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Spin-off Starz, Opportunity to Get Value

Gabriel Canelli

Gabriel Canelli

10 followers
On Jan. 11, 2013, there was a spin-off of Spinco, a subsidiary of Liberty Media Corp. Following this event, Liberty Media Corp. was renamed Starz, and Liberty Spinco Inc. was renamed Liberty Media Corp. (In this study we use the firms' names after the spin-off.)

Liberty Media Corp (capitalization of USD13 billion) is mainly engaged in the media and entertainment industry through investments in subsidiaries and other companies. The principal businesses include: the consolidated subsidiaries of the baseball team Atlanta Braves and True Position, equity affiliate of Sirius XM Radio Inc. and Live Nation Entertainment and shares in Time Warner, Viacom and Sprint Nextel Corp.

Starz (capitalization of USD1.95 billion) is a leading global media and entertainment company with operating units that offer: subscription video programming on U.S. national television channels (Starz Networks), global content distribution (Distribution Starz) and animated television and film production (Starz animation).

In other words Starz separated from the holding company, Liberty Media.

Our interest lies in the smaller company, Starz (STRZA). Particularly in these special situations, our analysis is different, companies are often undervalued and we as investors should evaluate events or situations that tell us if we can get value.

Starz competes with much larger companies like Time Warner (HBO) and CBS Show time, with much higher capital and volume of production. But our opportunity does not have anything in common with these characteristics. One of its main competitors and the industry leader is HBO. This achievement was given by the leadership of Chris Albrecht. He started working on HBO in June 1985 as vice president of West Coast. Later he became president of HBO Original Programming, Cinemax and HBO Independent Productions (developed and oversaw production for HBO comedy series including Martin and Everybody Loves Raymond). He was also in charge of HBO Sports and HBO Film Programming. But the most important is that under his presidency from 2002, HBO became the leader of the entertainment industry due shows like Sex and the City, The Sopranos, Six Feet Under, Deadwood, Band of Brothers, The Wire and Entourage among many others.

Chris Albrecht is the current CEO of Starz and has been leading the company since 2010. He is credited for Spartacus and Da Vinci's Demons which will come out in April. He has plans to increase the amount of the Starz original production from 28 hours (this year) to between 50 and 60 for 2015 and he would like to make six or seven shows per year. Competitors have approximately 90 hours per week.

A few weeks ago Netfilx (NFLX) and Starz competed for rights of Disney (DIS), and Netflix won with a bid of USD300 million (USD100 million for Starz). Actually, Starz has cash to compete with Netflix (USD846.46 million), but the current contract with Disney expires in 2016, and it has the intention to invest the capital saved in increasing their original production. Starz also has deals with Sony.

We have two options to earn capital: the skills of Chris Starz on the business growth and the interest of the competitors in buying the company. After the spin off, Starz has a market capitalization of USD2 billion, making it an easy target for the interested companies like CBS's with cash of USD660 million and debt to equity of 0.60, and Comcast, parent of Universal Pictures, with cash of USD1.62 billion and debt to equity of 0.8. The Weinstein Company (TWC) owns 25% of Starz Media, and has shown interest in this company. These companies are strong financially and could buy Starz without problems.

Starz

Volume

In 2012 Starz had revenues of USD1208,496 million, an increase 2.3% from 2011. In addition, net income grew 11.6% to USD202.499 million and FCF 6.3% to USD208.42 billion.

Financial Health

Starz has excellent financial security. The debt is 56.8% its market capitalization and 5.4 times its FCF after interest and taxes. The current ratio is 5.1, which cash and cash equivalents are USD846.46 million and current liabilities are USD310.47 million.

Efficiency

In 2011, Starz achieved a return on equity (before interest and taxes) of 20% and grew to 22% by 2012. It also has a return on invested capital (tangible assets) of 60%, increased its profit margin from 15.7% (2011) to 16.7% (2012) and has a capacity to generate FCF of 10.5% on capital.

Valuation

In spin offs we find appropriate to value the company by its FCF to total market (before interest and taxes), and compare it to the competition. The total market value is USD2531.7 million, 7.6 times its FCF (before interest and taxes) of USD325,699 million. Comparing to the competition, Time Warner sells 17.7 times the FCF (before interest and taxes) and CBS 11.7 times. We see a clear difference. Even if we want to evaluate Starz with low multiples, due difference in competitiveness, for example 9 times, would be trading 28% below the 11.7 of CBS. Now it is trading at $16.1. I think even $18 per share, would be a good price for Starz.

Our Opportunity

Being conservative, the current FCF could be traded perfectly at a multiple of 9 or 10 (which is completely reasonable in current valuations), our earnings would be 30%. On the other hand if it would repeat the last year growth of about 10% in earnings, could be sold to a multiple of 9 and we would earn 39% of capital gains.

Risks

The main risk is that futures original productions of Starz could be unsuccessful, and the company could lose competitiveness, subscribers, falling sales and thus profits. I see this risk covered under the direction of Chris Albrecht, who has extensive experience and success in this area. Second is the possibility to keep good contracts with Sony and other companies and fill the space (with original productions) when the contract with Disney expiring in 2016. The interest from competitors in buying Starz is very important in case of losing competitiveness.

About the author:

Gabriel Canelli
Economist. I am from Uruguay and I am 25 years old. Since 2009, I specialize in value investing.

Rating: 4.6/5 (53 votes)

Comments

donale
Donale - 1 year ago
The Weinstein Company owned 25% of Starz LLC... have you calculated that fact into your numbers?
Gabriel Canelli
Gabriel Canelli premium member - 1 year ago
Thanks for the comment. Yes, TWC owns 25% of Starz Media.

MritikCapital
MritikCapital - 1 year ago
Debt after spin is $1.1B. At price of $16 with 120M shares this implies Debt/Equity of 57.3%, much higher than 37%. Am I looking at this wrong?
Cornelius Chan
Cornelius Chan - 1 year ago
This stock is in my "too hard" pile.

Please leave your comment:


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