Hunger Games Is A Huge Success, Yet Lions Gate Sells Off

Nov.27.13 | About: Lions Gate (LGF)

In the last few years, Lions Gate (NYSE:LGF) has made a lot of successful movies based on popular modern fiction books. Being one of these movies, second movie of Hunger Games series Catching Fire saw huge box office success in its initial opening in the US. Yet, the investors sold the company off, leading to a 10% decline on Monday. Of course, this is confusing for the remaining shareholders of the company and they are wondering whether they should sell their shares. Many investors are also worried that something "under the hood" might be wrong that they are not aware of.

Usually when a sudden major sell-off happens, it's either an overreaction to something or some investors got their hands on some information that might be really bad. If the first scenario is true, the stock price usually bounces back soon after, but if the second scenario is true, things might linger for a while. Of course, a lot of times, a panic selling will trigger additional automatic selling based on margin calls or stop-losses. After Monday's sell-off, Lions Gate is now down 20% from its October high of $37.50.

First, let's review the reception of Hunger Games: Catching Fire. In its opening weekend, the movie grossed $158 million in the US and it became the top movie of last weekend. In the movie industry, the rule of thumb is that a movie will reach breakeven when its gross revenue is double of its budget. Given that Catching Fire's budget was $130 million, we can expect the movie to reach breakeven and become profitable soon enough. In its first weekend, the original Hunger Games movie had gross sales of $150 million, which shows us that the second movie showed a 5.33% improvement in its first weekend over the first movie. On the other hand, keep in mind that the production budget of the first movie was about $80 million, which is roughly half of the second movie.

The first movie was a huge success as it generated $408 million in domestic box office revenues, $276 million in international box office revenues and $190 million in domestic home video sales (both in DVD and Blu-ray). I couldn't find the exact numbers of any additional revenues such as international home video sales, movie rentals, or other related merchandise sales such as t-shirts and toys (then again Lions Gate generated $743 million in revenues in the fourth quarter of 2012 when the movie came out and another $785 million in the following quarter when the movie's home videos and other merchandise came out; even though not all this revenue was due to Hunger Games as the company also had other projects going on). In summary, the first Hunger Games was hugely successful and profitable for the company.

If this movie continues to outperform the first movie like it did in the opening weekend, we can see a lot of good things to come out of it. Again, keep in mind that the second Hunger Games movie had almost the double production costs that the first movie had, so it will probably have lower margins unless it outperforms the first movie by a lot. This is not to say that a sell-off is warranted though.

Currently, Lions Gate has a market value of $4.17 billion, which is significantly down from October's high of $5.17 billion. In the last four quarters, the company generated $2.81 billion in revenues and $1.36 billion in gross profits. During this period, the operating income was $297 million and net profit was $289 million. Basically, investors are currently paying for a trailing P/E of 14 and a forward P/E of 15 for 2015 based on the earnings estimates. Keep in mind that the movie industry is a highly capital intensive industry. Due to the dynamics of the industry, as soon as one movie comes to completion, a large amount of money has to be invested for the next movie. On the other hand, Lions Gate has a nice pipeline for the foreseeable future as there will be 3 more Hunger Games movies in addition to other projects such as Hercules: The Legend Begins and The Expendables 3.

The movie industry can also be very volatile and even some well-established companies like Disney (NYSE:DIS) can sometimes see their movies perform badly in the box office. Sometimes, a company will spend hundreds of dollars on a movie and it will "bomb" and other times it will spend far less and the viewers will make it a huge success. Some movies will make 5 times their initial investment; some movies will make half of their initial investment.

Having said all that, if investors are looking for decent growth in a company with a nice pipeline and recent sell-off, Lions Gate might be a good pick. I honestly don't think the recent sell-off was warranted, especially given the Catching Fire's huge success. The more conservative investors might want to wait until the dust settles before putting their money in what may look like a "falling knife" though.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.