The general media stocks panic in August 2015 (following Disney's (NYSE:DIS) ESPN subscriber trends comments) and the share swap with Lions Gate (NYSE:LGF) have been brutal to Starz' (STRZA, STRZB) valuation - as if some pirates from the Black Sails Starz Originals series attacked their own mother ship.
From an all time high of $46.59 in July 2015, Starz' stock price has fallen of a cliff and now finds itself between $24 and $26. The total company is now valued at $2.5 billion market cap which buys you over 55 million subscribers (Starz & Encore combined) and net profits of between $200-250 million per year.
Remind me... What is Starz again?
Starz provides premium subscription video programming in the U.S. to cable companies, telcos,... ('MVPDs' or Multichannel Video Programming Distributor), online retailers (Amazon (NASDAQ:AMZN)) since very recently directly to consumers through its app 'Starz'. Additionally, Starz has started an international growth plan and has launched (with a local partner) Starz Arabia.
Additionally, Starz also distributes its own & other content (Starz Distribution).
Starz is not a top player. HBO, part of Time Warner (NYSE:TWX), and Netflix (NASDAQ:NFLX) are. Amazon is working hard on its Prime Video offering. Showtime is part of CBS (NYSE:CBS) and is also a strong competitor.
While Starz has good movies (agreements with Sony (NYSE:SNE) & Disney, this last one is expiring) and investing a lot in quite successful original series (Outlander, Power, Black Sails,...), Starz (still) misses an identity, lacks a voice with the customer. Also, strategically speaking, Starz is an independent company and this can be seen as a weakness. Being part of a larger group with direct access to more original content (movies, series) seems necessary long term.
That being said, Starz shouldn't be underestimated. Starz & Encore (part of Starz) combined have over 55 million subscribers in the US. Starz has distribution agreements will all major US telco, cable and satellite companies. This kind of distribution and subscriber base takes time to build and is very valuable.
Historically, Starz has long been part of John Malone's Liberty Media (NASDAQ:LMCA) empire but was spun off (actually a reverse spin) in 2013. Malone remained (and remains) a major shareholder.
One reason for this spin off clearly was to help find a partner that would acquire Starz. Since 2013 lots of M&A rumors surfaced, but not actual deal took place. However, early 2015, Malone swapped a 4.5% stake in Starz from his personal holdings for a 3.4% stake in Lions Gate and a seat on the company's board, a move widely seen as the prelude to a future marriage of the companies. Lions Gate's shares come with 14.5% of the voting power in Starz. Early 2016, Lions Gate did indeed announce they were looking into a Starz acquisition. However, almost immediately after the announcement Lions Gate stock crashed due to issues with the box office performance of some of their recent movies, taking the Starz stock along with it.
"It is like they tied one of their legs to ours, tied an anchor around the other leg and threw the anchor off the boat," Mr. Albrecht said.
What do the bears say about Starz?
It's easy to list the main negatives about Starz.
- The media landscape is changing rapidly. Starz has been and will remain a second tier player. Better and stronger competitors exist and continue to emerge in OTT (Over The Top), mainly Netflix & Amazon (and long term Alibaba & other Chinese players). Buying second tier players in a rapidly changing industry can be risky and is something e.g. Berkshire Hathaway doesn't like doing.
- Although Starz is investing a lot in original content, Starz still hasn't found a voice. Total subscriber number growth has been low. For many, Starz primarily remains a movie channel.
The content agreement with Disney only covers the films until end 2015. As of Jan 2016, new Disney output goes to Netflix.
Starz is for sale for more than 3 years now and still is not sold. The tie-up with Lions Gate could limit options and flexibility. Lions Gate itself might not be able to pay full value for Starz after the Lions Gate stock price crash.
Reasons for being bullish
- Companies with distribution assets using content have historically been able to generate a lot of value for shareholders.
- Starz itself is highly profitable business that generates good free cash flows.
- Audience studies cited by management show that Starz audiences are more diverse (African-American,...) and are true fans of their Starz Originals series.
- The entertainment industry will continue to grow in the US and internationally.
- Starz has a massive US subscriber base and should be able to grow this subscriber base thanks to more dynamic MVPDs (T, CMCSA,...), its new app for cord cutters/cord nevers in the Google Play and Apple App store.
- The international opportunity for Starz is huge. The future belongs to global subscription businesses. Starz should and will invest internationally.
- Starz is a disciplined and shareholder friendly company: John Malone owns a majority of voting rights and is (obviously) on the Board of Directors. Starz spends it money on content (output license agreements + original content) in a disciplined and controlled way. Starz uses its free cash flows and financial leverage to continuously and opportunistically buy back its own stock. Since the spin off, 23% of outstanding shares (at spin off date) have been bought back.
- Starz' large US subscriber base and distribution agreements combined with international growth opportunities make it a potential acquisition target for several media players. The past years the media speculated on tie ups with Lions Gate, AMC Networks (NASDAQ:AMCX), CBS/Showtime. Thinking out of the box, other companies might be interested, such as Disney, Amazon, Alibaba (NYSE:BABA), Dalian Wanda, Vivendi (OTCPK:VIVHY) and more.
One more reason for bullishness: valuation
No need to make things complicated:
- At current stock prices, the market capitalization is $2,5 billion. Net annual profit is approx. $200-250 million. This gives a Price/Earnings ratio of 10 to 12.
- Net debt is around 1 billion. Enterprise Value ($3.5 billion)/EBITDA ($400 million) ratio is 8.75.
Both ratios seem low if you buy into the bull arguments. A stable subscription business at scale with nice growth opportunities could easily be valued 30% higher.
We believe that any acquisition will not happen below $35 per share. Without acquisition, Starz' non-stop stock buy backs combined with a growing business will ensure that the value and price per share will move back to $35 sooner rather than later.
Starz being a subscription business a scale generates strong and stable free cash flows.
Since the Lions Gate tie up and the stock price movements in tandem, Starz management has repeatedly said they work in the interest of Starz shareholders and will only consider an offer (by Lions Gate or any other interested party) if it correctly reflects Starz' value. In the 4Q2015 results call, Starz management stated they consider the stock strongly undervalued since the February crash and they will increase buybacks. Last year, the company was buying back shares at over 40$ per share.
However, we only believe in the potential combination for Starz that fully appreciates the value of our business and provides an appropriate return to our shareholders. While we believe recent stock market volatility left our stock meaningfully undervalued, at an approximate 30% discount to our media peers and which has led to our increased buybacks, the fundamentals of our business have not changed.
At the current valuation, the Starz stock offers an attractive risk reward proposition.
We believe the downside is limited given the nature of the business (subscription based), the overall growth opportunities in a fast changing media landscape and the undemanding valuation.
Thanks to continued share buybacks and potential M&A, we see the share price moving back up to the $35 region (giving a market cap of approx. $3.5 billion and a P/E around 15) within the coming 12 months.
Disclosure: I am/we are long STRZA.
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.