2023-11-17 12:33:33 ET
Summary
- The impending studio spinoff could indicate Lions Gate is interested in being acquired in the near to mid-term.
- A prolific studio segment with both theatrical releases and television shows, a large library, and an established streaming service with Starz would provide value to strategic buyers.
- Hopefully, the company is acknowledging that in its current form, it is having difficulty competing and providing value to shareholders.
There will be multiple business casualties in the paid streaming wars and a few business victors. Digital markets for industries that have high fixed costs and relatively low variable costs have tended toward a few, unusually large winners, and I believe such will be the case in entertainment... Expect two or three major mergers and/or acquisitions involving entertainment companies in the coming 24 months as a result.
- Jason Kilar, former CEO of Warner Media, December 2022
Overview
I was initially attracted to Lions Gate (LGF.A) (LGF.B) due to its announced spin-off of its Starz DTC unit from its studios. I also found it interesting that Steven Mnuchin took a significant position in the company. Mnuchin was the previous US Treasury Secretary and is married to Louise Linton, a Scottish actress. Like the rest of the industry though, the company is currently struggling to make a profit in a tough operating environment. As a spin-off is slated to take place i n Q1 of 2024, evaluating the company on a sum of parts basis appears appropriate at this time. Spinning off Starz from the studio segment could make an acquisition more likely in the near to mid-term.
The Starz Segment
Taking a look at the performance of Starz over the last few years, the trend has not been encouraging. Starz consistently has one of the highest churn rates , with a turnover rate of 12% reported as recently as July. This could indicate the service just doesn't have enough content to keep subscribers. Segment reports show a steady decline in profits, with the international segment (Lionsgate+) regularly making losses and dragging down earnings. In t he Q1 2024 earnings call , management mentioned that they were planning to exit Latin America completely by the end of December and focus more on English speaking territories. This perhaps is the main silver lining that could improve earnings in the short term. Lionsgate+ losses totaled $165 million in FY 2022 and $111 million in 2023. Reported media network profit over the last few years is shown below:
Despite all this bad news on the financial side, there has been clear interest in investing in this segment from a number of bidders. Roku, Inc. ( ROKU ), Apollo Global management and Canal Plus reportedly have been involved in making 20% bids for the post spin-off company, with a valuation range from $2-4 billion. If these bids hold, this would mean the Starz segment alone is valued about the same or a slightly greater price than what investors can purchase the whole company for right now. The company is also operating a profitable streaming segment (despite full company earnings operating at a loss), which is better than can be said for many large streaming competitors.
The Studio Segment
This segment has been the more consistently profitable division of the company and can be visualized below.
I believe this is the crown jewel of the business with both a prolific film and TV division. On the film side, the company produces 10-15 theatrical releases each year which is almost on par with major movie studios such as Paramount Pictures ( PARA ). Newer media entrants such as Apple (AAPL) have also expressed more interest in theatrical releases so a buyer could see this segment having major strategic value.
Its studio segment has also proven itself to be a valuable producer of high quality TV shows for its Starz network and nearly every streaming service. Below is a list of shows either produced or coproduced by the studio segment in the previous fiscal year, 2023. In addition to those listed below, the company also has an extensive unscripted slate through its Pilgrim Media Group subsidiary.
As can be seen above, the studio segment is prolific to say the least. True valuation is quite tricky though, as full company earnings are negative. If we assume the reported profit from the studio segment can be taken as a proxy for EBITDA, a 7x multiple would indicate a $2.8 billion enterprise valuation for the studio segment. More realistically though, perhaps the company should not be valued on an earnings basis, but compared to similar acquisitions in the past.
Compared to another small studio acquisition, Amazon's ( AMZN ) $8.5 billion acquisition of MGM, Lions Gate is a newer studio founded in 1962 while MGM was founded in 1924. The library does not have as many franchises that are deep seated in the American's psyche, like MGM names such as James Bond , Pink Panther and Rocky . Lions Gate has names such as John Wick , The Hunger Games and Saw , which are valuable and rebootable, but to me don't have the same "legendary" status, at least not yet! As far as depth of the library, Lions Gate reports an 18,000 film and television library (not including the impending eOne acquisition), whereas MGM reported 4,000 movies and 17,00 tv shows , so MGM's library was slightly larger in size.
In the end, it's difficult to compare these two as MGM appears to me to be slightly higher quality from a library perspective. But if we assume the Lions Gate studio is at least 50% as valuable which I think may be conservative given the prolific nature of both its TV and film studios, we could value this segment at approximately $4 billion. So for the full company at this time, if Starz gets the low end $2 billion floor valuation and the studio is worth $4 billion, this could indicate a $6 billion value for the entire enterprise. With EV at around $4 billion currently and a market cap of $2 billion, upside to equity could be 100% from here conservatively.
Risks
Spin-off Tax Considerations
Generally, there is a waiting period after completing a tax-free spin-off before a company can be acquired without incurring a taxable gain. Therefore, investors may have to wait a bit longer (2 years maximum) before an acquisition can occur without tax at the corporate level, so a longer time horizon could be required. Interestingly, the company has decided to spin off its studios rather than Starz, which may make it easier for Starz to be acquired as it will be considered the parent. I am not sure of the exact laws governing this though. I would love if someone with a better understanding of spin-off acquisition tax code could weigh in here.
Debt Servicing Issues
Lions Gate has not been covering interest charges with EBITDA for the last 2 years indicating financial distress. Despite this, the company has agreed to purchase eOne from Hasbro ( HAS ) for $500 million. Though clearly selling at a fantastic discount from Hasbro's $4 billion purchase price in 2019, one must question the financial prudence of burning more cash or taking on debt in this interest rate environment.
Acquisitions May Not Occur
There is no guarantee an acquisition of the split up business segments, or if this is management's current plan. Further poor profitability and destruction of shareholder value is a possible alternative to a sale. Additionally, being in financial distress pre acquisition negotiations could reduce the company's bargaining power and therefore shareholder payout.
Conclusion
In its current form, Lions Gate does not appear to be an attractive investment. It is not a particularly shareholder friendly business, it is operating as small player in a highly expensive and competitive sector, and it is making acquisitions when it should probably instead be selling itself. Despite this, the impending spin-off of Starz could foreshadow consolidation of both the Starz premium channel / streaming service as well as the prolific studio segment to separate buyers. Hopefully management sees the tough operating environment in the sector, and the need for further industry consolidation. Personally, I don't really see any other good reason for completing a spin-off at this time. If this plays out as an acquisition target, shareholders purchasing at current market prices could be rewarded handsomely, and I calculate hopefully a conservative 100% upside to the equity holders at current valuation.
For further details see:
Lions Gate: Soon To Be The Industry's Lowest Hanging Fruit