Lions Gate Entertainment (NYSE:LGF.A) (NYSE:LGF.B) saw its shares react sharply to the upside after its earnings report on November 9, 2023. Fiscal second-quarter stats beat estimates (according to this SA news item, it was a wide beat) on the bottom line while coming in-line for the top.
The market gave the stock a bid up to $9.89 for the A shares before selling off the rest of the session to ultimately close several cents off to around $9.
What does such price action tell us? The stock was a trade for most participants is my read: the fundamentals of the buyout thesis have not yet taken hold in the imagination of investors, and with the current market climate, which includes money that is no longer cheap, potential buyers in the PE space will be reticent to step forward and make an offer.
Since I last wrote about the stock, in an article which discussed the purchase of some Entertainment One assets as well as the status of the company’s movie and library strategies, it has experienced a rise at the time of this writing by better than 20%, so those who agree that there may be a buyout at some point may want to be on the lookout for significant pullbacks before either initiating a speculative position or adding to an existing speculative position.
Yes, I used the word speculative two times, very purposefully. I’ll go over the risks at the end, but Lions Gate clearly may be stuck in a swing-range for a while before ultimately attracting capital looking to invest in smaller-cap media names with big library brands (this would include concerns such as Candle Media and A24, which could both be targets and acquirers, although not necessarily involving LGF). The company has to complete the Entertainment One purchase and finally rid itself of the Starz burden before price action might catch up to the buyout thesis (yes, it’s been a long time coming, and yes, call me perma-bullish about it).
LGF’S Q2
To begin with, Lions Gate continues to take advantage of its large library. As mentioned in the Q2 report, trailing twelve-month sales of library product came in at $870 million, up 17%. In some ways, this is the most crucial element of the studio’s story – its library asset was always an internal hedge against weaknesses in other parts of the company. Films down? TV segment down? The library would be there to pick up the slack.
Lions Gate believes it can take advantage of the FAST (free-ad-supported-TV) marketplaces that are out there. Tubi would be an example of one. It also believes that Netflix (NFLX) will be a prime licensee of product for some time to come. Whereas other platforms such as Disney (DIS) are more likely to be cutting back on licensed content because of residuals (that’s not to say Disney won’t license third-party material for its platforms, but I foresee a more conservative approach going forward for many streamers – which is interesting if you think about it because everyone will want to sell their content to others and reduce their exposure to being buyers), Netflix seems to be doing so well that it can afford to experiment with different programming mixes.
Here’s some commentary from the conference call (from CEO Jon Feltheimer):
Our success in the quarter came from doing the things we do best, taking advantage of the diversification of our film and television businesses, utilizing new business models to monetize the FAST and AVOD space…”
If there’s one company FAST was made for, it was Lions Gate, the consummate arms-dealer of content.
CFO Jimmy Barge expanded on the library issue by responding to an analyst question about the strike perhaps assisting Lions Gate in selling catalogue product:
I would also say on the library side, there’s been a couple of things. First of all, if you look in ’23, half of Netflix top titles have been licensed titles, 50% of it. So it’s kind of like they’ve really been aggressive on the licensing side from third parties. A little bit of the Suits effect that I’m sure you’ve seen.”
Suits, as you are probably aware, is an older program that is resonating with Netflix viewers in a significant way in terms of viewership, as mentioned in this article and also the following one. The point here is that Lions Gate would be wise to – and probably will – focus a lot of its potential library sales to Netflix, and hopefully on a non-exclusive basis in many cases. By retaining the ability to sell to multiple platforms, it most likely will be able to receive a higher overall bid for its content by generating more than one license. It’s analogous to the linear model of selling rights to one cable platform for weekday stripped airings and then brokering weekend rights to another channel (independent stations could also be one of the buyers in this scenario). I’d be shocked if this wouldn’t be the company’s blueprint for the library, and I assume it may double down on the strategy.
Adjusted free cash flow for the quarter was basically $130 million versus $120 million, so a modest increase to some degree, but the six-month frame saw the metric well more than double to $180 million. Lions Gate adjusts the free cash to reflect a better sense of timing – this includes production loans taken/repaid, tax credits realized or to come, etc. Because of this, I also like to check regular cash from operations, which for both the quarter and trailing two quarters, was over $300 million against utilization of cash in both comparable periods.
The company seems to be doing better on the cash front, although it is unclear to me how much benefit there was to that metric because of the strike (presumably there was some). The company did state that the overall net impact from the work stoppage was $30 million, and for guidance going forward, it might be around that number as well. So, in a net sense, the company apparently is surviving the strike fairly well based on its diversified model of a long-tail series of production partnerships backed by that aforementioned library jewel.
The movie business, though, could be doing better. Although Lions Gate actually has a great distribution ecosystem that focuses on ancillary channels – and maximizing those ancillary channels, in fact, to an enviable degree – the best thing for shareholders and for a buyout is to generate more buzz, both financial and social, at the box office.
To that end, if one reads between the lines, Feltheimer sort of knows that. Take the latest Saw film for instance. It’s done about par for the course in terms of performance for later iterations of the franchise, with about a $100 million global take (at the time of this writing).
Such a gross isn’t enough to rally Wall Street short-term. And Feltheimer needs some short-term rallies so that ultimately a nice premium can be attached to an already higher stock price in a consolidation transaction.
In some ways, Lions Gate is luckier than its media-conglomerate colleagues. Whereas a company like Disney is make-or-break at the box office because of its scale and commitment to blockbuster bets, LGF can play the field a little more loosely and rely on profitability over large grosses to attract PE money. And why would private funds want the company anyway?
An investing entity looking for yield could use the LGF library – and remember, you’ve got Entertainment One soon, as well – to generate long-term income, especially if said entity hooked together a long-tail portfolio of libraries. If such a hypothetical entity bought the studio/library, it could fade the studio ecosystem (i.e., sell everything but the library) to reduce risk and simply become a licensing machine. And licensing goes beyond selling to Netflix/FAST/et al.; remember, too, that a new owner of Lions Gate assets could take product within the catalogue and make deals for remakes and reboots and spin-offs and sequels and you name it…and simply become a profit participant, no need to actually make the stuff itself, since some of the media conglomerates would probably be happy to do so. Libraries always come with rights issues, certainly, but they always do, and there are expert consultants to deal with that. It’s a low-risk, low-reward model, akin to early Marvel when it was a standalone public media concern, but it’s a valid roadmap that Feltheimer should use in his bag of tricks as he drums up interested buyers. And there obviously are similarities between this concept and the concept of buying up libraries of song publishing rights – that’s been a trend lately, as we all know.
Starz, at this point, is becoming less and less relevant, but let’s briefly look at what the company is doing with the asset. Simply put, it is streamlining the business by exiting multiple international markets. This kind of rationalization makes sense, and for a buyer, it could lead to opportunities for reinventing the service, especially one that might be tied to advertising-support (the future of Starz will by necessity, in my opinion, rely on ad-support and the implied advantage of a dual income stream); another possible route would be to use an AMC Networks (AMCX) model, with a linear cable channel supported by a premium option. One perhaps more relevant aspect is my expectation for management to secure content deals with new owners as part of a transaction, thus de-risking entirely from the streamer while still participating, in a sense, in any potential upside. Total global streaming users (excluding markets that will be eliminated from the base) stand at 28 million, with linear-vs.-over-the-top subscribers continuing to benefit the latter. It’s a pretty stagnant story for Starz, but again, this is what the separation will set out to fix.
Thoughts On Stock/Risks
Here’s my thinking. Given this is mostly a buyout thesis, the technicals may weigh most importantly on buy points. I believe this is a long idea, not a short one, for investors.
But it is very speculative. Why? The buyout may either never come or take a longer while to come, tying up investing capital.
Why, then, do I continue to be bullish?
When I look at the library revenue, and consider how the media environment has changed, I see that asset as becoming more valuable.
I also see how changes in the media environment will make private equity more amenable to smaller deals as the trading environment improves (i.e., investor sentiment eventually sustainably improves, as it undoubtedly will). These changes center on the need for content for FAST assets, digital broadcast networks (e.g., channels such as MeTV and other library-driven channels), and other on-demand models. As the advertising industry improves over time from the current bear market, I anticipate that being favorable for the company.
Companies such as Netflix and Amazon (AMZN) will continue to push into licensed content, even as other media conglomerates become sellers. Yes, that may create unfavorable pricing at times because of supply competition, but libraries also essentially hedge themselves by being licensor agents of IP – as I mentioned, a buyer of Lions Gate does not necessarily have to go into production themselves, they can auction off remake rights and the like.
What I’m getting at is the profile of the buyer of Lions Gate may have evolved over to PE – but perhaps only in the short-term. Long-term, when the shock of bond rates has lessened and the auction market has become more consistently stabilized, the usual suspects may come back into play – a Comcast (CMCSA), for instance, could still find Lions Gate (and even Starz) a valuable addition to a content portfolio.
The big thing to keep in mind is that LGF is a very speculative stock only for investors familiar with media assets. Because remember, the strikes, as well as talent costs in general, will be harder on a studio of this scale.
Feltheimer, I’m sure, is as baffled as anyone as to why he couldn’t strike a deal with an attached premium long before the markets began sinking into bearish territory. And keep in mind, while technically we seem set for a rally into the end of December, even if that does occur – and I myself have been in a buying mood for strength as opposed to pullbacks because of the technicals – I can easily see a reversal after the first of the year (or sooner). Volatile market conditions are a risk, and uptrends are just par for the course of a bearish cycle.
Another risk is the film side itself – without Starz, Lions Gate will go back to its roots of simply investing in content to sell to any platform willing to put up a bid – platform agnostic, as Feltheimer sometimes calls it. The big risk here is that the company loses the small scale-advantage it had with Starz and totally fails at theatrical output and television deliveries. Hits are always needed at the multiplex, they can’t all be stories centered around pay-per-view sales and the like.
The next Hunger Games feature will have opened by the time this article is published (it currently is projected to gross in the mid-$40 million area at domestic theaters, which probably won’t translate into a stock-moving event), and whether or not it ultimately turns into a big hit, Lions Gate will need to counteract multiplex-slate risk by focusing on commercial product, including horror; one of the problems some of these big-IP names are facing is maturation of their models – in other words, if one looks at Pixar or Star Wars or Hunger Games, it’s clear they are becoming more risky as new, younger franchises start to generate appeal among the current youth demos (e.g., Barbie). Joe Drake, the motion picture group chairman, had this to say during the call:
[…]we have a content strategy that sort of relies on a couple of big branded all audience IP movies every year and then want to be in that faith-based, the action space, leaning into horror as well. We got a fantastic mix of that in ’25.
[…]we’ve got multiple spin-offs and Wick V that we started to work on right when the writer strike started, and we’ve gotten back to work as soon as it ended. Our faith-business is fully loaded with some of the best brands in that space. As we as Jon mentioned earlier, we’ve got our first Jason Blum movie and hope we can do more there. So very, very excited and have pretty much everything we need to keep hitting our stride.”
You’ve got to love the mention of Jason Blum, a legend in the horror genre as well as being hot off the recent success of Five Nights at Freddy’s (of course, to be fair, audiences didn’t have much faith in the second coming of the Exorcist franchise, as I covered here).
To sum up:
- I’m still long for the buyout thesis
- Those looking to speculate here as well must look at how the price action is proceeding and plan accordingly
- Look for pullbacks to reduce risk
- Count on the Starz separation to assist in unlocking value
- The company’s library asset is a real plus here, with trailing twelve-month revenue looking to increase
- The movie side could be doing better, which represents a risk
- Another major risk is market volatility
- Interest rates also make it difficult for consolidation to happen
- The advertising sector may take longer to come back, thus impacting the stock performance
One final point: valuation scores relatively highly on the SA factor-grade system (at time of writing); also at the time of writing, the SA quant system was high. These will change over time, but the ultimate conclusion for me is that Lions Gate shares continue to warrant a look.
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