The Roar of the Lion

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Hollywood loves a good story and Lions Gate Entertainment (NYSE: LGF), the only major independent movie studio, has been delivering one for investors in 2012.  It was only two years ago that legendary investor Carl Icahn was bidding to acquire the company at a price that peaked at $7.50 per share in cash.  Instead, management saved their jobs by selling debt to another investor, a former protégé of Mr. Icahn, who now reigns as the chairman of the company with a 35.1% stake.  While the move seemed self-serving at first glance, long term investors are certainly smiling as the company’s market value has gained roughly 80% over the past twelve months.

Small Fish, Big Pond

Lions Gate is a global producer of films and television programming that are delivered through theatre, television, cable, and digital networks.  The industry has long been dominated by entertainment giants, with vast distribution networks and solid balance sheets.  According to data from IMDb, Sony (NYSE: SNE), Disney (NYSE: DIS), and Time Warner (NYSE: TWX) are the top three grossing studios in 2012 with a 47% combined market share, which is pretty close to the 51% combined market share that the three companies held in 2006.  The motion picture business is highly capital intensive with low individual project success rates, a recipe for disaster unless a company has diversified revenue streams.  To offset the risks in the sector, Sony has strong financial services and music businesses, Disney has a media and theme park kingdom, and Time Warner has a publishing and cable network empire.  The film business only composes between 10% and 23% of these companies’ annual revenues.

How Do They Compete?

Lions Gate has achieved success by finding partners to share the risks and by making selective acquisitions that meet their financial goals.  While the company started out as a movie producer, its focus has historically been on the home entertainment segment, which composed 43% of revenues in the latest fiscal year.  Lions Gate has created a library of 15,000 titles, through acquisitions of Trimark in 2000 and Artisan in 2003, which has provided a stream of recurring cash flows to reinvest in the studio business.  In addition, it continues to use its distribution network to provide value for third party content providers, including the recently announced deal to distribute home entertainment programming for A+E Networks.  Most importantly, Lions Gate has taken calculated risks, such as this year’s $412 million acquisition of Summit Entertainment, owner of the blockbuster Twilight series.  That debt-fueled gamble is looking pretty good, as the latest film release in the series, Breaking Dawn – Part 2, has already garnered roughly $254 million at the domestic box office.

In its most recent fiscal year, Lions Gate reported flat revenue growth, while operating income fell 46.4% versus the prior year period.  Operating profits were negatively impacted by rising film production costs, as well as lower theatrical and home entertainment releases.  In 2012, though, the company’s financial results have soared on the back of the box office success of The Hunger Games, which grossed over $400 million at U.S. theatres.  Through the first six months of FY2013, Lions Gate reported revenues and operating income of $1.2 billion and $94.0 million, increases of 90.3% and 396.0%, respectively, over the prior year period.  The company’s operating margin rose substantially as its film releases performed above expectations and led to further gains downstream in the home entertainment distribution channel.  On the company's second quarter conference call in November, management was confident about their ability to meet or exceed financial goals for FY2013 and continue building on the success of their film franchises.

Looking to the Future

It’s rare to see an upstart company challenge the major powers in an industry, but Lion’s Gate seems to have slowly accomplished that feat.  Its 12.3% share of the box office in 2012 compares favorably with the 3.6% market share that the company earned in 2006.  While leverage is high, due to film production needs, management’s significant ownership should ensure a watchful eye over the company’s bottom line.  Of course, there is also always the possibility that one of the global entertainment giants may want to pay a premium to add Lions Gate to their studio roster.  Until then, the company is one for the investor’s portfolio.


rghanley has no positions in the stocks mentioned above. The Motley Fool owns shares of Walt Disney and is short Sony (ADR) and has the following options: long JAN 2013 $22.00 calls on Sony (ADR). Motley Fool newsletter services recommend Walt Disney. 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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