Starz Gazing

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Shares of premium cable channel Starz (NASDAQ: STRZA) soared 31.2% through February 28 since hitting the market as a standalone entity on January 11, but the estimable upswing has stalled in recent weeks and the company’s first reported standalone earnings did little to reinvigorate the stock. That doesn’t necessarily mean the run is over, just that the newfound operational clarity deserves a thorough parsing to determine what the future holds for Starz shares.

The company delivered $422 million in 4Q revenue, ahead of consensus estimates of $418 millon, and 2012 revenue of $1.63 billion, up slightly over the prior year. 2012 operating income dipped 3.9% YOY to $405 million primarily due to escalating programming and production/acquisition costs, and operating cash flow fell 16% to $292 million. 2012 net income did tally $252 million (+6.8%), and EPS of approximately $2.10 was ahead of estimates. But enough with the formalities: what really matters now is how Starz is positioned for the future—and I believe it’s sitting pretty.

Starz now counts 21.2 million Starz subscribers (+8% YOY) and 34.8 million Encore subscribers (+5%), a healthy base of 56 million through which it can leverage increases in affiliate fees going forward. By comparison, HBO and Time Warner’s Cinemax (NYSE: TWX) together count approximately 41 million US subs and CBS’s Showtime (NYSE: CBS) approximately 22 million. Beyond sub counts, however, it's difficult to directly compare the top US premium cable channels. HBO sits within Time Warner's networks business that includes cable channels such as TNT, TBS and truTV. The unit delivered revenue of $14.2 billion (+5.4%) and operating income of $4.7 billion (+6.9%) last year. Showtime joins with CBS Sports Network and Smithsonian Channel in powering CBS' cable networks business, which notched 2012 revenue of $1.8 billion (+9.3%) and operating income of $785 million (+14.8%). Irrespective of the direct comparison problems, the cable networks business overall is marked by steady annual revenue increases on the affiliate side and a plethora of content licensing opportunities given the explosion of online viewing platforms. 

Also important to Starz: several pay-TV operators have begun offering their customers STARZ PLAY and ENCORE PLAY, companion services that give subs of the linear channels free online access to content including 300 movies and 100 episodes of original series. The importance of this digital initiative cannot be understated. Time Warner president/chief executive officer Jeff Bewkes has long raved about the customer loyalty such add-on services engender (read: subs receive more bang for their buck), and pay-TV operators love proffering similar value propositions to their own customer bases.  

Also, Starz recently inked a deal with Sony Pictures Entertainment that extends an exclusive first-run premium pay-TV deal for theatrical releases through 2021. Set to hit Starz channels this year are films including “Zero Dark Thirty,” “Men In Black 3,” and “The Amazing Spider-Man.” And even if Starz’ output deal with Disney is winding down, Starz maintains a first-rum window for Disney products such as new Marvel and Lucasfilm titles for its linear channels and digital services into 2017.

However, Starz chief executive officer Chris Albrecht, formerly the boss of HBO, knows expanding the company’s original programming slate must be the focus if fully leveraging all the aforementioned assets is the goal. Said Albrecht during the company’s recent earnings call: “original programming…is key to fortifying the Starz brand, expanding our global content portfolio and ultimately growing our already healthy business.”

The downside to this thrust is a swelling of production costs which should eat into operating income and net income in out years, but with HBO and to a lesser extent Showtime well ahead on the originals front Starz has some catching up to do. On tap to buttress “Magic City” and make up for the 2013 completion of the “Spartacus” brand: “DaVinci’s Demons,” a look at a young Leonardo from David Goyer, co-writer of the “Dark Knight” trilogy; “The White Queen,” based on the book by Philippa Gregory; and pirate adventure “Black Sails,” the first scripted TV project from filmmaker Michael Bay.

Savvy investors know, however, that I could erase all the previous paragraphs and counsel a purchase of Starz shares based solely on the chance that a media conglomerate could move to purchase Starz at any time—and likely at a handsome premium to the company’s current share price. What we have then is a healthy business armed with myriad growth prospects amid a pay-TV space marked by consistent growth. Plus, few know the premium channel business better than Chris Albrecht, and Liberty Media patriarch John Malone is among the shrewdest businessmen around. If he spun off Starz to unlock additional value, well, I believe there’s more value to be gleaned through Starz shares.   

cwheiges has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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