Description

Thesis

Starz (STRZA) is a pay television network company that is well-run and trading at a reasonable price, at 9.3x EV/EBITA on 2014 and 8.3x EV/EBITA on 2015.  The CEO is longtime HBO senior executive Chris Albrecht and the Chairman is Greg Maffei, CEO of Liberty Media, and the company has long been under the Liberty umbrella.  The company has repurchased 10% of shares outstanding in the past year plus, and management has indicated on multiple occassions that there is economic logic to STRZA being part of a company with a larger collection of cable networks due to the resulting cost and revenue synergies.  I believe that it is likely that the company gets sold at some point in the next few years at an attractive price to equity holders.  At 10x EV/EBITA post-synergy, I can see conservatively see a price in the high $30's per share.  In the event this does not occur, I think the company is still reasonably cheap and should see increasing Adj EBITA goign ahead along with rational capital allocation.

Business Description

Starz (STRZA) is a media company with three segments: Networks, Distribution, and Animation.  The main business is Networks, which is comprised of the Starz and Encore premium pay television channels, which are sold to consumers through wholesale relationships with pay television distributors and have 22.2m and 34.9 million subscribers respectively.  Distribution and Animation are minor contributors to profitability and relatively stable and reside in the company due to legacy corporate issues.

Starz has been part of the Liberty empire since its founding by Liberty Media Group in 1991.  It existed within Liberty entities over the years in various forms (subsidiary, tracking stock, etc) and had a spin-off to a freestanding public company in January 2013 at $14.15/share.  Media vetern Chris Albrecht (longtime senior executive at HBO) joined Starz as President & CEO in January 2010 and is currently running the show, with Greg Maffei, consigliere to John Malone, as Chairman.  Malone owns 10% of the company and controls it through supervoting shares.

Starz & Encore are sold through the pay television distribution channel.  Simplified, a company like Time Warner Cable or DirecTV sells Starz to its customers, usually as part of a pay channel bundle, and keeps a slice of the revenue and passes the rest on to STRZA.  Starz is not available "over-the-top" (online without a pay television subscription) due to the channel conflict that creates with its distribution partners.

STRZA is following the path that HBO and Showtime have blazed and transitioning away from carrying only movies and towards offering more original content.  It has a film output deal with Sony that runs through 2021 and a similar deal with Disney that is ending with 2015 releases (with movies from Disney coming through 2016 as a result of how the scheduling works).  The Disney deal was taken over by Netflix.  STRZA is taking the money saved from the Disney deal and investing it in orignal programming, with a goal of 65-75 hours of original programming per year, up from 28 hours in 2012 and in the same ballpark as HBO and Showtime.

The transition to original programming is a good strategy if it is done well, as HBO, Showtime, and Netflix have illustrated in recent years.  There is some risk that such a strategy may become less effective over time as everyone has seen how successful it has been in recent years and is attemping to duplicate it and there is a flood of new original content.  However, STRZA has a scale advantage vs. upstarts as one of the few existing fully distributed pay television channels and, combined with its strong management and ability to show R rated content, I think it is well positioned to succeed.  I also think that demand for original content is likely to remain high as the current channels successfully evolve to address different niches.  Thus far, STRZA has not had any real breakthrough hits with their original programming and I think if they do have one it could considerably change sentiment towards the stock.

The company's financial performance has been strong in recent years, with Adj EBITDAS in the Networks segment growing from $396m in 2009 to $456m in 2013.  Total EBITDAS has been even better due to Distirbution moving from a big loss to $24m Adj EBITDAS in 2013.

The business is excellent from a financial perspective with a very high ROIC and net income translating almost directly into FCF.  Management has been aggressive and creative in selling international rights to original programming in order to reduce their risk.

The big risk here is that STRZA fails to differentiate itself through quality content, it sees increasing competition, and the company loses subscribers over time.  Even in this bad case scenario, I think the decline would be fairly slow.

I don't have a strong opinion about who might acquire STRZA, but I think it would be one of the media conglomerates without a strong pay television channel.  FOXA, VIA, CMCSA, or AMC are all candidates.  Besides the cost benefits of reduced SG&A, I think there would be meaningful revenue synergies as well, as any one of those companies would have more leverage with distributors due to their larger stable of channels.  There was been a decent amount of chatter coming out of the recent Sun Valley conference regarding increased content consolidation required to match the recent distibutor consolidation (CMCSA/TWC, DTV/T, etc).  I think we will see movement in this area in the future and that STRZA is likely to be one of the targets.

Catalyst