2 Factors To Consider In These 3 Media Stocks

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

If you are looking to buy stock in businesses targeting the film industry, I recommend looking at several variables. First, consider the competition. Media can be very unsustainable, which is complicated by the unpredictability of consumer interests. Second, look at the corporate track record. At least in the short-term, I believe in picking momentum winners in media. Below, I review 3 stocks with this consideration in mind.

Why The Bears May Be Right About Netflix (NASDAQ: NFLX)

The bears have long targeted Netflix as the ideal short. 28% of the float is now being shorted and analysts are calling it closer to a "sell" than a "buy." It's not hard to see why the outlook is weak. International expansion is cutting into margins, content costs are rising as free alternatives emerge, and the management is terribly entrenched. With Billionaire activist investor Carl Icahn disclosing around a 10% stake in the company, there is potential that he could launch a proxy fight, replace the board, and thereby unlock some shareholder value.

Going forward, the online streaming & DVD provider faces several headwinds. At a long-term debt to equity ratio of 67.2x, leverage is also well above the industry average. I also see competitive pressures coming from three different mediums. First, Coinstar's Redbox is a low-cost alternative to Netflix's DVD business. For those unfamiliar, Redbox is essentially a movie "vending machine" that enables consumers to pick up and return DVDS on the fly. They have a great selection and are quick to pick up titles after theater releases, especially compared to Netflix--a belief that I, as both a Redbox and Netflix user, share. Second, Amazon's online streaming option is at a discount. CEO Reed Hastings's charge that Amazon is losing upwards of $1 billion a year on Prime Instant Video has also been challenged. Third, pirating is, of course, free and widely accessible to those who know how to do a Google search.

And then there are headwinds across geographies. At the end of November, America Movil launched a streaming service in Mexico that is 33% cheaper than Netflix's. And, despite Carl Icahn's view of industry-wide consolidation, Netflix is not likely to get much of the love. I already dismissed speculation that Microsoft is interested in buying the company out. The software producer has enough on its plate, and the worst decision it can make now is to strap on a business popularly recognized as "overvalued." Instead, Microsoft will focus on getting shareholders to realize that it is generating plenty of free cash flow relative to its market cap and has significant growth opportunities with a degree of predictability. Netflix would throw a wrench into that plan. Supporting my view that Netflix is not a takeover play is one analyst who believes that recent HP-Autonomy debacle has quelled interest.

Buy Lions Gate (NYSE: LGF), Avoid Dreamworks Animation (NASDAQ: DWA)

Lions Gate, a previous Icahn target, is a more likely takeover target. It trades at only 11.8x forward earnings and is rated around a "strong buy" on the Street. A few weeks ago, Barrington Research put out an "outperform" rating with a $21 price target, which is at around a 30% premium to the prevailing price. It has more than tripled in the last two years or so.

There are several reasons to be optimistic about Lions Gate. Strong box office sales were strong from Twilight: Breaking Dawn Part 2, which yielded $43.6 million in three days. This title took the lead in the five-day Thanksgiving period and has sent the shares soaring. Some have even called the film series a bigger "game changer" on the studio industry than Harry Potter in the sense that it shifted over the marketing sweet spot to teens. There have already been speculations that Yahoo will acquire Lions Gate's TVGuide.com, but the entire company can be easily taken over at just $2.4 billion.

I would recommend, however, avoiding DreamWorks Animation. It trades at a respective 19.6x and 16.4x past and forward earnings. Analysts expect it to grow EPS by 12.6% annually over the next 5 years. Assuming expectations hold true, 2016 EPS will come out to $1.41. At a multiple of 16x, this translates to a future stock value of $22.56. This means, you are looking at average returns of just 7.8% over the next 5 years. In order to find how much the stock was trading at relative to its intrinsic value, you would discount future EPS backwards by 10%. This ultimately suggest the stock is around 14% overvalued. For this reason, I recommend avoiding and buying peers instead.


TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Netflix. Motley Fool newsletter services recommend DreamWorks Animation 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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