The basic thesis of this short idea is that LGF has a management team that has not been able to operate profitably in the past, that they got lucky with the Hunger Games, and that they will return to their marginably profitable ways (or lack thereof) in the future. If that happens then the shares should go to the $10-$15 area.
LGF is a large independent movie and television producer although with LTM revenues of $3 billion or so, it's size almost compares with that of the majors (Disney, Universal, Paramount, Fox and Warner). Check out the website (www.lionsgate.com) for the properties they own. They include Hunger Games, Twilight, Saw, Weeds and Anger Management. They also own interests in EPIX and TV Guide.
Management's Track Record
Management did change LGF's profile considerably for the better in 2012. Hunger Games was a success, as was the TV show Anger Mangement. The acquisition of Summit (the producer of the Twilight series) has been viewed positively although I doubt whether it created meaningful value over the purchase price paid of $925 million (including $93 million of goodwill and $315 million of cash acquired). Summit was a known property when it was shopped so most buyers had a good idea of the cash flows it would produce since the Twilight properties had already been through some degree of commercial exploitation. Hollywood is a small town so the other studios looked and passed or didn't like the price.
Let's look at managment's track record up to the end of FY2012 which is a March 31 year. The 2012 numbers above are LTM. The data below are from the Bloomberg FA function. Number crunching the company's SEC filings doesn't lead to different conclusions.
Cash from operations for the last 5 years has been a total of -$268.86 million (total). For the last 10 years it's been -$84.71 million. This is important since cash from operations reflect the working capital swings related to funding and releasing product and the receivables that go with it. It reflects the real cash flow from LGF's businesses outside of capital expenditures, M&A and financing. Not much payoff here. Keep in mind that these periods reflect when LGF was positioning itself as a niche horror producer with "Saw" and "Hostel". Now of course they are the go to "teen novel" producer. Not like any of other other studios are going to think of that.
Operating income (a bit less than EBITDA for a filmed entertainment company) for the last 5 years has been -$66.42 million (total). For the last 10 years it's been -$55.72 million. Where's the profitability? Don't blame film accounting. Over long periods, film accounting should produce profits and cash flow if you're making profitable movies (profitable enough to cover overhead at least). In this case, there haven't been any profits or cash flow.
Management likes to say stuff like they are investing for the future and that the balance sheet underestimates the value of the company's assets, especially it's library. I think this is ridiculous. The company has an accumulated deficit of almost a half billion dollars, book value of less that $2 per share, and negative tangible net worth. Any "underestimation" of value defies belief. It's not as if LGF is a technology play, investing in the next social media phenomena, and simply waiting for the dollars to flow in.
LGF is Not in a Great Business
The business of making filmed entertainment has changed over the last few years. Pretax profits have declined by approximately 40% to 50% over the last 5 years at the major studios. Box office revenues and ticket sales are doing relatively well in the US, but are not growing much. Internationally, where there is more growth, releases tend to be less profitable. Revenues from non theatrical windows like DVD are under pressure from declining unit volumes or from less lucrative terms (Redbox, Netflix). Production costs continue to escalate (think special effects). LGF is not going to escape these pressures and is perhaps more at risk from them give its historical dependence on DVD sales. In addition, production costs for the next two Hunger Games films are likely to come under pressure given expectations for high quality hit material.
Analysts are currently valuing the remaining Twilight receivables at around $500 million and all of LGF's equity investments at around $500 million. Estimates for the Hunger Games range from $1 to $1.5 billion. That seems really high considering that it's just a three film series. Disney's purchase of George Lucas' company (Star Wars) at $4 billion or so seems like much better deal. Even so, if one values Twilight, the equity investments, and Hunger Games at a combined $2.25 billion (Hunger Games at $1.25 billion), LGF's remaining business have an implied value of about $1.9 billion (I'm assuming convertible debt is converted in my EV calculations and share count). These are the businesses that have produced no cash and no profits for the last 10 years. What's that worth? Nothing is a reasonable point of view...this implies a stock price of less than $10. $500 million perhaps is more practical...gets you to just over $12.50. $1 billion is generous...around $15. Note that this "stub" part of LGF is the part that includes all the overhead needed to support the production and distribution of Twilight and the Hunger Games. I particularly enjoy it when analysts do a sum of parts value of LGF and back out out "corporate" at a 4x multiple while they apply a 10x multiple to "operating" cash flow. This only makes sense if LGF is bought by someone that already has the "corporate" or another studio. We do not think any other studios have an interest in LGF.
Alternatively, street estimates for EPS (always hard to do for a movie producer and LFG seems to miss estimates a lot of the time anyway) for FY13 are about $0.90 and for FY14 are about $1.40. What multiple do you use for a company where sustainablility of earnings is a big issue? AAPL is under 10x. Again, we're looking at low double digit stock prices for LGF.
If one looks at LGF's book value or a multiple thereof, you get a value for the company that is less than $10.
The flip side of these arguments is that if you think management can sustain its estimate of average annual EBITDA for the next three years of around $300 million LGF is merely just "expensive" at about 13x to 14x EBITDA. This idea is not for you. LGF has NEVER done this before.
Analyst Coverage and Technicals
Coverage of LGF is almost all positive. In addition, most analysts seem to raising price targets and monkeying with their models just to keep pace with the stock as opposed to when something really changes with the company. As a result the company's stock has been a momentum investor's dream. Short against this trend carefully!
I do not hold a position of employment, directorship, or consultancy with the issuer. Neither I nor others I advise hold a material investment in the issuer's securities.
Finding a good catalyst and entry point for shorting LGF is admittedly difficult at this time. With the Hunger Games franchise still having meaningful exploitation potential, it's likely that the investors who currently own LGF will probably not abandon the company soon unless the next Hunger Games episode (Catching Fire) is a dud. Even so, the tendency is for LGF to disappoint at earnings time. If you look at the Bloomberg EE function, the company appears to disappoint roughtly 50% of the time. Much of the time investors don't care all that much and dips tend to not last long, especially after listening to management blabber on about how good things are in conference calls. However, we think that at some point investors will focus on the company's appalling track record and that results will be sufficiently off target that the stock will trade much lower. Short into earnings, but be prepared to cover quickly.