Who Will Buy Starz?

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

With $300 million in annual cash flow and an Enterprise Value of $3 billion, $315 million in net cash on its balance sheet, content contracts for several years going forward and a slew of original series, Starz (NASDAQ: STRZA) will likely be bought out later this year. 

As a shareholder of Starz, I cling to the hope that the company will merge with a well-run business where its assets will prove to actually be synergistic with the combined company’s business model going forward. The three companies discussed here are those that I believe would potentially work best with Starz.

Netflix

A relatively under-appreciated aspect of TV shows in 2013 is the amount of viewers who begin to watch the show well online. I would never have watched shows like How I Met Your Mother, The League or Parks & Recreation if their episodes were not readily available for binge watching on Netflix (NASDAQ: NFLX). Today I watch them all live and don’t miss an episode. 

I was introduced to each of the Starz shows I like when their content was on Netflix a few years ago. Unfortunately, it is no longer available there and because I do not subscribe to Starz I must wait for the DVDs, pay exorbitant per-episode prices on Amazon/iTunes or do illegal things to watch the episodes.

Like Starz, Netflix’s original series (excluding the weird werewolf one) have come out to generally good reviews. If Netflix were to acquire Starz, it would simultaneously increase the amount of viewers who have access to its original series and increase and improve the content available on its site.

The problem is whether or not Netflix is financially capable of pulling off a deal. Netflix currently has about $300 million in net cash, not including off-balance sheet content deals. However, the deal would be immediately (and incredibly) accretive for Netflix shareholders if the company used stock. Despite Netflix having the $14.6 billion to $2.8 billion market cap advantage, Starz has net income and operating cash flow of around $300 million, vastly more than Netflix’s numbers around $20M.

Amazon

Amazon (NASDAQ: AMZN) has attempted to enter the subscription content business with its already-established Amazon Prime service. Amazon has also tacked on unlimited streaming of 41,000 movies and TV episodes, according to its website. I do not believe that the streaming content is much of an attraction to customers, as there is very little that is not available on Netflix. Amazon's streaming site is also incredibly plain and hard to search through, and the player that Amazon uses is prone to bugs and random stoppages. In addition, Amazon recently created fourteen pilots for possible original shows, none of which earned any real acclaim from fans or critics. The pilot for a show based on the movie Zombieland proved to be particularly disappointing after fans of the movie "hated it out of existence."

Any way you spin it, Amazon has failed to produce anything of value in its content subscription business. Acquiring Starz would immediately bolster its available content, giving it titles that Netflix does not have available and give it another advertising chip to sell Kindles. 

Financially, Amazon would have no problems pulling off the acquisition. It currently has more than Starz’s enterprise value in short-term investments, to go along with $8 billion more in cash, $4 billion in annual operating cash flow and just $3 billion in long-term debt. Also, its market valuation is so high there would be no problem with paying in stock for the acquisition.

DirecTV

Like Amazon, DirecTV (NASDAQ: DTV) has had a failed experiment at producing an original series. I haven’t actually seen Rogue, and I literally don’t know anybody who has even heard of it. Starz's content and in-house talent would exponentially increase the quality of any originals DirecTV wanted to experiment going forward.  

Not only would DirecTV gain superior original programming and a power over its competitors by buying Starz, it would be merging with like-minded management from the John Malone tree. Like Starz, DirecTV was spun-off by a John Malone holding company. It is likely that of the three companies mentioned here, DirecTV would have the quickest and easiest transition following a merger.

Financially, the deal will be tough to pull off for DirecTV. Though the company has $1.6 billion in cash and a very predictable $5.5 billion annual operating cash flow stream, it already has negative shareholder’s equity over $6 billion.  In addition it only trades for 13.7 times its earnings and management is not willing to dilute shareholder value. DirecTV’s ability to pull off a $3 billion acquisition will hinge completely on its ability to increase its massive debt load to over $21 billion at a reasonable interest rate.

Conclusion

Starz is a cash cow with several valuable assets in content and talent that keeps churning out new content, yet it still trades for just 10 times its cash flow. It is extraordinarily likely that it will be bought out within the next year or so. Hopefully, for both its shareholders and the shareholders of the acquiring company, either Netflix, Amazon or DirecTV will be the one doing the buying.

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Mike Price owns shares of Netflix and Starz. The Motley Fool recommends Amazon.com, DirecTV, and Netflix. The Motley Fool owns shares of Amazon.com and 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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