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It’s getting interesting with Lions Gate (NYSE:LGF.A) (NYSE:LGF.B).
No, the stock isn’t at a 52-week high. It hasn’t popped on news of a buyout.
But we seem to be getting closer. And beyond consolidation, the studio reported in its earnings call a stellar quarter for its television division.
Nevertheless, Lions Gate is still struggling to write yet another act in its story as a public company trying to survive the lingering effects of a virus that ravaged the world, a plot that sounds much like one of its own direct-to-digital dystopian projects.
It has become clear that the way this is going to go is for Starz to go first…via a spin-off. After that, Lions Gate itself, the studio portion, will have to figure something out. CEO Jon Feltheimer would be wise to hold out hope – and to hustle like crazy – to get a buyout for the entire company, as that would probably be the best outcome for all concerned.
But that outcome does not appear, at least at first glance, to be of high probability. This means the studio portion, the content maker, will continue making little investments/partnerships here and there to find hits for the marketplace and to absorb as much of the costs as it can for that search; in other words, if some other conglomerate doesn’t look to Lions Gate for scale, Lions Gate will bide its time by constructing its own scale, piece by piece.
I’m still long Lions Gate, still bullish, still intending on seeing this stock reach its ultimate conclusion. If not for the pandemic, the ending might have already been written. Yet, there are some opportunities for Feltheimer to seek improvement in the overall model of his company…how it markets product, how it looks at its Hollywood deals, all of that. This is the background for a look at the most recent quarter and news on Roku (ROKU) being an interested party for a stake in Starz (take it all, Roku, make a bid and really go Hollywood!).
The Quarter, In Brief
Lions Gate’s Q4 (reported on May 26) disappointed with a miss of expectations, as the top line of $930 million was off by about $30 million, and adjusted diluted earnings per share of $0.06 was four pennies short. At least those six adjusted pennies per share beat the previous year’s zero adjusted pennies per share. Unfortunately, for the full year, adjusted income dropped fifty cents to $0.42 per diluted share.
For adjusted free cash flow, which takes into account production-loan activity (borrowing versus repayment), was up during the quarter significantly, $87 million versus last year’s $3 million. This adjusted cash flow is also used to indicate tax credits, which the company wants to break out for investors. However, one might concentrate more on the use of cash for operating activities…$170 million in Q4, $661 million for the full year. Like I mentioned, the pandemic has been rough on this smaller-scale studio.
Television production, however, was a standout, as highlighted in this trade article. Revenue for this segment was $370 million versus $210 million for the quarter, and $1.5 billion versus $0.8 billion for the full fiscal year. That gain led to a profit of $33 million versus $9 million for Q4, but the full year didn’t do as well, remaining flat at $83 million. You will note that big jump in full-year intersegment eliminations at just under $650 million, which must obviously account for some synergies between content production and the Starz channel. The gross contribution on both the quarter and full-year television revenue was basically the same, so production expenses must have been a particularly high offset (you will note that SG&A expenses on the TV side was flat).
Finally, motion pictures and media networks basically showed declining and flat performance during various timeframes.
The Main Lions Gate Thesis
Lions Gate is still a stock for consolidation speculation. And it feels as if things may be speeding up, even if, to some degree or other, it also feels like a one-step-forward-two-steps-back sort of deal.
Here’s the step forward: there are interested parties circling around Starz. Roku, which would be a very logical owner of the streamer, wants to invest in the business, even if it doesn’t necessarily want to take on the risk of the entire asset. According to this SA news item from the beginning of May, Roku wants to take on 20% of Starz, but with a partner – right now, that would be Apollo Global Management (APO), but quite frankly, I see the situation as fluid, so I’ll say that theoretically it would be with Apollo; Roku, however, I see as staying in the game. To put this development into further context, during the earnings call, Feltheimer said, right at the beginning of his remarks, that Starz would be spun off in some way. Exactly what method would be employed is hard to say…tracking stock? Possibly, if no investors come to the table. More likely, I’m imagining something along the lines of the news item – Roku comes in with a partner. Or maybe a SPAC comes along and takes a stake. As of now, it looks like Lions Gate wants to retain some interest in the streamer instead of letting go 100%.
Well, you can be sure the company would like to let go of itself at 100%, but I get the impression that Feltheimer is still holding out for a certain price in his mind. By getting some money for partial stakes in Starz, the company might be able to reduce debt and fund further expansion of its content slate. Feltheimer also intimated that Lions Gate itself might buy something else (obviously a much smaller acquisition, not anything approaching a larger-scale merger), or maybe even Starz could look around for assets to add to its portfolio (maybe a smaller streamer?); this was mentioned during the call while answering an analyst question, as Feltheimer discussed the idea that a separation would lead to the identification of various “strategic initiatives” that otherwise would be obfuscated (in other words, Starz, with new backers, could start to scale itself, and Lions Gate, without Starz, could likewise be more flexible and opportunistic).
Interestingly, Feltheimer rejected a bid of $5 billion for Starz a few years back from Paramount Global’s (PARA) CBS division. This is definitely a sum-of-the-parts game for the CEO (he even said as much), as Lions Gate’s market cap is certainly less than $5 billion. Even with the weakness in Netflix (NFLX) shares, Feltheimer is betting that streaming gets back on top in the eyes of Wall Street, at least for a less-mature example such as Starz (if the latter explored an advertising-supported tier, I wonder if that would make a sale easier; certainly one would expect Roku to explore that option if it bought a controlling stake).
Roku has its own filmed-entertainment ambitions, so even though one could understand why the content-aggregator would just want the simplicity of taking Starz and adding it to its platform, it is a little puzzling that the company wouldn’t want the studio portion as well. Owning Lions Gate would immediately grant Roku access to Hollywood in streamlined fashion, and Starz, as a total-premium channel or one with advertising attached, would immediately up the ante for its device/connected-television-OS lineup. Consider that Roku could have access to almost 36 million total global subscribers with a Starz transaction. This number represents one of Lions Gate’s better sequential-growth quarters, and it compares favorably to the 29.5 million global users reported in the year-ago period (I do still wish the company had somewhere near 50 million subscribers by this point in the game). Roku could actually follow that up with more acquisitions/investments to increase its access to subscriber-based models – imagine taking a stake in AMC Networks (AMCX), for instance, and combining Starz with Shudder and AMC+.
Then again, that’s been the problem, hasn’t it? The studio, even before SARS-CoV-2, was always in need of more hits, more scale. Starz is easier to understand and to imagine integrating into another media concern than Lions Gate is given that its strategy of filmmaking/distribution is to be everything to all concerned…it isn’t like Disney (DIS) or Netflix, where the model is more finetuned and specific (with Disney, you’ve got tentpoles powering the rest of the company’s ecosystem, with Netflix, one sees the monetization of first-mover advantage and multiple expansion powered by a lot of content funded by a lot of debt, with the latter working until it didn’t). After the arrival of SARS-2, Lions Gate offered even more proof that smaller screens can sometimes trump the larger, silvery ones.
Television Vs. The Movies
As I mentioned, the television segment did really well in Q4. As per the previously linked trade article, Lions Gate saw all three of its current series on broadcast linear receive renewal offers. In fact, since July 2021, the company has received new-season orders for all fifteen of its episodic series (this goes beyond the broadcast market, of course).
What, exactly, drove this success? According to the Deadline author, it was nothing more than a motivated team working extremely hard to get a deal. Executives as high up as Feltheimer even pleaded the case. It goes to show that when you’re a smaller-scale player, you have to make up for whatever leverage you lack with focus and determination. Cliché though that may be, that appears to be what happened here. It’s an example of Lions Gate’s agnostic strategy – i.e., no matter the platform, fight like hell to be a supplier to it.
Which brings up an emphatic counterpoint – what happened with the company’s movie division? Yes, it is still struggling along with theaters as the covid crisis matures, but I mean a project in particular – that Nicolas Cage film.
You might know it – The Unbearable Weight of Massive Talent. I thought this was going to be a big hit for Lions Gate, something that would help to buy the company some time so it could figure out its next move in the consolidation game.
Unfortunately, it was anything but – it grossed $28 million worldwide, with $20 million of that amount captured domestically.
What happened?
The reason I ask this is because there seemed to be a lot of excitement surrounding the project. Cage was out there promoting the film, there was a lot of interest in his comeback, and it struck me as a unique work, a story/concept that might share some cinematic DNA with Charlie Kaufman’s very smart screenplay for Adaptation. The latter gave Cage’s talent a lot of attention and praise.
Frankly, I was puzzled by this underperformance (I haven’t seen the movie, I should note), and it stands in stark contrast with the work ethic shown on the television side. Yes, the variants of the virus continue to multiply, but the multiplex is back per Spider-Man and Top Gun sequels, and this seemed like the kind of movie with which Lions Gate would do well – an independent-minded production that propelled an original idea and took it from arthouse origins to mainstream appeal. This was Lions Gate’s marketing wheelhouse; Lions Gate could own this one.
This article offered some analysis at the time of the box-office physics of the film. It states that the movie cost $30 million to make before taking into account any selling costs. There’s mention of why it went to theaters and not streaming – mainly that the big-screen was a selling point itself for this kind of production. Fair enough; and you have to wonder how the company’s cash flow (and other economic challenges, like debt) impacted decisions on how many resources could be devoted to selling the Cage feature. In other words – if getting renewals at broadcast is less capital intensive than buying ads for movies on networks and digital, why not focus on what’s working and simply look at this single, non-IP film as one to be amortized post-theatrical via output deals and other platform windows.
I suppose I again have to go back to how important the theatrical side is (something I’ve mentioned in previous LGF pieces) for the consolidation thesis: solid hits at the box office will help to yield a premium offer on a buyout. Why is this? Well, especially at this time, Wall Street is said to be tired of the streaming trade, so any hedge against it will most likely receive increased, and most importantly, favorable, scrutiny…so count Lions Gate the studio as a beneficiary.
Feltheimer would be wise to disallow any distractions that would derail the reconstruction of a box-office slate, a targeted, commercial one, with a vision for tentpole hits no matter the budget – i.e., shuttle everything else to streaming, whether it be Starz or elsewhere. If you read Feltheimer’s comments in earnings calls, it’s easy to discern his current driving force: he’s looking at his company the way a PE firm would, as a set of data where a lever here changes the numbers this way, and a lever there changes it that way. He wants to maximize asset values, and so that has become his focus: how do I structure a macro-spin-off deal such that I get X price for it? Structuring a movie slate, or even a marketing campaign on a film that had a lot of social conversation surrounding it, gets lost in the shuffle, as they say.
And it should not. Cage’s film was a perfect experiment to see if Feltheimer could get it right. It was Lion’s Gate’s moment to lose, and unfortunately, the company did. It’s going to be a while before the big intellectual properties get set loose on theaters, and therefore on investors’ screens at the same time – the next Wick film, the next Hunger Games film, both come out next year. Maybe I’m overvaluing the situation, but not only did I think Cage’s Talent picture would have scored, I thought there was a chance of it becoming new IP, something that could have traded its equity for a Starz adaptation as well as a sequel. Looks like that won’t be happening.
Going back to television – right now, this segment appears to be where the momentum is for Lions Gate. If the company can structure something with Starz, it could rid itself of some of the risk and distraction and receive, as I said, a useful cash influx to enhance financial flexibility. Going back to Roku, Feltheimer could make a case that the entire company could go to the aggregator because of that success in episodic – the company obviously knows how to leverage its long-tail studio system to find stories that resonate with the viewing public and achieving that for broadcast is rather impressive in this streaming era. Feltheimer deserves credit for keeping this engine going, and he could point out to Roku that as shows incubate on other platforms, their post-broadcast (or whatever platform) runs could be owned by the content-aggregator, thus enhancing that company’s long-term prospects. There is opportunity here, I sense.
Conclusion
I continue to be long LGF (both share classes) and intend on adding to my position at opportunistic moments. SA rates the valuation as attractive. Growth, however, is not rated well, and yes, the company is still getting its momentum back during the pandemic and trying to keep streaming churn down and hitting subscriber-growth goals. However, both the A and B stocks sport a $9-handle as of this writing, and that is way off from the 52-week highs ($21 in the case of A, $18 in the case of B). Still, please note: this is a higher-risk stock and a speculative purchase.
But the main point here is spinning off Starz, keeping content on that platform via a stipulation to go along with the transaction, and then going for a sale of the studio portion itself. I believe we will get there. Definitely taking longer than expected, but this Roku situation has me very interested. Roku simply makes sense as a buyer/investor, especially considering it would be a logical move after the Quibi purchase. There are other worthy concerns out there for Lions Gate, but sure, a company such as Disney might not be the greatest of fits (beyond the Hulu angle, which could see Lions Gate as a supplier to that streamer, as well as a Starz integration) considering that company’s strategy, but Roku could absolutely use Lions Gate to its advantage given its current stage of development in its evolution toward creating content as a new, major business strategy.
Yes: it’s getting interesting with Lions Gate…
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