Tuesday, September 22, 2015

Lionsgate Entertainment: A Strong Firehose Candidate on Is Own, but Stronger Still With Malone Liberty Involvement

  • Lionsgate is a high growth company in the film and television businesses, a mini studio close to becoming a major - all the while adding fresh tent pole franchises like“The Hunger Games”, the “Twilight Saga” which have generated billions of dollars in theatrical income while building a major television platform.
  • LGF owns attractive positions in a number of affiliates- in particular a 31.4% interest in EPIX a fast growing profitable premium TV channel.
  • Having built a very strong financial footing with roughly $200 million in library operating cash flow annually, LGF management expects to be able to make cash accretive acquisitions, possibly taking advantage of lower Canadian tax rates.  At the same time, John Malone has invested in Lionsgate possibly to make LGF the lead content provider to his over 60 video cable subscribers worldwide. 
If our thesis is to invest in world wide, wireless and wired data demand created by growth in smartphone and mobile technologies, how can a studio be a Firehose Media Investment? 

Basically all movie studios are firehose companies. By their very nature, they spew out content to a hoped for worldwide audience : nevertheless, being a fire hose movie company does not ensure value creation for investors. All motion picture studios run hot and cold with a disheartening lack of predictability. All. Tens of millions in production and marketing costs can be poured into a film which audiences shun. The hard truth about the movie business is that nobody can predict how much income a film will generate until it reaches the theater.  This all sounds bad, right? 

Actually, all one can expect from a “good” studio is that management will grow the film library prudently from self produced and acquired films, reduce debt with proceeds from library sales and tilt the studios film release to the plus side of the ledger. Not a great business model right? 
In general no. So why invest in Lions Gate? 

One main reason: Lionsgate isn’t really a studio.  It is a growth company in the film and television businesses. Management thinks growth, seeking to expand both organically and through acquisition. It uses leverage in a disciplined way to enter businesses with leading edge franchises and to acquire free cash flow in order to pay down debt associated with the acquisitions. And, it is extraordinarily well positioned to capitalize on growth in demand for media content across all device platforms. 

Ok how? 

Lionsgate has built a very strong financial footing with roughly $200 million in library operating cash flow annually.  This cash flow, from acquired libraries like Summit and Artisan Pictures, offers very predictable revenue from home video sales, domestic and international television sales, and from new digital avenues like Electronic Sell Through (iTunes, Amazon) as well as over-the-top digital platforms like Netflix, Amazon Prime and Germany’s Max Dome.

LGF  is a mini studio close to becoming a major - all the while adding fresh tent pole franchises like“The Hunger Games”, the “Twilight Saga” which have generated billions of dollars in theatrical income.  Big successful franchises provide leveraged upside beyond high profitability from theatrical receipts.Sales to home video, electronic sell through or digital streaming bear a direct relation to theatrical success, and can predictably generate multiples of income over various release windows extending 30 to 40 months in the future At the same time, there’s the opportunity to add sequels to the franchise -predictably profitable (though often not as much as the the original)- but still able to add annuity like income and cash flow to the library far into the future.. Other studios have had success with franchises in the past but have have difficulty moving beyond yesterday’s franchise series. What is attractive about the Hunger Games and Twilight Saga is that they appeal to young people especially teenage girls, an under served demographic segment.  Finally, success breads success as writers, directors and actors will want to associate their projects with a hot studio. This last doesn’t guarantee success but it has been a model that worked for Warner’s and Paramount in the past. 

Lionsgate has acquired or developed a number of successful television franchises: Orange Is The New Black on Netflix is now in its fourth season and commanding ever higher license fees.  In the current year, LGF will have 30 TV series on 20 networks. Will they all survive? No. But TV is a game of numbers and typically the game goes to the bold creatively and cautious financially.  

LGF owns equity positions in a number of interesting companies- in particular a 31.4% interest in EPIX a premium pay TV, which contributed almost $32 million to after tax earnings last year and is growing rapidly. We think that EPIX's very low cost structure, ownership by three major studios and management promises that the network will be very competitive even against the major OTT players. LGF also owns a 41% interest in Roadside Productions, an independent film production company, which helps fill Lionsgate’s distribution pipeline -THE most profitable of all studio activities on a risk adjusted basis. 

The company is adding to its cash position and liquidity through internal growth. Over the last two years, LGF has paid down almost $500 million in debt related to its acquisition of Summit Pictures and has $200 million in cash as of the first quarter up from $90 million last year.  LGF also has another $1.0 billion available under its current credit agreements.

In virtually all of its public statements about growth through acquisition, LGF management expects to be able to make cash accretive acquisitions. Importantly, Lionsgate is domiciled in Canada and can take advantage of lower Canadian corporate tax rates (35% vs 15%) when acquiring assets. A number of companies have taken advantage of tax inversions between the US and Canada. In fact, Lionsgate can absorb companies up to four times its size without triggering inversion prohibitions. We believe tax driven inversion deals are a tremendous opportunity for Lionsgate to add significantly to add assets and to create discontinuous increases in cash flow and value.

To that point, John Malone has invested in Lionsgate (taking a 3.4% position) and has gone on the board; thus, bringing LGF into proximity with his Liberty Media / Broadband/Global Plc empire. We expect Malone to increase his holdings of Lionsgate, at some point in the near future, possibly in conjunction with a Lionsgate acquisition of other Studio assets. It makes sense to us that Malone would like to leverage his position Lionsgate to make LGF the lead content provider to his worldwide cable holdings,which will total over 64 million households after the Charter/Time Warner Cable transactions. Doubtless, Malone would not make any additional investments in LGF until the deal closes -expected in the fourth calendar quarter of 2015. But, we are sure he sees the investment opportunity, as well as the strategic and tax advantages offered by LGF in a technological and global media landscape which is transforming very rapidly.  

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