Lion's Gate Entertainment -- Film Industry Lion or Lamb? (LGF)

Lions Gate Entertainment (LGF) defines itself as “a diversified independent producer and distributor of motion pictures, television programming, home entertainment, family entertainment, and video-on-demand content.” With this in mind, we recently began reviewing LGF as a potential investment.

Our initial thesis was that the company would have attractive free cash flow, a high quality media library, and a unique business model of producing and acquiring niche content on a tight budget. After some research, all these things seem to be proving true.

The company’s net income looks ugly but operating cash flow is much prettier since charges for the “amortization of films and television programs” are added back. In a recent conference call, CEO Jon Feltheimer stated, “We can keep throwing off 90 to 100 million dollars of consistent free cash flow and still keep building our long tail for the soon-to-come explosion of digital demand without a big film hit or TV show is a model we believe is sustainable.” Taking the mid-point of Feltheimer’s estimate, LGF is priced at about 9.6 times free cash flow.

Lions Gate Entertainment’s library of 6,200 movies and 1,800 TV shows is a fantastic asset that throws off high margin, recurring revenues. Sample films the company owns include Total Recall, Reservoir Dogs, Dirty Dancing, and It's a Wonderful Life. Should LGF ever have trouble monetizing this library, we believe buyers would line up for it.

While major studios can spend royal fortunes trying to produce blockbuster films, LGF takes a much more disciplined approach. They’ll seek out films that have a niche audience or films that are too controversial for the majors. The 10K elaborates, “Historically, we have primarily produced English-language motion pictures with production budgets of $20 million or less. Films intended for theatrical release are generally budgeted between $5 million and $35 million, and films intended for release directly to video or cable television are generally budgeted between $1 million and $5 million.” We like the idea of making numerous smaller, more targeted bets on films.

Initial concerns of ours include the balance sheet which has a debt/equity ratio of 3.8 and a current ratio of 1.1 (Yahoo Finance). We’ll need to spend some more time on it before we are comfortable with LGF’s ability to stay out of financial trouble.

We’ll also be trying to figure out whether $90 - 100 million is a sustainable level of free cash flow, as Mr. Feltheimer suggested.

At this writing we don’t own any shares of Lions Gate and probably won’t end up paying current ask prices to own the stock, but we thought the story was interesting enough to warrant sharing.

For different perspectives, read why Analyst Oz is short LGF here, or get Catablast’s take on the company here.

LGF 1-yr chart: