Hunger Games nearly pure profit for Lions Gate

I suspect you may have heard of The Hunger Games by now.

You may also have heard of Lions Gate Entertainment Corp., the studio company that is bringing The Hunger Games to the box office this weekend. If you are a regular VOX reader, you may recall a "buy" recommendation last September when the shares were trading around $7, or a 100-per-cent gain ago.

(Hey, I'm open about my mistakes, so I'm also going to remind you about the good calls.)

The premise at the time was that the analysts were badly underestimating the potential of the Hunger Games franchise; Doug Creutz at Cowen & Co., who had an "outperform" rating at the time, modelled domestic box office of $70-million (U.S.) for the first film.

What made me suspect that was low? In part, the trading of Hunger Games "shares" on the Hollywood Stock Exchange, a website that allows users to trade shares of upcoming films. The price on HSX is based on the first four weeks of U.S. box office expectations (which make up 80 per cent or more of total). And last September, HSX priced Hunger Games at $184 (million).

Analysts have come around, significantly boosting their expectations for Hunger Games and for the cash flow it will provide Lions Gate. But are they still behind? Perhaps so.

James Marsh of Piper Jaffray & Co., in moving his price target from $14 to $20 on March 2, said he was raising his domestic box-office target from $180-million to $225-million, which at the time was above analysts' consensus.

David Joyce of Miller Tabak & Co. LLC, in raising his target price from $14 to $17 on March 20, said Hunger Games "could" generate $100-million to $110-million in its first weekend and "could go on to be a $300-million film."

Benjamin Mogil of Stifel, Nicolaus & Co. Inc., in raising his target price from $15 to $17.50 on March 21, says he has raised his Hunger Games box-office expectation to $300-million.

What does the Hollywood Stock Exchange say? In midday trading Wednesday, The Hunger Games was priced at $331.6-million.

What is the import of a better-than-expected Hunger Games performance? Nearly pure profit and cash flow for Lions Gate.

Lions Gate has rights to four Hunger Games films. Mr. Marsh of Piper Jaffray believes the costs of the first film are fixed at around $130-million, meaning there's "massive operating leverage" if Hunger Games becomes a blockbuster.

Nine months ago, when he had estimated a mere $100-million in domestic box office for the first film, he modelled profits for the entire four-film series at $130-million. When he boosted his estimate to $225-million in box office, his model revised the total profit estimate to $1.4-billion.

"The key point here is that a 125 per cent increase in domestic box office results is almost 1,000 per cent growth in profits," he says. " Hunger Games will be the single largest film in the history of the company and we get to multiply it by four."

There's no doubt that Hunger Games is the single largest economic driver for a small company such as Lions Gate, which booked just $1.3-billion in revenue, companywide, in the last 12 months. (By contrast, Walt Disney Co., a $40-billion company with $5-billion in annual profit, can afford a disaster like John Carter, whose $100-million-plus loss was also easily foreseen by Hollywood Stock Exchange.)

However, if the prospect of Lions Gate being a one-trick pony worries you, fear not. The company – legally based in Vancouver but doing much of its work from Hollywood – acquired Summit Entertainment LLC in January, giving it ownership of the Twilight vampire series, which has Breaking Dawn – Part 2 scheduled for November.

The company also produces the cable series Mad Men, which it reminded folks when it sent the show's exceptionally attractive cast to ring the opening bell at the New York Stock Exchange Wednesday.

And it has a number of other films in the works, including the sequel to the surprisingly successful Sylvester Stallone film The Expendables. Says Mr. Marsh: "Any objective look at the Lions Gate slate over the next 18 months or so reveals a remarkable list of films."

It also augurs what could be another remarkable run for the stock. You don't need the Hollywood Stock Exchange to bet big on Lions Gate – the NYSE will do.