Should you be buying what Carl Icahn is selling?
Generally, it's been a better idea to be on Mr. Icahn's "buy" side: The wily investor/raider has a fine track record of extracting gains from undervalued companies. But Lions Gate Entertainment, which recently beat back Mr. Icahn's overtures after nearly two years of court cases and proxy battles, may turn out to be an exception.
To quickly review: The producer of movies and television shows struck a deal with Mr. Ichan late last month in which he sells off 44 million shares in the company at $7 (U.S.) apiece to investors of Lions Gate's choosing. Mr. Icahn essentially breaks even on the deal.
That, say a number of analysts covering the company, removes an "overhang" on the shares and will allow the market to focus on the company's business. Which, to be fair, has given investors a reason to be wary.
The company – legally based in Vancouver but doing much of its work from Hollywood – has had a light slate of films scheduled in recent months. Two of its highest-profile recent releases – the Conan the Barbarian remake and a mixed-martial arts drama called Warrior – have been duds.
Additionally, the company has what even bullish analyst Doug Creutz at Cowen & Co. calls "messy and opaque" financials. While the company claims significant profitability on an "adjusted EBITDA" basis, Mr. Creutz notes there have been losses, on a generally accepted accounting principles basis, since fiscal year 2007, and "disconnects" between its earnings measures "make it difficult to determine the company's true earnings power."
Of course, if you'd racked up $45-million in expenses battling Mr. Icahn in your most recent fiscal year, as Lions Gate did, you might search for some special effects for your accounting. Mr. Creutz (who has an "outperform" rating and suggests a valuation of at least $8 a share is reasonable) believes Lions Gate will return to GAAP profitability in the current fiscal year, now in its second quarter, and will post a level of free cash flow not seen in four years.
In recent years, the company has churned out a respectable number of hits, notably the cable television series Mad Men, Weeds and Nurse Jackie. Its biggest cinematic hit has been the Sylvester Stallone testosterone-fest The Expendables, which has a sequel in the works.
The most exciting project on the slate, however, is the adaptation of the teen novel series The Hunger Games; the Lions Gate project already earned a breathless, multi-page cover story in Entertainment Weekly. The movie is slated to hit theatres in late March.
If this sounds a little like Summit Entertainment's teen vampire Twilight series – which has grossed about $800-million through three of its five planned films – well, that's certainly what Lions Gate would like. Mr. Creutz, the analyst, has the opening film modelled at a modest $70-million in U.S. box office, virtually all flowing to the company's 2013 fiscal year. (The Hollywood Stock Exchange, a website where users can speculate on future box office receipts, has Hunger Games "shares" priced to reflect a $184-million gross.)
It's unclear what real-world investors expect from the film. However, it's fair to say they're overestimating the negative impact of declining home-video sales – down 23 per cent from their 2004 peak – on the company.
While Lions Gate hasn't been immune, the company was early to embrace digital distribution (its Mad Men syndication deal is with Netflix.) While "packaged media revenue" fell 2 per cent in its most recent fiscal year, Mr. Creutz notes, its "electronic media revenue" jumped 80 per cent. That created a single-digit gain in total home-video revenue and, with the lower costs of digital distribution, a 12-per-cent jump in segment profit.
At less than $1-billion in market capitalization, Lions Gate is smaller and less-known than industry giants like Time Warner and Disney – but that means one big hit can move the needle significantly for the company. Given recent noise in the company's earnings, Lions Gate looks expensive through most price-to-earnings measures. Given the potential of The Hunger Games and an emphasis on digital distribution, however, the company might provide investors with a Hollywood ending.
David Milstead