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AMC Networks: Value Needs A Catalyst

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About: AMC Networks Inc. (AMCX)
by: Vince Martin
Summary

AMCX is as cheap as it's ever been, at 5x+ both EBITDA and EPS.

But concerns are mounting on the top line - and this is a model with leverage on both the balance sheet and the P&L.

Sub-$50 prices traditionally have been solid entry points - but even near a multi-year low, AMCX probably needs something to change investor sentiment at this point.

AMC Networks (AMCX) is cheap. At Tuesday's close of $46.93, the stock trades just north of 5x trailing twelve-month adjusted EPS, and at about 5.4x EV/EBITDA. Those valuations come despite the fact that this isn't a declining business - at least not yet. The company is guiding for revenue and Adjusted Operating Income (which is what most companies call Adjusted EBITDA) to grow this year, if modestly. Leverage is a concern, but debt levels have come down (particularly relative to underlying profits) and AMC Networks' bonds actually have strengthened over the past ten months.

Historically, a price around $50 has proven to be an attractive entry point; indeed, I stepped in around that level back in 2016 before exiting last year. There's the possibility of a sale, with two peer takeouts coming at EV/EBITDA multiples nearly twice that AMCX currently receives. Even 'muddling through' via direct-to-consumer streaming services, expansion of The Walking Dead universe, and affiliate fee and ad pricing suggests material upside at this point.

But there are significant top-line concerns here - in a model with significant leverage, both financially and operationally, to revenue growth. The sell-off may have gone too far - but it's not necessarily unjustified, given YTD performance and the second quarter subscriber numbers across the MVPD (multichannel video programming distributor) space. There's still a credible argument that AMC Networks' profits are at a peak right now. That argument suggests that as cheap as AMCX looks, it could get even cheaper - unless and until management can find a way to respond.

The Revenue Problem

After the first two quarters of 2019, AMC Networks has maintained its initial consolidated guidance for low to mid-single-digit revenue growth and an AOI increase in the low single digits. But how the company is getting there has changed. Licensing revenue, per commentary after both Q4 and Q1, was supposed to accelerate from 2018 growth (which was in the 2-3% range). The outlook there was pulled down to ~flat performance on the Q2 call. Subscription revenue (i.e., affiliate fees paid by operators to carry AMC channels) was targeted to mid-single-digit growth after Q4; expectations there have moderated. The weakness in those categories is being offset by performance on the advertising revenue front. Early-year ratings for The Walking Dead were better than expected, according to the Q1 call, and upfront performance this spring appears solid as well.

Disclosures from AMC Networks can be thin, owing to an inability to discuss contractual matters such as affiliate fee increases (or even the length and timing of contracts). But based on disclosures in filings and conference calls, and using disclosed figures for advertising revenue in the National Networks business plus segment breakdowns in the International & Other business, I've attempted to create a workable revenue model that matches the company's discussions. Here's what 2018 and, based on guidance, 2019, look like:

Category 2018 Figure 2018 Growth

2018 % of Total*

2019 Figure 2019 Growth

2019 % of Total*

NN Advertising $944.7M -1.6% 31.4% $965M +2.1% 30.8%
NN Subscription** $996M +5.5% 33.1% $1,006M +1.0% 32.1%
NN Licensing** $472M +1.7% 15.7% $472M +0.0% 15.1%
I&O Advertising $91M +0.3%*** 3.0% $89M +5.0%*** 2.8%
I&O Distribution $507M +1.3%*** 16.8% $605M +1.7%*** 19.3%

'NN' = National Networks; 'I&O' = International & Other

* - before intersegment eliminations (~1-2% of total revenue); may not foot due to rounding

** - 2018 results as well as 2019 outlook are author estimate

*** - organic

On their face, the numbers look good enough, particularly in the context of the screamingly cheap valuation. But going category-by-category, the concerns become apparent.

Why Ad Growth Isn't Necessarily Helpful

In advertising, revenue at AMC Networks keeps falling. That held again in the first half: the 10-Q cites a $33.5 million decline in advertising revenue at AMC, a full 7-point headwind to revenue growth on a consolidated basis. There are some timing issues, and no Better Call Saul this year (though that series aired during last year's Q3), but the weakness at AMC Networks' advertising isn't new. Ad revenue at the network declined $47 million in 2018, per the 10-K, and fell the year before as well.

Higher pricing has offset some of the significant ratings pressure, most notably on flagship The Walking Dead. But that pressure continues, with the Season 10 premiere of TWD this weekend posting the lowest rating in the series' history. The company's AMC Premiere streaming service likely had an impact, as Deadline pointed out, given that it allowed for early viewing of the episode. Still, the trend in TWD is clearly negative, and that also affects the hugely profitable Talking Dead, which has benefited from millions of viewers on an apparently minuscule budget.

In addition smaller networks have been able to pick up the slack and keep ad revenue relatively stable (-1.6% last year, -3% YTD). Guidance seems to imply better back-half results, but the concern on both fronts is that the trend simply has to break at some point. After years of subscriber increases, networks like WE tv and BBC America are seeing counts peak. As far as pricing goes, management continues to insist that advertisers only have two high-quality networks from which to choose: AMC and FX. Most other 'buzzworthy' shows now are on ad-free platforms like Netflix (NFLX) or Amazon.com's (AMZN) Amazon Prime. But pricing gains can only go so far against lower ratings and lower subscribers, as the ad revenue figures on AMC have shown of late.

This is why the declines so far this year - AMCX is down 31% from brief post-Q4 highs in early March - make some sense, despite the unchanged consolidated guidance. Increasing reliance on ad revenue for growth this year suggests a longer-term problem - because investors don't believe that growth can sustain for too much longer. Ratings for TWD and Fear the Walking Dead are down, and subscriber numbers for AMC dropped 2%+ last year and no doubt have weakened even further in 2019. Pricing can't keep rising double-digits forever, even if admittedly that's what AMC in the Q2 release called out at this year's upfronts. If ad revenue growth is keeping AMCX profits afloat this year, the core concern is what happens when that growth inevitably turns to a decline.

The Subscriber Problem

Meanwhile, the revenue streams that underpinned the bull case at $50+ - and $60+ - were the affiliate fee revenue from MVPDs and licensing revenue of existing content. After all, even if TWD ratings diminished, those streams were set to be at least stable, with contractual affiliate fee increases offsetting subscriber declines in recent years.

The news on both fronts looks exceedingly concerning. Subscription revenue grew mid-single-digits last year, and was guided for a repeat this year. That guidance has come down after a decline in subscription revenue in Q2, which appears to have sparked some of the negative reaction to the report.

That decline is enormously concerning. It suggests subscriber declines have accelerated: AMC doesn't disclose those figures mid-year, but CFO Sean Sullivan noted on the Q2 call that the major operators all had reported, and "we are subject to what the world is doing". The "moderation" in the outlook for sub revenue was attributed after both Q1 and Q2 to "macro factors" - in other words, declines at distributors.

That comes after a Q2 that one analyst called "freaking ugly" in terms of cord-cutting trends, with an estimated overall rate of 5.5%. The news may be even worse for AMC, who was removed from AT&T (T) unit DirecTV Now and its 1 million-plus subscribers.

This almost certainly is AMC's biggest revenue stream, given that management said on the Q4 call that licensing revenue had cleared $400 million in 2018. It may well be in decline for good if cord-cutting, even with net additions in vMVPDs (virtual MVPDs) like DirecTV Now, accelerates. Combine even flat affiliate fee revenue with an eventual decline in ad revenue, and 60%+ of the top line is headed in the wrong direction. In this model, those lost revenue dollars come off the bottom line at very high decremental margins. Add to that the financial leverage, and free cash flow starts declining in a hurry - perhaps justifying the almost ridiculous multiples assigned to AMCX at the moment.

Licensing and International & Other

The news doesn't look a ton better elsewhere. Licensing revenue has decelerated sharply. The category grew 14% in 2017 by my model (management called out "double-digit" growth on the Q4 2017 call). AMC then saw a big jump in last year's first quarter, with a $31.7 million year-over-year increase per the Q and 25%+ growth per the Q1 2018 call.

Since then, licensing revenue is going in the wrong direction. Full-year dollar growth was just $8 million-plus for the full year. And initial guidance for an acceleration of growth this year, as noted, now has retreated to comparable performance.

It's not entirely clear what is driving the disappointment. Management last year called out the timing of releases into SVOD (streaming video on demand) windows for distributors like Hulu. But that explanation didn't necessarily seem to hold up: indeed, I wrote last November that licensing declines seemed a substantial potential risk for AMCX stock. That risk now is playing out, and in the worst-case scenario suggests that delayed viewing for the Dead franchise is disappointing. That colors both longer-term monetization of that content and the plans for a new Dead spin-off and a movie starring Andrew Lincoln (who played Rick Grimes on the series), both of which arrive next year.

Meanwhile, International & Other results seem strong - but due mostly to the acquisitions of Levity Entertainment (a talent agency and comedy club operator) and a majority stake in RLJ Entertainment last year. Organic growth continues to be modest. AMC simply has never been able to get Chellomedia, for which it paid $1 billion back in late 2013, to create consistent profitability.

There's been one piece of good news in the segment: the company's direct-to-consumer services. AMC has focused on niches like British TV (Acorn) and horror (Shudder) and is having some success. The services provided almost $10 million of growth in the first half, according to the 10-Q. The company said at a presentation last month that the services combined were on track for $100 million in revenue this year, which suggests y/y growth in the range of 20% in H1. AMC is targeting $500 million by 2024; hitting that bogey would drive 2-3% annual consolidated revenue growth on its own. But the key phrase there is "on its own": AMC Networks simply needs at least one more growth driver, and the worry at the moment is that it may not have one.

Valuation and the Bull Case

Of course, at least some of these pressures seem to be priced in at 5x earnings and mid-5x EV/EBITDA. Even with some very cheap stocks in the space - like the soon-to-merge CBS (CBS) and Viacom (VIA) (VIAB), which are trading at 6-7x pro forma EPS - those multiples are the lowest. In the context of that valuation, top-line declines can be manageable, with EBITDA margins above 30% and the company using its free cash flow to aggressively reduce its share count. (AMC Networks has bought back 25% of its shares just since 2016.)

And there's still the possibility of a sale. The Lions Gate (LGF.A) (LGF.B) takeout of Starz and the Discovery Communications (DISCA) acquisition of Scripps both were done at 10.6x EBITDA. That multiple would value AMCX at $133. There's a way for AMC, seemingly, to get a deal done at a multiple that is attractive to an acquirer but still creates real value from current levels. A Bloomberg columnist last year suggested Comcast (CMCSA) as an intriguing suitor - it could leverage TWD IP for its amusement parks - and other players might be interested at the right price. Could 8x EBITDA - which still values AMCX at $89 - get a deal done?

The case I made in the past at $50 was that AMCX was a higher-risk version of a "heads I win, tails I don't lose much" situation. (It appears I wasn't alone; $50 held as support multiple times before AMCX finally busted through to current levels, which are the lowest in nearly seven years.) The stock was cheap enough that existing performance probably kept valuation reasonably intact, while the optionality of a sale or another major hit wasn't. With the share price lower, the share count down, and underlying profits higher, it might well be easier to make that case at the moment.

But both pillars seem weaker right now. AMCX likely has been unofficially on the market for years now. It's been clear that the controlling shareholder, James Dolan, has wanted to sell former Cablevision sibling MSG Networks (MSGN) for some time. It's not clear why AMC Networks would be any different. In an era of content consolidation, surely potential buyers have at least considered AMC Networks. If a deal hasn't come yet - after three years in which AMCX has traded mostly sideways, and a reasonable multiple probably could have led to an acquisition - it's tough to see why it will now.

And the weakness in subscription and licensing revenues creates a huge problem as a standalone. AMC Networks can't cut costs significantly - certainly not on development and production - without undercutting much-needed leverage with distributors. It can't create more subscribers. Outside of Dead, its best-known shows - Mad Men, Better Call Saul, and Breaking Bad - aren't owned.

So something here needs to change relative to the current story. And, to be fair, there are some possibilities. A sale can't be completely ruled out. Management continues to believe that The Walking Dead is a franchise along the lines of Star Trek, CSI, or Law & Order, to name content CEO Josh Sapan highlighted on the Q1 call. (Worth noting: I do think AMC management, including Sapan, is more than capable, which helps the bull case.) The D2C strategy might be a winner, and allow the company to keep profits stable, which combined with buybacks could drive upside.

But there are a lot of questions in even that bull case - and a business that looks on the precipice of heading in the wrong direction. Without any real organic turnaround potential - due to the nature of the operating model - and unless AMC Networks can find a buyer, that's going to be real trouble. The market clearly has become more concerned about that potential scenario over the last few quarters - and I tend to agree.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.