AMC Networks (AMCX) is a small player in a rapidly changing industry, facing significant competition and eroding traditional cable subscribers. It's also been left for dead by investors because a) it lacks scale relative to most competitors and b) its largest programming franchise, Walking Dead, is shuffling inexorably toward its final curtain. However, I think this overlooks some good characteristics:
- Creative talent with a track record of producing hits: Mad Men, Hell on Wheels, Breaking Bad, The Walking Dead.
- Excellent management and good capital allocation along with Dolan family oversight.
- Potential to either 1) operate independently, or 2) be acquired by a) traditional competitors trying to build breadth or scale, or b) tech competitors looking to acquire creative capabilities not easily built from scratch.
- Opportunities to expand into direct to consumer (DTC) with AMC Premiere, Sundance Now, Shudder, Acorn TV and Urban Movie Channel (UMC) and internationally with AMC and SundanceTV.
- A small line-up of only five channels (AMC, WE tv, BBC America, IFC and Sundance) which reduces distributor renegotiation risk.
- Growth from AMC Studios content creation and IFC Films distribution.
Cable Network Industry
Investors aren't just avoiding AMC Networks, but most of the legacy cable network businesses, too. The content apocalypse is a well-known narrative. To wit, everyone knows:
- Netflix (NASDAQ:NFLX) has changed pay TV forever.
- Scripted programming is shifting to larger-scale production.
- Cable networks are losing subscribers through the bundle to subscription video on demand (SVOD), advertising video on demand (AVOD), transactional video on demand (TVOD) and DTC alternatives.
- Virtual Multichannel Video Programming Distributors (vMVPDs) are gaining share, but also experience higher churn and are mostly losing money.
- Consumers are sharing their passwords to the detriment of both traditional and new distributors.
At the end of the day, though, content matters. If viewers want to watch programming, whether DTC, AVOD, SVOD, TVOD, vMVPDs, time shifted, or through the traditional linear bundle, they will find it and are willing to pay through 1) subscription, 2) advertising support, 3) payment or 4) some combination of the above. The companies able to produce compelling content will survive and, over time, thrive. This will likely take time to work out as content creators, distributors and consumers adapt to a rapidly changing video landscape until a new paradigm emerges and becomes dominant. Video consumption isn't going down, but up, both in developed and developing international markets, and end demand is growing as consumers watch what they want where and when they want. Networks with compelling, unique content will have viewers regardless of how the industry shakes out.
AMC Networks includes five U.S. channels. The AMC network shows original series like Walking Dead, its film library and some unscripted programming. It has 89 million subscribers and those subs declined 1.7% in 2018. WE tv has an unscripted focus, but also shows series such as CSI: Miami and Law & Order and feature films. It has 85 million subs that declined 1.6% in 2018. BBC America is AMC's joint venture with BBC of the UK, focusing on original series, natural history and unscripted programming. It has 81 million subs which increased 0.4% in 2018. IFC has a comedy focus, a minority ownership of Funny or Die, and shows feature films. It has 75 million subs that increased 1.2% in 2018. SundanceTV was originally founded by Robert Redford, and now focuses on creative and distinctive storytelling and independent films with 70 million subs that declined 1% in 2018. AMC Networks' overall decline of subscribers was 0.6% in 2018, holding up better than the average cable network lineup. Fewer channels relative to other large cable TV networks also means less likelihood of haggling over coverage where over-bloated lineups and less-popular channels are a problem.
Internationally, AMC Networks operates in 130 countries. In the UK, it has AMC, SundanceTV and Eva, as well as partnerships with Outdoor Channel and CBS Studios. In Southern Europe, it operates in Spain, Portugal, Italy and France with AMC, SundanceTV, Canal Hollywood, Odisea, Sol Musica, Canal Cocina and Decasa. In Central/Northern/Eastern Europe, it has channel lineups in sports, kids, infotainment, film and general entertainment categories. In Latin America, it operates in both Spanish and Portuguese, with AMC, Sundance, Film&Arts, Europa Europa, Mas Chic and El Gourmet. In its grab-bag other group, it operates in the Middle East with SundanceTV, AMC and IFC.
AMC Networks has also gotten into the DTC market and currently has five offerings. It launched SundanceTV in 2014, operating in the U.S., Canada and parts of Europe showing independent films, TV shows, documentaries, and original series, predominantly with licensed content. It launched Shudder in 2015 and now operates in the U.S., Canada and parts of Europe specializing in films within the horror, thriller and suspense genres, again focusing predominantly on licensed content. AMC Premiere launched in 2017 and is now shown through Comcast Xfinity (NASDAQ:CMCSA), YouTube TV (NASDAQ:GOOG) (NASDAQ:GOOGL) and fuboTV, providing mostly AMC content with no commercial interruptions. UMC, the Urban Movie Channel, was acquired just last year, showing feature films, documentaries, original series and stand-up comedy for African American and urban audiences. Also acquired last year, Acorn TV provides British and international mysteries and dramas. Acorn also has a majority interest in the Agatha Christie franchise. These five DTC offerings are expected to generate $100 million in revenue in 2019, so small but growing fast.
AMC Networks also has its own in-house production operation, AMC Studios. It was launched in 2010 with the first Walking Dead season, and has ramped to producing 15 original series this year. AMC Networks wants to have its own content and grow that original content. Having its own studio is a big strategic effort to make that happen. It also have its own film distribution arm, IFC Films, focusing mostly on independent films. This also includes Sundance Selects and IFC Midnight distributors. AMC Networks runs a broadcasting and technology group that serves AMC Networks as well as other Dolan family holdings: MSG Network, MSG+ and Mid Atlantic Sports Network. Finally, AMC owns Levity Entertainment Group, which owns comedy venues and produces original content for live, digital and linear TV.
AMC Networks' strategy is to produce and distribute high-quality content, with increasing ownership and control of that content. This effort is spread over its five U.S. and many international channels as well as DTC, studio and film distribution arms. The company's first capital allocation priority is organic investment to generate high-quality content, but the company has also demonstrated an ability to conduct tuck-in acquisitions where unique content, creative or technological capabilities can be attained. If excess capital is left over after these two priorities have been fulfilled and the price is right, it has also bought back its own shares (more on this below).
The executive team at AMC Networks is led by long-serving CEO Josh Sapan, who has been in charge since 1995 and took AMC public when it was spun out of Cablevision in 2011. The CFO, Sean Sullivan, joined AMC in 2010 and has been CFO since 2011. Edward Carroll joined AMC in 1997 and became COO in 2009. This battle-hardened team has grown revenues 12.2% per year, net income by 19.1%, free cash flow by 10.9% and EBITDA by 10.3% since coming public. That's an impressive record. The team has also done a good job of buying back stock when it has been low priced - not just buying all the time or indiscriminately. Also important, management has made smart tuck-in acquisitions which have, on the whole, added incremental shareholder value.
Pay is high for the CEO, but reasonable for other executives. Bonuses are based on revenue, adjusted operating income and free cash flow growth as well as stock performance and other subjective factors. Those are, on the whole, good metrics for this business and seem to reward management for adding value. It must be said that Josh Sapan may be worth the high pay considering both business metrics and his long tenure with the company.
The board consists of two CEOs, an academic, a private investor, an investment firm advisor, six Dolans, one Dolan-in-law, and a credit investor and consultant with Dolan connections. The board isn't great, but I think the Dolan family, which has majority voting power, are smart players willing to take the long view on growing shareholder value while also being willing to sell if an eager buyer comes along (witness Altice's buy of Cablevision).
AMC Networks faces significant competition. This includes both legacy and new threats. On the new side, it faces over-the-top distributors and content creators like Netflix, Hulu and Amazon (AMZN). It's also confronting vMVPDs like AT&T's (T) DirecTV Now, Dish's (DISH) Sling, Sony's (SNE) PlayStation Vue, Google's YouTube TV and now Apple (AAPL) too. Rounding out the new side are new distributors like Philo and fuboTV. On the legacy side are Comcast's NBCUniversal, Disney/Fox (DIS), New Fox (FOXA), Discovery (DISCA), Viacom (VIAB) and CBS (CBS), just to name the biggest.
In other words, AMCX is a small fish in a big pond. Some industries require scale to win, with wireline cable and railroads being good examples. Such businesses spread their huge fixed costs over a broad revenue base, and the broader the base, the more profits accrued. Other industries tend to have segments of high-scale dominators and lower-scale niche players, like you see in auto manufacturing, fashion and cosmetics. I think AMC Networks' industry, content creation, resembles the latter more than the former. By this, I mean it can survive and thrive as long as it can create compelling, unique, in-niche content. It doesn't need massive scale to do this, it just needs to pick its spots carefully and exploit its niches well. So far, it has succeeded in doing this. It's hard to know if it can continue its track record of producing hits, though. After all, the content creation business is notorious for making fools out of long-time players with good prior records. But neither can AMC Networks be dismissed out of hand - it has a stellar track record, narrow model and steady leadership. All this goes to say I think AMC Networks competes in an industry where niches work and it has done well there, so the odds seem good it can continue succeeding even in a crowded field.
Despite my assessment and its track record, AMC Networks is still in a disadvantaged position with respect to competitors. First, you have large content creators getting larger with Disney buying Fox, NBCUniversal buying Sky, Discovery buying Scripps, and rumors of CBS and Viacom combining. AMC Networks doesn't seem to have a dance partner, and there are growing concerns among investors that scale is needed to compete. I don't completely agree with this argument, as articulated above, because that interpretation seems to say that small, niche brands can't succeed against big competitors when the facts in many industries indicate the opposite.
In addition to large legacy content businesses, there are the large tech. So far, Netflix has pushed hardest into content creation with gobs of money thrown at the problem. But its batting average so far may serve as a proof point for AMC Networks rather than against it. Amazon is another big player that could put much more money into content, but it's been more of a distribution and buyer than creator thus far. Hulu has grown content spend, too, but is beholden to its new dominant holder - Disney - and its model will likely shift accordingly. Apple is just getting into the content side and it's not clear how far it is willing to dive into original content that would directly compete with AMC Networks. Google and Facebook (NASDAQ:FB) have different business models that could both complement and compete with AMC Networks, so it's too soon to predict what either will do. All this competition has a lot of dough it can aim at content creation, and that might jack up content and talent costs for AMC Networks, but it also could make the company an acquisition candidate for someone willing to truly get into the game.
There is little doubt that AMC Networks can't fling the same amount of dollars at new content as Netflix, Disney, Amazon or NBCUniversal, but smaller companies like Ferrari (NYSE:RACE) still compete without the scale of Toyota (NYSE:TM), and a plethora of niche cosmetics brands successfully compete against the likes of L'Oréal and Estee Lauder. It's more about finding niches and producing great content than scale itself, and there seems to be an unlimited amount of new talent that can be found to create content for a small player like AMC Networks.
At around $60 per share, AMCX looks pretty cheap. I base that on a look at both price to earnings and EV/EBITDA which are highlighted below.
AMCX's sales per share are around $48. Its sales growth has declined from low-double-digit rates 10 years ago down to low-mid-single digits now. Considering what the industry is going through, that's not bad. Granted, part of its growth rate has been due to acquisitions, which can neither be counted on nor ruled out going forward. I'm assuming a band of 1.8-6.8% growth over the next three to five years, which is at the low end of its historic range. I think this accounts for its difficult industry dynamics without being overly pessimistic. The future, however, may look different from the past, especially if its content fails or subscribers decline more precipitously than they have so far. I'd call my range conservatively optimistic.
Profit margins, too, have declined from past high levels, but not by as much as you might think: operating margins are down from 28% to 26%, net margins have declined from 18% to 15%, free cash flow margins have come down from 22% to 16%, and EBITDA margins have declined from 37% to 29%. You never want to see margins coming down, but considering AMCX's increased spending on international and DTC relative to slowing sales, those margin declines seem surprisingly small. I'm assuming 13.4% bottom-line margins (implying $6.45 in forecast earnings per share) and 29% EBITDA margins. I think those metrics are conservative and reasonable. From those levels, I think margins will either increase back up to the higher part of their historic range if international and DTC spending pays off or decline back to recent lows if things get worse - but not dramatically so. With that, I'm expecting earnings per share margins to decline 1% per year or increase 3% per year over the next three to five years.
Buybacks have become an important part of the AMCX story, recently, which means they play an important role in valuation. I know buybacks have been a lousy thing to count on as demonstrated by Viacom, Philip Morris International (NYSE:PM) and IBM (NYSE:IBM) over the last several years. However, AMCX has not been funding buybacks by underspending on growth like Viacom and IBM, or by large debt issuances like Philip Morris International. In fact, AMCX has had the cash flow to buy back shares at a 6-10% rate per year, but only started buying back shares aggressively since the third quarter of 2016. Check the price chart on any content company from Disney to Viacom and you'll see the whole sector took a nose-dive in the summer of 2016 after Disney announced ESPN's earnings would grow mid single digits instead of high single digits. In other words, management at AMCX didn't get heavy into buying back stock until investors started despising content creators. That looks like intelligent capital allocation to me (unless, of course, AMC Networks does much worse than I expect). As for AMCX going forward, I see a range of 0.5% issuance of shares if share price recovers to 7.2% buybacks if they don't. As long as revenues and margins don't fall apart, and I don't see that happening in the short to intermediate term, that range seems justifiable.
Put all those assumptions together - 1.8 to 6.8% sales growth, -1% to 3% margin growth and 0.5% to -7.2% share growth - and you get 0.3% to 17% per share earnings growth. I think growth in that range deserves an 8x to 24x multiple versus the current 8.5x at around $60 per share. That puts AMCX at the low end of my multiple range. It would also imply a market price of around $52 to $155, implying a just below S&P 500 return to a market-trouncing one from here. In other words, low downside and lots of upside. It must be added that this story has more than an average risk (more on this below), so the downside could turn out worse than I expect, and the upside would only occur if things turn out very well. I like the odds, asymmetry and upside.
On EV/EBITDA, AMCX looks like a 7.8x multiple at around $60 per share. That's using $3.1 billion in debt and minority interests, $869 million of trailing four-quarter EBITDA, and a fully diluted share count of 60.51 million (56.725 million basic plus 3.785 share equivalents in options, restricted stock, etc.). AMCX has historically traded around 7.9x to 13x, implying a share price of around $65 to $135. In that set-up, AMCX is again trading at the low end of range with significant upside potential. That upside, both in terms of fundamentals and in terms of multiples, depends on a future where AMCX doesn't turn out to be the walking dead. I've highlighted above why I believe that's the case.
Every investment has risks, and AMC Networks faces its fair share, or more so.
First, there's competition, already spelled out above. AMC Networks faces large and small, old and new competitors. Threats are legion, and in a rapidly and unpredictably changing market, no less. Such challenges could lead to increased costs for programming, and potentially create shortages of veteran talent. Increasing competition could also cause AMC Networks to be blocked from both old and new distributors. As a small fish, it may have to struggle for scraps at the bottom of the fish bowl. I think that's the narrative already priced into the stock, though. Yes, things could get worse. But it could also turn out that competitors find it as hard as they historically have to make unique, compelling content, while AMC Networks continues to do what it has been doing for over a decade: producing hits.
Next, there's the possibility AMC fails to produce new hits: a content drought. This would be very damaging for the company and its valuation, because without compelling, unique content, it's dead in the water both with distributors and relative to its competition. There's no magic formula for finding and producing excellent content, and even AMC's great track record may falter. If it can keep the hits coming, it's in a position of power with fans, consumers and distributors; if not, it's in trouble.
Decreasing subscribers are clearly a threat for AMC Networks. Its business is heavily skewed to distribution revenues, and lower subs would hit distribution revenues hard as well as advertising revenues over time. Consumers want more for less, and less could mean distributors might kick AMC Networks to the curb. This risk goes from small to large if they fail to generate new, fan-worthy content going forward. With good content, it has a hand to play with distributors; without, it doesn't. Mitigating this risk is its DTC offerings to consumers and international growth, but with small scale that would be little consolation over the short term.
Weak advertising results are another threat for AMC Networks. Lower subscribers means less revenue for showing ads, and weak content would exacerbate both sub losses and pricing for advertising minutes. Further, it's possible AMC Networks' lack of scale and digital know-how will make it difficult to compete with much bigger and more tech-savvy players from Comcast and Discovery to Google and Facebook. Exploiting advertising dollars with better knowledge and targeting of consumers has become a big and growing business, and AMC is seeking to capitalize on that with its Aurora and Mediator digital efforts. How does it stack up to the competition? It's new to the game, so I'm guessing its scale and experience aren't in the same league as others. This could make the path forward more difficult.
AMC Networks' push into international and DTC are both an opportunity and a risk. It needs to push hard in both directions, but those efforts are unproven, uncertain and risky. It's spending heavily to boost both international and DTC, but the capital spend comes long before revenue or profits. If the returns are good, then AMCX will fare well; if it turns out to be a dry hole due to competition, mismanagement, poor timing and even bad luck, then not so good. It's a huge opportunity, and a potential threat.
Having the Dolans as dominant owners could prove a downside as well as an upside. On the one hand, the Dolans have proven to be shareholder-friendly and smart, long-term-oriented, creative investors. On the other hand, they might block a lucrative takeover in hopes of a bigger score or to keep owners' economics. The Dolans could also cause the company to shift focus, make poor asset allocation decisions, or foster bad managers. There is less to fear from this risk than the others, but it can't go unacknowledged.
The content business has gotten tricky and AMC Networks has been feeling the pain - you can see it in its valuation and subscriber declines. It faces massive competition, both old and new, swimming in its waters. These threats are real, but not necessarily catastrophic. Right now, AMC Networks still owns its destiny, I believe, especially if it continues to find and produce compelling, unique content that fans love. It has a great track record of doing so, and that's still the odds-on bet, I think. There are risks to be sure, but I don't see scale or technological expertise as necessary for its success, both as a business and as an investment. AMC Networks' future is mostly a tale of story-telling, and I think it can continue writing that epic in its own way.
Disclosure: I am/we are long AMCX CMCSA VIAB DIS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: © Copyright 2019 Athena Capital Management Corp. All rights reserved. Permission is hereby granted to electronically link, forward, or store this document in its entirety or to quote passages as long as source is attributed to “Michael Rivers, CFA, Athena Capital Management.” Nothing in this letter should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this letter has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.