With the Dow Jones Industrial Average hitting 30,000 recently, U.S. Stocks have been on a tear. The stock market is pretending as if Covid is history, but the reality is we are still in a pandemic and economic crisis.
Lions Gate Entertainment Corp LGF.ALGF.B has caught my eye because the stock is finally recovering after having fallen off a cliff in March. The company is producing lots of cash, much more than it ws before the pandemic, as spending on new production has been constrained. Lions Gate Starz on-demand has been a hit during the pandemic. The following chart shows the cash flows of the company:
Lions Gate Entertainment is a content developer and provider for films, television series, digital products and linear and over-the-top platforms. Lions Gate has three reportable business segments:
- Motion Picture, which includes the development and production of feature films, acquisition of North American and worldwide distribution rights, North American theatrical, home entertainment and television distribution of feature films produced and acquired
- Television Production, which consists of the development, production and worldwide distribution of television productions
- Media Networks, which consists of the following product lines: Starz Networks, STARZPLAY International and Other Streaming Services
Lions Gate stock has actually been suffering since it bought cable channel Starz in mid-2016 for $4.4 billion in cash and stock. It was a highly leveraged buyout that saddled the company with $3.16 billion in debt. The renowned cable, media and telecom investor John Malone, who was the majority owner of Starz, enabled the merger and still retains a stake in the company.
The union was billed as a natural fit for a studio that is increasingly invested in high-end TV content and a premium cable group that has momentum with original programming as well as a deep library of digitalized entertainment content which could become very valuable as the said content is increasingly distributed over the internet. Starz was supposed to give Lions Gate a strong platform to launch series that can be sold around the world. The market, however, saw the big debt load and the collapse of linear (cable) TV as outweighing the content creation and the vast library of Lions Gate.
The company has strong cash flows and has whittled down the long-term debt from $3.16 billion to $2.76 billion in the last three years, as shown below:
While revenue and Ebitda have grown decently over the last three years, per-share values are not impressive as the company has issued a lot of equity to fund the Starz acquisition in 2016. This caused significant dilution.
| Lions Gate | CAGR over 3 Years |
| → | Mar17→Mar20 |
| Revenue | 6.71% |
| EBITDA | 10.39% |
| Revenue per Share | -1.34% |
| EBITDA per Share | 2.06% |
| Operating Cash Flow per share | -4.55% |
| Free Cash Flow per Share | -4.73% |
Why I like Lions Gate
The main thing I like about Lions Gate is its valuation. Based on Operating Cash Flow and Free Cash Flow, the company is selling at a very attractive valuation. Lions Gate has very large amortization and depreciation expense because of the acquisition. This makes earnings-based valuation irrelevant. Also Lions Gate's assets are mostly intangibles, so traditional value-based balance sheet metrics like book value and tangible book value not very useful. Operating Earnings and Cash based valuation measures are much more relevant, in my view.
According to Gurufocus calculations, Lions Gate is undervalued by 50% or more by Earnings Power Value, Discounted Free Cash Flow and Projected Free Cash Flow:
The movie and TV businesses have bounced from their bottoms and are recovering. As advertising starts to rebound, the demand for Lions Gate's high-quality current content and library will increase. By licensing its movies and TV series to others, Lions Gate is able to minimize direct risks that are associated with the traditional advertising market, which will eventually decline due to cord-cutting. At the same time, Lions Gate can monetize its old titles in its vast library for years to come on different platforms run by dominant over-the-top (OTT) distributors.
It is clear that with the decline of cable TV and the rise of mammoth OTT, on-demand streaming platforms, Lions Gate will have to increase scale. There is increasing likelihood that the company will be acquired in the near to mid term future, in my opinion. The acquirers could be companies such as ViacomCBS (VIAC), Apple (AAPL), Comcast (CMCSA) or any big name looking for top notch studio and content library.
Conclusion
Lions Gate is very attractive equity, in my opinion. It is executing well and has gained momentum in the pandemic. The market has been slow to recognize that, and even though the stock has more than doubled from the 52-week lows, I think it has a lot further to go.
It is true that the company has high leverage (with an S&P issuer rating of B), but it is producing great cash flow. Debt servicing does not appear to be a problem. I think it has the potential of 100% gains in three years or sooner (if a takeout happens). Thus, I think it deserves a place in the "risky but high potential" side of my portfolio.
Disclosure: The author does not yet own Lion Gate Entertainment Stock but is considering a long position.
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