Add Value to Your Portfolio With AMC Networks

The general perception about media companies is that their fates are tied to the traditional, or linear, TV. This sentiment is not accurate. Not all media companies are affected by the linear TV industry. On the distribution side, companies will face headwinds when linear TV goes south, but content creators and networks can simply adjust their distribution strategy.

The point of mentioning all this is that this perception is keeping the price of some good media networks in check, which creates several decent value opportunities in the space. AMC Networks (AMCX, Financial) is among the media companies that are trading on the low side despite having strong fundamentals and top quality content. Before diving into the details of why AMC Networks is a value play, let’s find out what the company business is.

AMC is an entertainment network that owns and operates several media channels nationally and internationally. The company provides content to consumers through distributors. It also provides advertisers time on its network. AMC Networks operates five media networks in the U.S. including the famous AMC. Its programming is also available internationally, reaching Europe, Latin America, Asia, Africa and the Middle East. The company is also involved in the provision of original content, which is distributed through a network of its channels. Moreover, to keep up to speed with changing industry dynamics, the company also distributes its content through alternative distribution channels like Netflix Inc. (NFLX, Financial) and Amazon.com Inc. (AMZN, Financial) Prime.

Revenue classification

AMC Networks generates most of its revenue from National Networks. The revenue is split between affiliate revenue from distributors, licensing revenue from content and revenue from ad sales on its network. During the first half of 2017, AMC Networks generated $896.3 million from distribution, an increase of 6.8% on a year-over-year basis. Advertising revenue was around $534.5 million for the same period.

Why is AMC Networks mispriced?

The entertainment industry is in the midst of a change. Content delivery dynamics are changing. Distribution models are getting digital. Consumers’ watching habits are changing. They prefer customized content as compared to bundled content. That’s forcing cable service providers to create skimmed bundles targeted toward certain user groups. A shift toward internet streaming is also hurting the ratings of networks. All in all, industry disruption is the primary fear that is affecting the stock performance of media companies including AMC Networks.

Media stocks were hit recently when the CEO of ViaCom (VIA, Financial) pointed out that ad sales will continue to fall going forward. This comment hints toward the secular decline of linear TV. Consequently, media stocks were a hit. AMC Networks is down 10% since the comments of ViaCom’s CEO.

Do linear TV fears justify AMC Networks’ price decline?

The short answer is no. The decline of linear TV is expected to hurt the distribution side of conventional entertainment companies. Content creators, or content portfolio holders, won’t be hurt in the long run. They will distribute their content through alternative services.

AMC Networks is already distributing its content through Netflix, Amazon, Hulu and YouTube TV. Moreover, in collaboration with several media companies, AMC Networks is soon launching a stand-alone streaming service to offer content for consumers who don’t want sports. Excluding sports allows the company to offer subscriptions at a cheaper rate. A changing distribution landscape isn’t a material threat to content networks like AMC.

Regarding the comments of ViaCom’s CEO about ad sale decline, they don’t imply secular decline of linear TV. PricewaterhouseCoopers expects the traditional TV market to grow until 2021. In PricewaterhouseCoopers' own words, the market is resilient. PricewaterhouseCoopers believes that terrestrial TV advertising revenue will grow to $128.1 billion by 2021. The transition toward digital will follow, but it’s not like linear TV is going to vanish overnight.

ViaCom’s revenue problem stems from the quality of content. Cable providers are getting conscious of costs and quality of content. Slim bundles are the new norm, which leads to the elimination of subpar content. Only providers with good content will be a part of skinny bundles. Therefore, the decline in ViaCom’s ad sales doesn’t imply decline in AMC Networks' ad sales.

Why AMC Networks, not other media companies?

Content networks will prosper if they have quality content and they embrace the changing landscape of entertainment distribution. Skinny and customized bundles will put an end to the 200-plus channels culture, resulting in the death of subpar content networks. Therefore, all media companies are not at an advantage when it comes to the transitioning industry.

AMC Networks is a suitable pick in the industry because the company is known for offering quality content. More important, the company is adapting to the new distribution norms. Finally, AMC is trading at quite a discount compared to its peers.

• AMC has a history of offering quality content.

Regarding quality, AMC Networks has some top quality shows including "The Walking Dead" and "Better Call Saul." The company has been consistent in producing quality content in the past as evident from productions like "Breaking Bad" and "Mad Men."

• AMC Networks recognizes the changing dynamics of the industry.

Regarding transition, AMC Networks is making its content available through Netflix, Amazon and Hulu. YouTube recently struck a deal with AMC Networks to offer TV service in five cities of the U.S. Moreover, recent collaboration between media companies to launch stand-alone streaming service also says a lot about AMC Networks’ ambitions for industry transition.

• Valuation paints a favorable picture for AMC Networks.

Despite high-quality content and decent distribution transition moves, AMC Networks is trading at a low multiple. Forward price-earnings (P/E) of AMC Networks stands at around 8 as compared to P/E of ~15 for Time Warner Inc. (TWX, Financial). Trailing P/E comparison is as follows:

Valuation screens of GuruFocus also paint a favorable picture for AMC Networks. GuruFocus’ Peter Lynch calculator reveals a fair value of $94.5 for the company. You can access GuruFocus’ Peter Lynch screen here.

A median price-sales (P/S) ratio that assumes the stock valuation will revert to its historical mean in terms of P/S ratio indicates a fair value of $91 for AMC Networks.

EVA valuation based on analyst consensus and 3% five-year growth reveals a price target of around $80 for AMC Networks.

Focus Equity Estimates

Final thoughts

The media and entertainment industry is rapidly shifting toward digital platforms. Bundle culture and related cable distributors are threatened by this change, but this change won’t necessarily impact networks.

Entertainment companies like AMC Networks will successfully transition amid high-quality content and focus on alternative distribution channels. AMC Networks also looks good on a valuation basis.

Overall, AMC Networks is a value stock that is mispriced amid linear TV decline. Linear TV sentiment is misplaced as the company can redefine its distribution strategy. It’s a good value stock for any value-oriented portfolio.

Disclosure: I have no positions in any stocks mentioned and have no plans to initiate any positions within the next 72 hours.