On Thursday night, Lions Gate (NYSE:LGF) reported a mixed set of quarterly results, and shares traded around the flat line after-hours as a result. Over the past year, shares of Lions Gate have fallen 10%, but they have rallied 19% in the past three months. Lions Gate has been aggressively investing in film production to build major franchises that can deliver consistent box office returns as it tries to compete with larger studios. Clearly, The Hunger Games has been a great success while Divergent is also a profitable franchise, though other efforts like Ender's Game have been far less successful. At the end of the day, a few products with relatively near term end dates are driving the majority of Lions Gate's business. Given this, shares are still too expensive at $30, and I would use the recent pop to sell shares.
In its fiscal first quarter, Lions Gate earned $0.34 on sales of $449.4 million while analysts were looking for $0.17 on sales of $489 million (all financial and operating data available here). Adjusted EBITDA of $77.3 million was 27% higher year over year thanks to lower distribution and operating expenses. Still, revenue was 21% lower year over year due to a smaller film slate. Thus far in 2014, Lions Gate has 4.7% market share at the domestic box office with grosses of $300.7 million (all box office data available here). At this point last year, Lions Gate had generated $460 million in sales.
2014 has been a challenging year. Apart from Divergent, no other film has generated even $30 million at the domestic box office for the company. Last year, Lions Gate had 7 films that passed $30 million. Now, the film business is obviously very event driven, and quarterly results depend very much on the timing of major releases. Lions Gate should have a stronger second half of the year with The Expendables 3 and more importantly the penultimate Hunger Games. Typically, investors pay a certain multiple on earnings, but I don't believe this is an appropriate way to value Lions Gate.
Its business varies dramatically depending on when it releases movies, but a lot of these major films are limited in number. It will not have a Hunger Games every year for the foreseeable future; there will be only two more of them. Apart from this brand, the Lions Gate film unit tends to churn out modest hits that generate far less profits. Its TV unit tends to deliver more stable results, but the end of Mad Men will also challenge these results. I would suggest we value Hunger Games on a standalone basis and then determine the value of the rest of Lions Gate.
Based on the success of the first two films, I expect the final two to combine for around $2 billion at the global box office and to do better home video business. After considering production and marketing costs, these films should generate about $560 million in cash for Lions Gate. The company has a market cap of $4.16 billion, meaning ex-Hunger Games, it is worth about $3.6 billion. With its library, other films, and TV offerings, Lions Gate should generate about $1.30 in earnings power. Given the unpredictable nature of the media business, I would be unwilling to pay more than 15x earnings. This suggests fair value of LGF is around $25.
At $30, investors are pricing in another massive franchise, which does not appear in the pipeline. If anything, the results over the past two quarters are concerning because the company is struggling to make minor box office hits while key TV properties will be coming to an end. Once The Hunger Games comes to an end next year, investors will realize the rest of LGF is not as impressive. I expect shares to push back towards $25 before the end of the year, and I would be a seller here.
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