The Dolan Family, owners of Cablevision (NYSE:CVC) and its vast empire of assets, made a colossal mistake in spinning off its Rainbow Media subsidiary as AMC Networks (NASDAQ:AMCX). Or rather, it’s a trap stock for AMC investors, but Cablevision is helped by the deal (click here for my article on trap stocks).
Cablevision essentially off-loaded $2.4 billion of its debt onto AMC, then had AMC use a billion of it to pay down some Cablevision debt. That enhanced Cablevision’s credit profile while also, according to the prospectus, permitting Cablevision to issue additional equity for acquisitions. So Cablevision shareholders win with the decrease of debt, but unless subsequent acquisitions prove to be accretive to the point of offsetting dilution from equity distribution, that would be a losing bet. Meanwhile, AMC Networks gets saddled with all that debt out of the starting gate.
There is a fundamental problem with AMC Networks (which includes IFC, WE tv, Sundance Channel, and AMC) as a separate entity. As I’ve written about in other articles, both film and television operate in a statistical environment of extreme uncertainty. Success of any given piece of produced entertainment is, literally, random. It is impossible to predict revenues of any given piece of entertainment. Or rather, you can, but with a standard deviation of infinity, which is no estimate at all.
So for starters, investors are literally gambling (as they are with IMAX) on unpredictable revenues. If revenues can’t be predicted, neither can earnings. If earnings can’t be predicted, than neither can earnings growth, and so attempting a valuation is folly. That kind of company is not what I would call a "forever hold".
That enough should scare away any savvy investor.
The story, however, gets worse. AMC’s primary revenue streams depend on affiliate fees (57%) and advertising (37%). Affiliate fees are a portion of what the distributor, such as Cablevision itself or DIRECTV (NASDAQ:DTV) or other cable and satellite companies, collects from subscribers. Those fees depend upon the demand of subscribers for distributors to carry those channels. ESPN, a subsidiary of Disney (NYSE:DIS), has a lot of leverage over extracting higher affiliate fees because sports programming is huge. AMC Networks, not so much.
Advertising fees depend entirely on ratings. And since the success of any given piece of programming is random, so are advertising fees. They will depend not on the quality of the content, but on viewer’s reactions to that content. I want to point out that the good people at AMC have extraordinarily good taste in content. They are doing outstanding jobs of selecting great programming under very arduous conditions. But great content doesn’t always draw lots of viewers.
There are two other big problems. The first is that AMC does not have deep pockets for programming as its many competitors do. Network and Pay-TV, as they are part of large conglomerates, have very deep pockets and established operating histories. Network television, even with unspectacular ratings, can still draw substantial advertising fees.
Pay TV, such as HBO, commands sizable subscription fees. Thus, budgets are higher, and production values are often of higher quality than cable content. AMC simply cannot compete on that level. It must produce compelling content in cheaper ways. The network’s high-profile firing of Frank Darabont from Walking Dead exemplifies this problem. The series was too expensive on an episodic basis ($3.4 million per episode) and that, coupled with huge salary demands by Mad Men creator Matthew Weiner, forced AMC into a box.
They had to cut Walking Dead’s budget, which hamstrung Mr. Darabont, which led to his firing, which now places AMC in a bad position as far as attracting talent who may fear getting thrown under the bus. Again, this is not the fault of executives at AMC. It’s the fault of the Dolans for executing this foolish spin-off.
Naturally, the spin-off was done to benefit the Dolans. Even worse, they still have arranged to own 71% of the AMC spin-off. As if all the good people at AMC don’t have enough to worry about, they have to be concerned about the Dolans messing around with their operation whenever the mood strikes them.
What does this mean for AMC shares? It certainty suggests they should be avoided. Sell if you hold it. Should they be shorted? I prefer shorting stocks that literally have a chance of going to zero, or that are vastly overpriced. The shares are selling at 20x this year’s earnings. But as I said, who knows what a reasonable valuation is for AMC? 20x earnings is not a cockamamie number, though, so I’d be wary on shorting.
But AMC has a competitor that is a screaming long-term buy and hold. Investors who want to hold entertainment are better off with the diversified conglomerate known as Walt Disney. Since revenues are diversified across other, more predictable, product streams besides film and TV, you can ascertain Disney’s value.
It’s also a world-class brand name with a long history. Analysts still project 15% annualized growth over the next five years and the stock is trading at a 15 P/E ratio. Disney’s balance sheet is so solid, it just raised $1.85 billion in debt at a blended rate of only 2.5%, talk about cheap debt! The company also pays a 1.2% dividend, providing very stable if not spectacular fixed income. That’s a buy. AMC is not.
I’d also be wary of Cablevision. The stock is selling at about 12x this year’s earnings, on 20% earnings growth, suggesting it is undervalued. But there’s too much unsightly management history by the Dolans, and the company carries a whopping $12 billion in debt. Debt service chews up 60% of its EBITDA, and its net margins are far below its peers. Can’t say it’s a short, but I wouldn’t hold it.