Should You Follow the Starz?

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

Netflix (NASDAQ: NFLX) trumps Starz (NASDAQ: STRZA) in stock performance and investing popularity, but in the real world, Netflix has 36.3 million subscribers, while Starz has amassed 57.5 million subscribers. It might appear as though Starz is undervalued. Even if we determine that’s not the case, there’s something about Starz that might make it an appealing investment option for you.

Original content

You can read all about Starz’s fundamentals and quarterly progress, but the most important factor for this story is original content. Starz isn’t your average premium subscription video programming service. It might offer first-run movies, classics, and documentaries, but that’s not the company’s primary focus. Starz ultimately wants to be the No. 1 high-quality original content provider. If it can accomplish this goal, which it likely will, then the potential is enormous.

Netflix offers original content, but not to the extent of Starz, which has hit home runs with "Spartacus," "Da Vinci’s Demons," and "Boss." "The White Queen" and "Magic City" have also received relatively positive feedback. Additionally, Starz has slated two new series for 2014: "Black Sails," a pirate adventure filled with thievery, prostitution, conmen, and violence, and "Power," a story about a New York City drug kingpin/nightclub owner who yearns for power and dreams of turning his nightclub into a Fortune 500 company. 

Understanding the content is imperative because it’s what determines future revenue potential. 

The man behind the curtain

Starz CEO, Chris Albrecht, knows what he’s doing. This can be stated with confidence because he has a lot of experience in the field, and he has proven that he’s capable of delivering winning shows. As HBO CEO, he provided several hits, including "Sex and the City," "The Sopranos," "Band of Brothers," "Entourage," "Deadwood," "The Wire," and "Six Feet Under." Earlier in his career at International Creative Talent, he signed Jim Carrey, Keenan Ivory Wayans, Billy Crystal, and Whoopi Goldberg. Here’s a simple and important question: is this the type of guy you want to bet against?

Albrecht is the man behind the drive for original content. He’s ahead of industry trends, which should set Starz up nicely for the future. HBO currently has 114 million subscribers. Considering Albrecht seems to be a competitive guy, do you think it ever crosses his mind that he would like to surpass that number with Starz? Of course it does, and he eventually will.

Many investors considered Netflix outbidding Starz for Disney as a huge failure for Starz, but great leaders find alternative routes toward solutions. Albrecht’s aim for original content market leadership will likely pay off in a big way down the road. Do you remember when "The Sopranos" ruled the world? People would cancel plans and leave family functions early, just to rush home and watch the next episode. Starz will eventually have a hit of this magnitude. When that happens, Starz’s popularity will shoot higher, and the ticker will become well known among retail investors.

Important notes

Warren Buffett’s Berkshire Hathaway owns approximately 5% of Starz. When the broader market performs at least moderately well, Berkshire Hathaway tends to make very wise investments. This is an excellent sign for long-term investors.

Rumors continue to swirl about Starz being an acquisition target. Time Warner (NYSE: TWX) and CBS are the most common names mentioned as potential acquirers.

Time Warner owns HBO and Cinemax. If Time Warner chose to purchase Starz, it would reduce future competition and help top-line growth. Time Warner seems to be one step behind industry trends. If it doesn't make a significant acquisition soon, then its growth potential will be limited.

On the other hand, Time Warner has a debt-to-equity ratio of 3.9. If Time Warner was to make an acquisition, it could impact the company's ability to return capital to shareholders. Time Warner currently yields 2.30%, which investors appreciate. 

Time Warner's revenue and earnings continue to grow on an annual basis, as there have been no setbacks over the past five years. In the first quarter, revenue increased 6.60%, and earnings improved 5% year-over-year. The company's consistency has led to stock price appreciation -- Time Warner is up more than 15% year-to-date. Overall, whether or not Time Warner should consider this acquisition is debatable.  

Regarding CBS, it's a highly strategic company always looking for quality content, and the balance street is strong. All that said, you should never invest in a stock based on acquisition speculation.

Conclusion

Starz trades at 11 times earnings, whereas Netflix trades at 514 times earnings. Starz has more subscribers, it’s ahead of the original content curve, and it has stronger margins than Netflix. Furthermore, Starz has won the confidence of Berkshire Hathaway and its leader is a proven winner. So, Starz currently offers a better value than Netflix. 

On the other hand, Starz sports a high debt-to-equity ratio of 7.67 versus an industry average of 0.50. This high-leverage position substantially increases risks for investors as debt has the potential to impede growth. If a bear market presents itself, then the stock would likely lack resilience. 

All factors considered, Starz appears to be a good speculative play for now. If you only allocate a small percentage of your available capital to the stock, then you might have a win/win situation. If the stock appreciates, you have a small win. If the stock depreciates, then you didn’t risk too much and you will have an opportunity to buy more at lower prices. 

The television landscape is changing quickly, with new entrants like Netflix and Amazon.com disrupting traditional networks. The Motley Fool's new free report "Who Will Own the Future of Television?" details the risks and opportunities in TV. Click here to read the full report!


Dan Moskowitz has no position in any stocks mentioned. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix. 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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