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What The Dip Means For Investors In Lionsgate

|Includes:Lions Gate Entertainment Corp. (LGF.A)

There are a number of data points I look at before I decide to invest in a company. I often begin with an analysis of the business considering both the internal and external environment. I look for companies with a sustainable competitive advantage that offer products and/or services with a unique value proposition for their customers. I also consider a detailed analysis of the company's fundamentals focusing particularly on the growth potential and the sustainability of the company's margins and free cash flow. Only then do I consider other factors like technical analysis, investor sentiment, and the influence of the macroeconomic environment.

Those who have followed me on StockTwits know that I have been an investor in Lionsgate Entertainment Inc. (LGF) since before the first Hunger Games movie. I started aggressively buying the stock when I discovered the number of English classes around the U.S. that were reading the book and planning to take their students on field trips to see the film. Social Media was trending and book sales were taking off leading up to the film. My due diligence provided convincing evidence that the management team at Lionsgate was highly competent and I became extremely impressed with the company's prospects after it's purchase of the Summit Entertainment group.

When the stock dipped to $12.75 after the release of the film I began aggressively buying more shares. I had seen that type of dip before. Retail investors flock to a stock on speculation, buying near term OTM call options in anticipation of record breaking box office returns. The stock falls until greed is overcome by fear. Wise short sellers cover their positions and go long the stock, buying shares from the retail investors who have given up on the stock and can no longer stomach their losses. Sound familiar?

After Lionsgate ran up to $37 a share it pulled back as those who caught the run from $12-$13 area began to take profits. The release of Divergent brought back speculative retail traders looking to make a quick profit by purchasing OTM call options and common stock. The film was expected to gross $50-$60 million in its opening weekend by the frenzy presented by investors and chatter on social media led to increased projections. In the week leading up to the release of the film, projections increased to as high at $68 million.

The data was extremely encouraging at the time, as social media buzz showed a very bullish level of interest in the film in the days right before its release. I have been tracking and predicting movie releases since the first film relatively successfully and was cautiously concerned with those who were calling the film the next Hunger Games. I leaned toward the high end of the $65-$70M projections but was fairly confident that Wall Street was not expecting Hunger Games like returns. With 97% of the shares owned by institutional investors I was less concerned than I had been during the release of the Hunger Games that investor greed would lead to a selloff.

This was a pretty big misread on my part. Not only did the film fail to match the box office draw I was expecting, it also sold off more than I would have expected on a relatively good box office draw. The final numbers came in just shy of $55M, the midway point in the $50M-$60M box office projection that had dominated discussion in the weeks leading up to the film. An in-line result though was not enough to ward off a selloff with an all out retail blitz on the stock.

The stock has now sold off more than 20% since the film was released and many retail investors are confused about the causes and concerned about their investments. The chart is clearly broken and technical analysis indicated a strong sell when it failed to hold the $29-$30 level. Is it time to take losses on the stock or is a turn around in order soon?

As always, the first place to consider is the strength of the company's operations and forward outlook. Few companies are positioned better in the industry to generate a positive and impressive return on assets while minimizing risk. Lionsgate has purchased the rights to an assortment of books with impressive sales figures on the hopes of continuing to convert on the success it has had with Hunger Games. Their film archive is extensive and their TV segment is projected for significant growth in the years ahead. Lionsgate makes careful decisions about which projects to take on and sells international distribution rights to cover its costs of production. The cost certainty reduces risk and allows Lionsgate to focus on its core competencies in integrated marketing communications to drive interest in their films.

From a fundamental perspective, there is a lot to like. The stock currently trades at a price that is very attractive for the firms growth prospects. It's 0.83 price-to-earnings growth ratio (NYSE:PEG) and 14.48 price to trailing twelve month earnings ratio are both particularly impressive considering both analysts and the firm's internal expectations for the company's future growth. The firm also generates high margins and very impressive returns on assets. Catching Fire broke November box office records and international sales for the second film in the series were very strong. Two-thirds of the profits generated by Catching Fire will be booked this quarter and digital sales of Catching Fire during it's launch weekend showed outstanding growth of 40% over the first Hunger Games films. Nielsen data also showed that Lionsgate was also able to convert 51% of DVD purchasers to Blu-Ray, a very impressive feat that bodes well for home release margins. MockingJay Part I is due out this November and there is little question at this point that the film will be another blockbuster.

Divergent has a promising second weekend ahead as the film received an A+ CinemaScore about viewers under 18 and an A rating on average. The film had better than expected male to female splits with 41% of those in attendance being male. Even more surprisingly, 50% of those in the audience were over 25 and only 50% admitted to having read the book. By my own very rough calculations, only 17% of those who own the book had seen the movie as of the end of the first weekend, leaving 83% of all book owners yet to see the film.

Book sales are also on the rise as the Divergent series now occupies 3 of the top 4 spots on the USA Today Bestsellers list and the top 2 spots on iTunes Audiobook Sales Chart. Similar results have been seen on Amazon and the book series is a #1 New York Times Bestseller. The most recent statement from management indicated that 1 million books were being sold per week as of a week before the film's release.

According to the recent conference call, the firm's TV segment is looking even more impressive. On the most recent call, Lionsgate executives said that they expected 100% growth in the segment in the next two to three years. Recent industry speculation of a partnership between Apple and Comcast is almost certain to drive interest in content providers. Content is king and Apple's further entry into the TV space will only amplify the focus on the importance of content providers like Lionsgate. I expect Wall Street to take notice as companies like Netflix see increased competition and the providers themselves become more valuable.

Technically, the stock is broken but there are a few indications that a bounce may be near. The stock is nearing the potential completion of a DeMark 9- count that has seen this selloff. As greed has shifted to fear and the stock nears oversold areas, now may be the time to load up. I never recommend trying to time a bottom in a stock but the idea is to buy low and sell high. I typically wait for signs of a reversal to enter and will be watching closely in the coming days.

Disclosure: I am long LGF.

Additional disclosure: The above is not a recommendation to buy Lionsgate and represents only my opinion on the prospects for the firm's business operations, not the strength or direction of its stock price.

Stocks: LGF.A