less than a year, less $125mm in committed financing from Chinese partner Hunan TV-more on that below).
LGF’s film library, IP, access to talent, and feature film slate, should be worth more than $1.7B over the next few years. The global demand for premium video content is strong and growing. LGF represents one of the only scale assets remaining in the marketplace that can economically and consistently supply this content.
LGF owns valuable non-core assets that have become a large percentage of the EV with the stock slide. The most meaningful of these assets are: 1) 31.2% of EPIX; 2) 4.5% of Starz; 3) 50% of POP; 4) collection of gaming, and film and television distribution assets.
The most meaningful is LGF’s 31.2% ownership of EPIX. EPIX is the fourth largest premium channel in the U.S. EPIX has exclusive rights to movies in the Pay-1 window from Paramount, MGM, and Lionsgate. In 2015, EPIX grew its distribution by 60%. For the first 9 months of fiscal 2016, EPIX generated $107mm in EBIT. Valuing EPIX at $1.5B makes LGF’s stake worth ~$500mm.
The other non-core assets would be valued as follows:
1) Starz (4.5% interest)=$120mm (I think Starz is cheap here).
2) POP: $90mm (carrying value of LGF’s redeemable preferred stock)
*3) MISC. (i.e. equity interests in variety of assets (e.g. Telltale Games; Celestial Tiger; Roadside Attractions)=$100mm
Total Non-Core Asset Value-Pre-Tax: ~$800mm
*rough guesses here. LGF did invest about $40mm in Telltale games last year. Difficult to find much information on the other businesses.
LGF Vice Chairman, Michael Burns, went on CNBC on Feb. 5, the day the stock declined 27%. In the interview, Mr. Burns noted that LGF’s television production business was approaching $150mm in EBITDA in the next year or so (his words). At 13x EBITDA, the television production business would be worth ~$2B. There are few publicly-traded pure-play comps for a television production business with a specialty in scripted programming. LGFs television production business has grown from $350mm in revenue in 2011, to approaching $1B by FY 2018. Based on the growing demand for premium content, LGF’s television production business should grow for some time.
Only recently did television production become a fairly stable and strategically valuable business. The proliferation of SVOD services globally has increased demand for high-production value original programming, particularly scripted series. Three years ago, video distributors operated in privileged walled-gardens protected by scale. No longer; the internet has created competition where it did not previously exist, particularly in the demand for scripted shows. This is LGF’s specialty; it is the studio behind Weeds, Orange is the New Black and Mad Men.
The new television production economics have probably taken the home runs out of the business. The old model of a big network hit that could be syndicated to a cable network (i.e. Seinfeld; Big Bang Theory), and run continuously on a cable network, providing enormous profits to the studio, has been displaced because re-runs are no longer as valuable due to the abundance of choice. Networks need to fill their inventory with original, new shows.
That offset is that more distributors and networks are desperate for original programming and there are only a few companies that are able to produce high-production value scripted shows. I believe this is one reason that John Malone took a 3.4% percent stake in LGF last February (I can’t tell if Mr. Malone is being offensive or defensive-but his stock in LGF was issued at around $30).
What LGF’s television business lacks in high margins and major breakout hit potential, it makes up for with steady, growing revenue and profit, and favorable tailwind from the increased demand for original content. There has been a lot of deal activity in the television production space over the past two years in response to the changing dynamics. I have little doubt that there are would be many buyers for LGF’s television production business were it for sale.
Valuing the TV business at $2B, leaves a value of the film business at ~$1.7B. I arrive at the $1.7B by adding production and film obligation debt of $895mm, less $125MM in committed film financing from LGF’s Chinese partner, Hunan TV, in the next year. LGF does not include the $895mm in production debt as long-term corporate debt. I am including it because I am going to value the film business inclusive or their future film slate, and this production debt helps fund the slate (there is likely an offset to this debt for presold foreign film distribution rights-but that gets probably overly complex/I am attributing all of the production loan to the film business-some of it is probably for television/I am also including the entire production loan obligation-but only $710mm is due in the next year-the reason for this is to include the entire future film slate beyond one year in the valuation).
LGF’s film assets includes a library of thousands of movies, including The Hunger Games, Dirty Dancing, The Twilight Series, and the Saw franchise. LGF’s film library provides a recurring source of revenue because the titles can be licensed over and over to distributors around the world, as well as monetized through the sale of packaged home video, or remakes.
There is an ongoing debate about how much libraries are worth, and valuations tend to ebb and flow based on new technologies. In the mid 2000s, library values were at a premium as DVD sales were skyrocketing. Then in 2010, library values plummeted as DVD sales fell. I think it is likely that library values are again on the rise as global streaming services proliferate and the demand for premium content grows. LGF controls one of the biggest film libraries in the marketplace. Mr. Burns noted in the same CNBC interview referenced above that LGF’s library throws off $200mm per year in EBITDA. The library does need to be constantly replenished so as to avoid run-off. But you could close LGF down tomorrow and collect a nice stream of cash flow from the library for some time.
The film business also includes a slate of films. In FY 2017, the slate features a film based on the children’s property, My Little Pony, The Mighty Morphin Power Rangers, and a new interpretation of The Odyssey. The market is not pricing in the possibility that any of these turn into a franchise with multiple films.
The Hunger Games IP is probably undervalued in the film business. The Hunger Games is one of the biggest movie franchises of all time. LGF Management has hinted at the possibility of prequels. LGF is licensing the Hunger Games IP to theme park operators in Atlanta and Dubai for new attractions. LGF will look at many ways to keep the IP vibrant. I would love to see a deal for the Hunger Games similar to what Marvel has done with Netflix where LGF creates serialized television programming for Netflix, or another SVOD service, based on different Hunger Games characters or actual Hunger Games competitions. Because this is one the best known and most globally recognized films franchises, there will be a lot of energy devoted toward building new, profitable revenue streams from it. You see this with James Bond, Jurassic Park, Harry Potter, and Star Wars. While not in that echelon, The Hunger Games is probably one notch below, which is still rarified air.
There has been a flurry of capital investment in the movie business lately. Dalian Wanda recently paid a reported $3.5B to acquire Legendary Entertainment. Paramount is about to monetize a minority interest in its studio, presumably to an Asian buyer at a premium valuation. beIn Media, a Qatari-based media company, acquired the Miramax studio in early March. A Chinese film business called Film Carnival recently committed to put in $500mm to finance a slate of movies for a new production company called Dick Cook Studios.
LGF’s Board must be paying attention to the premium valuations being ascribed to studios, especially the Wanda deal for Legendary, which is a smaller studio with a smaller library. LGF does not gain any advantage by having a depressed stock price. The Company can’t repurchase meaningful amounts of stock due to the variability of the film business, and they can’t use the stock to finance acquisitions, something they have been doing successfully and actively for three years. It seem incongruous that LGF is trading at the lowest valuation it has seen in roughly three years; at the same time, studio valuations are increasing and Asian money is pouring into Hollywood.
It is difficult to value a film business because the cash flow is highly variable with film performance, and libraries values can be dynamic. But one framework is to consider what a content company, or any company that wants to own or create content, could get for $1.7B. If you buy LGF ‘s film business for $1.7B, you get a collection of branded IP, including one of the biggest movie franchises of all time, a deep library generating cash flow, access to talent, relationships with content creators, remake rights, marketing and distribution capabilities, and a future film slate with potential franchises.
On the other hand, you could invest $1.7B and try to create hits, which carries more risk. This calculation, particularly for foreign companies that need premium content and don’t have the relationships or capabilities to create it on their own, should make LGF attractive for a lot of buyers if the price stays this low. I won’t pretend that the movie business is a great business with high returns on capital; its not. But, at least historically, buying movie studios at the right time has worked out because there are always new constituencies of buyers who want to enter the movie business for a variety of reasons, but cannot reproduce the assets of a Hollywood studio. Lastly, I am not suggesting that a buyer would purchase the movie studio separate from the television business. I think it makes sense to own them both and keep them together.
Management does something to highlight discount