Lions Gate Entertainment (LGF), the movie and television distribution company that gifted the world with vampires and a tomboy played by the very beautiful Jennifer Lawrence, is on the prowl with 21 films released in FY2013 and 14 films to be released the next year. As of 2012, LGF is the seventh most profitable movie studio and the number one most commercially successful independent distributor. Despite those statistics, I believe LGF is a short option, and for good reason.
On January 13, 2012, Lions Gate announced that it had acquired Summit Entertainment for $412.5 million, and the big gain from this merger was the ownership rights to the Twilight Saga (a movie that is not just for teenage girls). For 2012, Summit Entertainment ranks 8th in gross revenue with 4.3% of the industry market share, ranking just behind Lions Gate at number 7 with 7.3%. After the acquisition of Summit Entertainment, Lionsgate will own a collective market share of 11.6%. The result of simple addition causes Lionsgate to actually be ranked higher on the above list. The addition of Summit Entertainment is necessary for Lions Gate to compete with the more established distribution giants such as Columbia Pictures and Disney (DIS).
Lions Gate has performed well this past year in reaping high revenues from 21 movie releases, including titles such as The Hunger Games, Twilight: Breaking Dawn 2, and the Expendables (a movie with an absurd cast by the way). Furthermore, LGF has released popular television dramas such as Nashville and new seasons of the popular series, Mad Men. Nashville has received a very strong showing, especially among women, and has earned the spot as the second most DVR'd program in 2012. If any of you watched Friday Night Lights, the TV show following Coach Taylor and the Dillon Panthers, Connie Britton who played Tammy Taylor is also one of the main characters on Nashville. With all of these assets, Lions Gate lauds a $2.5 billion gross global revenue for the past year.
LGF has 14 movies about to exit the pipeline onto the big screen next year with big titles such as Hunger Games: Catching Fire in November 2013 and Divergent, a film with Shailene Woodley of the Descendants and Kate Winslet, scheduled to be released in March 2014. Furthermore, according to CEO Jon Feltheimer, LGF has a three year guidance of $900 million EBITDA as the company hopes to expand its audience base with their Hunger Games and Twilight Franchise as well as its blockbuster TV programs such as Nashville, Mad Men, and the Wendy Williams Talk Show.
With all this to look forward to and the strong performance last year, why do I think LGF is a short candidate? Because LGF is swamped in debt.
Even though movies like Hunger Games reap high revenues in international ticket sales and pre-sells globally, the hundreds of millions of gross revenue is simply that - just gross revenue. After factoring in negative costs and marketing costs to prep up the release of the film, Hunger Games had a net profit that is still substantial but significantly less than gross revenue. Furthermore, considering licensing contracts, employee hires, rentals, capital expenditure, and investments, LGF racks up a whole lot of debt.
Currently, LGF is in $1.43 billion of debt and has $125.2 million in free cash coming into the end of Q3 FY2013. With those numbers, any accountant will tell you that LGF is WAY over leveraged and if the company does not leverage soon, a light gust of wind will topple this house of cards.
With such a high incidence of debt, the latest quarterly earnings report is misleading as the company's EPS and revenue is financed by leveraged funds and liabilities that the company cannot pay with its current cash flow. The truth is that there is a lot of erosion at the base of this company. It will be difficult to extinguish such a high amount of debt when the world expects you to perform at the level that Time Warner and Columbia Pictures do. As a company, LGF needs to pay their debts and please their investors; I do not think it can do both.
During the earnings call for Q4, vice chairman Michael Burns was asked by one of the analysts if LGF was planning on giving back any earnings to the shareholders, and to that question Burn responded the following: "I'll tell you that we don't have at the moment any plans for dividends, although it's obviously always an option."
Lastly, when asked about the high yield bonds and how they were going to pay them off, Michael Burns proposed the option of financing current high yields with additional high yields at a lower interest rate. I understand that this is not uncommon practice, but at the volatility of today's interest rate and the threats of increased federal regulation, these bonds could become just as difficult to pay off in the future. Furthermore, I personally do not like the practice of closing one door just to open another. A problem is solved when there is one less item to cross off the to do list. LGF has a lot of problems, and none of them are getting crossed off.
LGF is a short.
LGF is a $2.8 billion dollar company, trades with a current P/E ratio of 69.4, and has a 52-week high of $20.68 and $11.26 low. It is trading at a high and I expect that at any point now, this company is going to face some major pullbacks. A short now may lead to profit in the near future as investors begin to lose confidence in LGF because of the high level of leverage.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.