Lions Gate Entertainment: Why I'm Not Ready to Sign On

| About: Lions Gate (LGF.A)

As I mentioned in my previous blog entry Carnage on Wall Street and in our March investment newsletter, it was particularly difficult to find two stocks to feature this month. Amongst the stocks that I considered and then rejected were Lions Gate Entertainment (LGF) and several companies in the railroad sector.

Lions Gate is the independent Hollywood studio and distributor behind Crash, the movie that won three Academy Awards including the Oscar for best picture last year. Crash is a very powerful movie peppered with witty dialogue (the scene with the two African-American guys discussing their presence in a White neighborhood was very amusing) and I highly recommend watching it if you have not already seen it. Lions Gate is also the studio behind the gruesome but highly successful horror franchise Saw. For additional background about Lions Gate, check out this series of blog posts by Travis Johnson of One Guy's Investments who has extensively written about Lions Gate in the past.

Lions Gate appeared interesting to me because of its large library of movies (we will get to that in a moment), its successful model of investing in low budget movies that target niche audiences, the loyalty the company inspires in producers like Tyler Perry and the heavy demand for Crank, a fast paced action movie starring Jason Statham, which was recently released on DVD. If you really want to watch some cool Jason Statham movies, check out the British comedy movies Lock, Stock and Two Smoking Barrels (you will need a lot of patience to watch this one), Snatch (you may have to watch this one multiple times to understand what Brad Pitt and the rest of the cast are saying) and Mean Machine. But I digress.

As you can see from the article titled "Fox the day after tomorrow" in Fortune magazine, only 25% of a movie's revenue now comes from box office receipts, while the bulk of revenue comes from other distribution channels such as DVDs, cable and TV. Since this statistic is from early 2006, the number representing box office receipts has probably shrunk even more as additional distributions channels such as internet downloads have opened up. Lions Gate has a large library of movies and as each new channel of distribution opens up, this library becomes even more valuable. A good example of this is the recent agreement between Lions Gate and Apple (NASDAQ:AAPL) to distribute Lionsgate movies through Apple's iTunes store.

With such an interesting story, why did I decide not to feature Lions Gate this month? While Crash was nominated for 6 Oscars and won three of them last year, Lionsgate only had one nomination this year with Deliver Us From Evil, which lost in the Best Documentary Feature category to An Inconvenient Truth. Right after Crash won those Oscars, DVD sales of the movie soared, helping Lionsgate deliver stellar results in the fiscal fourth quarter last year. I am not sure the popularity of Crank or the recent iTunes deal will help Lions Gate deliver the kind of results it did last year.

Moreover with a P/E of over 30 (before the recent decline in price), the stock appeared a little pricey. The balance sheet is also not particularly strong with $325 million in long-term debt and $365 million in "other" liabilities when compared to $49.44 million in cash and $220.72 million in long-term investments. Based on these observations and the performance of Tyler Perry's Daddy's Little Girl, which received a dismal rating of 2.1 stars out of 10 on, I decided to hold off on buying Lionsgate for now.

The rise in oil prices have lead some companies to use railroads in addition to trucking companies to deliver their goods. The resurgence of coal as an energy source has also been beneficial to some railway companies and this trend is likely to continue in the future. The companies I considered in the railroad sector were Canadian National Railway Company (NYSE:CNI), Burlington Northern Santa Fe (BNI) and Union Pacific Corp (NYSE:UNP) but I decided to hold off on featuring them because of general weakness in the transportation sector and a slowdown in freight volumes related to the construction business.

I am glad I was able to find our March pick, Ambassadors Group (NASDAQ:EPAX), as an alternative to Lionsgate and the railroad companies.

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Tagged: , Movie Production, Theaters, Canada
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