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Long-Term Potential of Lions Gate Entertainment

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October 23, 2013 – Comments (3) | RELATED TICKERS: LGF

Today I opened a position in Lions Gate Entertainment (it’s near an all-time high, why not?). Lions Gate (LGF) is a relatively small rising star in the movie/television production and programming field, with hidden gems (low-cost, high-revenue projects) including the Saw franchise and, most recently, the ongoing Hunger Games franchise. Lions Gate has substantial debt and some irregular cash flow production, but the company has proven its ability to manage debt over the past several years while increasing margins.

So long as the company manages to produce sufficient cash flow and allocate incoming cash to paying down its debt levels, I see a bright long-term future for the business. Over the past year the company has reduced its debt from $1.12 billion to $917.07 million (that’s a $200 million decrease in debt in one year).

Lions Gate has shown its ability to adapt to an evolving market for movies and television programming: namely, taking advantage of growing online distribution through avenues such as Netflix with “Orange is the New Black.” Gary Bourgeault, in an article for the Fool, outlines why this is especially beneficial for Lions Gate:

What's also important to the growth of the company is the partnerships it has engaged in with streaming sites such as Netflix, Amazon and Hulu. Netflix and Amazon are particularly important to the international growth of Lionsgate, according to CEO John Feltheimer:

"This is a portion of the market that will continue to grow significantly in the years ahead because of the demand for original content from Netflix, Amazon, Hulu, and other streaming companies."

Producing online content, in other words, opens Lions Gate to an expanding online and international market. Lions Gate is a relatively new and small player in the realm of movie/television production, but the company is demonstrably innovative and adapting to a growing online and international market. Lion Gate’s CEO, Jon Feltheimer, has been with the company since 2005 and owns 2.1 million shares of common stock, making him the largest direct individual holder of the company’s common stock.

Lions Gate has its share of risks; any company with substantial debt will be vulnerable financially. However, Lions Gate is getting its financial house in order while continuing to innovate with an expanding product line and partnerships with Netflix, Amazon, and Hulu, which expose the company to an expanding online and international customer base.

While Lions Gate is close to an all-time high today (what stock isn’t?), in the ballpark of $36.30, I felt compelled enough to open a position in the stock today. An innovative and expanding product line, improving financial situation, and experienced and involved management team all contribute to my confidence in the business as a new long-term shareholder. 

3 Comments – Post Your Own

#1) On October 23, 2013 at 4:23 PM, JohnCLeven (76.17) wrote:

First, I enjoy your posts, so thanks for posting.

Also a disclosure, I don't know anything about LGF.

Now, my question for you is this. How do you value a company like this?

A quick peek shows that they've lost money more years than they've made money in the past 5-10 years, and have netted a 158 million in loss over the past decade.

The Enterprise value is $6.41B. That seems very expensive to me for such a difficult to predict asset.

I understand they have had a great 24 months, but do you really think this a sound long-term investment?

I'd love to learn more about your thinking on this one.

For me, this company would surely end up in the "too hard" pile. After all, there are many fish in the sea, my friend.

Thanks!

-John

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#2) On October 23, 2013 at 9:10 PM, TMFPencils (99.80) wrote:

Hi John,

LGF is certainly a riskier investment than many others in my portfolio. As you point out, the company has had its financial struggles over the past decade until the past two years. I don't think the story of the past two years is insignificant or a deviation from the norm, I think it is the new financial norm for the business.

The company has managed to build its margins especially over the past year, and I think their partnerships with Netflix, Hulu, and Amazon will give LGF a significant market share booth in the online and international markets (key growing demographics for LGF's business). 

The stock is also reasonably valued (and almost at a conservative level) with a P/E of 18.23. A helpful way to evaluate a stock can be the Future Value method, which is as follows: 

EPS * (Expected Growth Rate^# years) * Expected Future P/E

For instance, if LGF can grow it's EPS at an average rate of 15% per year for the next five years, and be trading in five years at a P/E ratio of 18, the stock would be valued as such in five years: 

1.99*(1.15^5)*18 = $72.05

This is a quick way to evaluate the potential future value of a stock using conservative, moderate, and aggressive rates of growth and future P/E levels. With the numbers stated above, which I would considerate moderate, LGF would double in five years. Stocks with higher P/E ratios today require aggressive growth rates in order to justify a high P/E ratio.

Does this make sense? LGF is risky in the sense that its financial situation only recently (within two years) began to improve. However, with the company's experienced management (and insider ownership) coupled with an innovative strategy to capitalize on new and growing venues for movies and television, I think LGF will continue to grow earnings and serve as a solid long-term investment.

Hope this gives you a better idea of my thinking. If you have any other questions let me know!

- David K  

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#3) On October 24, 2013 at 11:17 AM, JohnCLeven (76.17) wrote:

David, thanks for the response.

It'll be interesting to see how this thesis plays out over the next few years.

Best of luck!

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