The Secret Takeover of Lionsgate Films

Carl Icahn Triples Stake

When corporate raider Carl Icahn recently tripled his stake in Lionsgate Films (LGF), evidenced by a 13D filing, news spread quickly and many in the blog, entertainment and journalistic community began speculating at his motives (see here, here, here and here): Was it a tie up with Yahoo (YHOO) that he was looking for? Many people don’t realize or comprehend that Icahn has been a long term holder of LGF for nearly three full years, amassing an approximate 3.6% in the company in late 2005. At the time, others speculated that Icahn was looking for a quick marriage to his famed holding, Time Warner (TWX). Others were wrong.

Nevertheless, is Carl Icahn looking for Lionsgate to quickly put itself up for sale? Doubtful. Why? Most evidence seems to indicate that Icahn believes this company is massively undervalued, and any premium that would be received at the current distressed share price would likely not rise to the level he believes LGF’s true value is.

In his latest 13d filing declaring a stake of over 9% in the company, Icahn explained that he was investing in an undervalued asset. In addition, he has yet to make one publicly hostile statement regarding Lionsgate, and while he admits to having discussions with senior management, he has never once spoken negatively about how they are operating the company. Let me reiterate this point: not one negative or hostile comment about the company or management in three years, despite having a negative return on his investment. Instead, he purchased more shares and declared he thought the company was an undervalued asset. This doesn’t sound like the Carl Icahn we have seen recently with Time Warner, Motorola (MOT), Biogen (BIIB) and Yahoo.

The Value of Lionsgate

So how undervalued does Mr. Icahn think Lionsgate is? Well, in late 2005 and early 2006, Icahn purchased shares somewhere in the 8.50-ish range. And within the past few weeks, to put him over the 5% threshold, he began acquiring shares as high as $8.46, which represents a whopping 30% premium to the close of trading price yesterday.

So if Icahn, on October 7^th thought LGF was trading at a huge discount to value, and now, just 3 weeks later it is trading massively below that, what are others missing? For one, on simple paper, LGF doesn’t attract novice investors. It operated at a net loss last year, it has negative tangible book value, and EBITDA was negative last year.

However, these investors need to go a little deeper. What does Icahn see? He sees a massive content library that continues to grow, increasing in size from 8,000 titles since he began investing in the company to nearly 12,000 titles. A company that in 2004 was just a little indie studio, that is now a “mini major.” A company that has won the Academy Award for Crash and an Emmy for Mad Men. A company that has co-produced and distributed the number 1 horror franchise in history (which recently proved itself yet again with a $30 million opening), yet controls 15% of the DVD children’s family market. A company that went from putting out 6 wide releases a year to 18 (plus another 6 when you count their ownership of Mandate Pictures, producer of Juno and Nick and Norah’s Infinite Playlist).

According to Boxofficemojo.com, Lionsgate has increased its market share every single year, reaching 4% right now. Its DVD market share is even higher, growing to 7.7% of the market this past year, and Michael Burns, LGF’s CFO has publicly stated that next year he expects to have a DVD market share higher than some of the “majors.”

How about the financial statistics of value? $951 million in revenue in fiscal 2006 to over $1.6 billion in revenue anticipated for this fiscal 2009 (ends March 31, 2008), on its way to doubling revenue in just four years (expected fiscal 2010). On top of that, the company has produced consistent and growing free cash flow, with over $100 million in free cash flow for the past 3 fiscal years.

At the end of this year, LGF has stated that they will have over $400 million in cash on their balance sheet, still no bank debt, two giant 3^rd party film funds to help share their costs and reduce their risk, and a revolving credit facility of over $300 million from JP Morgan, with $0 taken out so far….making LGF perhaps the most underleveraged company in the film industry. Its only debt consists of $320 million of convertible bonds, many of which don’t come due until 2025, have a yield of merely 3.1% and don’t become dilutive unless the stock is over $14 per share.

With net cash of $80 million at the end of this fiscal year, at LGF’s current share price, they would be trading at a FCF multiple of less than 6, or probably less than half the multiple of what Icahn thinks it is worth. Lionsgate’s $100 million authorized share buyback, which has been on pause for the past month due to SEC mandated quiet periods before earnings releases, will likely come out with full force and power once their earnings are made public and the quiet period ends (LGF announces on November 10^th).

In addition, the size and value of their library continues to increase in value, producing $70 million in free cash flow 4 years ago, to about $100 million in this fiscal year. With library margins over 30%, Lionsgate is currently trading at a value less than its library alone, completely ignoring its smart film distribution and operating businesses, its investments in online videosite break.com, its investment in horror cable channel FEARnet, and its growing presence in the entertainment industry.

Lionsgate continues to put its cash to work to grow its business. Just yesterday it announced that it is starting two new pay TV channels in Asia. This will complement the new channel it is forming here in the States along with Viacom (VIA) and MGM to compete with the likes of HBO. With three of the largest libraries in the world, this channel, which is continually doubted, will prove the value of content.

The Secret Takeover

For an even more in-depth analysis of the value of Lionsgate, you must read my previous article "Lionsgate Misunderstood: Too Cheap to Ignore". Carl Icahn's long time friend, and former Chief Investment Officer, Mark Rachesky, has been a Lionsgate shareholder for 4 years, and continues to gobble up shares as recently as today, where he went over the 15% mark. That is right, his funds now own 15% of Lionsgate. Mark Rachesky is known as an investor in undervalued and misunderstood companies. This gives Icahn and Rachesky a close to 25% stake in LGF, if they chose to work together. Enough to cause a much bigger stir than Icahn has ever been able to erupt.

Who else has massive stakes? Steinberg Asset Management, another long time holder just increased its stake to over 15% as well in the past 3 weeks. Steinberg is also known as a shrewd value investing fund. Another value oriented and successful fund, Capital Research Management owns close to 10% of LGF stock. Between these four long time and stable holders who continue to purchase more every time the stock dips, they control close to 50% of the company, amounting to what I refer to here as “The Secret Takeover of Lionsgate Films.” Well, it’s no longer a secret.

Conclusion

To add fuel to the fire, to the best of my research, LGF does not have a shareholder rights plan, otherwise known as a poison pill. And they do not have a staggered board of directors. This just seems like the perfect investment for me during these times: low leverage, adequate cash supplies, continued top line growth, stable management, undervalued, with enormous activist potential.

Disclosure: I am long LGF stock.

Comments

[Longtime Li...:]

Very interesting situation. I will pay attention to this one!

2008 Oct 31 02:25 PM

[GoldDiggerAB:]

"Mark Rachesky, has been a Lionsgate shareholder for 4 years, and continues to gobble up shares as recently as today, where he went over the 15% mark. "

As of the mentioned form 4 below, Rachesky holds 7,391,634 shares.
Total shares outstanding last quarter were 117,371,945.
That resuluts in an ownership of 8,68%.
That`s clearly under your reported figure.
425,654 of this shares he bought AFTER the publishing of your article.

www.sec.gov/Archives/e...

2008 Nov 07 08:57 AM

[pnx:]

the writer just doesnt get it. THERE IS NO SUCH THING AS FREE CASH FLOW IN THE MOVIE BUSINESS> WHAT THEY CALL FREE CASH FLOW IS LESS THAN OVERHEAD AND THE CONCEPT ASSUMES THEY DONT HAVE TO INVEST IN NEW FILMS>


On Nov 07 08:57 AM GoldDiggerAB wrote:

> "Mark Rachesky, has been a Lionsgate shareholder for 4 years, and
> continues to gobble up shares as recently as today, where he went
> over the 15% mark. "
>
> As of the mentioned form 4 below, Rachesky holds 7,391,634 shares.
>
> Total shares outstanding last quarter were 117,371,945.
> That resuluts in an ownership of 8,68%.
> That`s clearly under your reported figure.
> 425,654 of this shares he bought AFTER the publishing of your article.
>
>
> www.sec.gov/Archives/e...
>
>
>

2008 Nov 09 09:16 AM

[Longtime Li...:]

You obviously cannot read an SEC filing. Those stakes are divided amongst five funds, all of which contribute to his beneficial ownership stake. Each fund has its own footnote and is listed separate on the same exact form which you diligently put the link up for. If you add correctly, you will see that he owns:

2,260,257 shares in MHR Capital Partners Master Account LP, an
Anguilla, British West Indies limited partnership
301,536 shares in MHR Capital Partners (100) LP, a Delaware limited
partnership
2,352,223 shares in MHR Institutional Partners II LP, a Delaware limited
partnership
5,925,953 shares in MHR Institutional Partners IIA LP, a Delaware
limited partnership
7,631,634 shares in MHR Institutional Partners III LP, a Delaware limited
partnership

Total shares beneficially owned by Rachesky = 18,471,603 shares
(Since, the link you published, he has purchased an additional 139,000 shares)
Total shares outstanding as of November 1, 2008 = 115,738,568 shares

Rachesky owned 15.96% as of that filing; and since he has since filed the additional 139,000 shares, and LGF has likely repurchased more than 1 million shares since then (we will see at the next quarterly filing), his percentage is likely higher and is over 16%.

You should check your facts before your post!



On Nov 09 09:16 AM pnx wrote:

> the writer just doesnt get it. THERE IS NO SUCH THING AS FREE CASH
> FLOW IN THE MOVIE BUSINESS> WHAT THEY CALL FREE CASH FLOW IS LESS
> THAN OVERHEAD AND THE CONCEPT ASSUMES THEY DONT HAVE TO INVEST IN
> NEW FILMS>

2008 Dec 27 05:18 PM