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Shares of the movie production company Lions Gate (NYSE: LGF) are now down nearly 40% in 2016. This puts the stock at two-year lows and shares are off 50% from their 52-week high in November.
That move speaks volumes for what the media industry and movie stocks are currently going through. Not only are conventional cable companies feeling the pressure, but so are filmmakers – hence the Lions Gate sell-off. But there is a bright spot: All this pain may eventually lead to industry consolidation.
Lions Gate in the Dog House
The steep sell-off for Lions Gate shares was due to a dismal earnings report. And, if anything, the recent earning announcement reaffirms the reasoning for Lions Gate’s interest in merging with a cable network: the film business is proving quite volatile. Shares were off over 35% on the earnings report alone, which was the biggest drop single-day drop in well over two decades.
The latest “Hunger Games” movie wasn’t as popular as the film studio expected, and the company’s reliance on movies is proving troublesome. It still generates over three-quarters of its revenues from films, despite moving into the TV business.
About That Consolidation
One key is that Lions Gate has rekindled talks with Starz (NASDAQ: STRZA) about a merger. Recall that Lions Gate bought a stake in Starz last year and also gave John Malone a board seat. John Malone is the largest individual investor in Starz and owns roughly 10% of Lions Gate.
However, Starz shares are now down 35% in 2016 given the recent Lions Gate slide – as any deal would be a stock-for-stock transaction. Lions Gate and Starz were very close to a deal over a year ago, but tax and valuation concerns led the two to stay independent.
With the two companies seeing their stock prices fall by over 30% for the last year, it’s time to take another look at the deal. Now, we know that John Malone is a tax aficionado and he’d certainly be able to save taxes by merging his Straz with the Canadian-domiciled Lions Gate (Canadian taxes are lower than those in the U.S.).
There is some pressure on Lions Gate to act sooner rather than later as well. Starz is a prized commodity. AMC Networks (NASDAQ: AMCX) is said to have expressed interest in Starz. However, the two couldn’t agree on the valuation. The thesis here is that the two would gain a big leg up in negotiations of pay-TV carrier fees.
Now, John Malone has said that Starz needs to combine with another company to be able to compete with the other major industry players. Starz operates the Starz and Encore channels. A Starz and AMC merger would lead to a “bundle” of sorts.
AMC is suffering through the loss of big TV series like “Breaking Bad” and “Mad Men,” meaning the pressure could be even greater to make a move. Meanwhile, Starz is actually gaining ground on its peers; it passed Showtime in terms of subscriber count last year.
Buying into the media industry has been a falling knife of sorts. Just look at the likes of Time Warner (NYSE: TWX) and Viacom (NASDAQ: VIAB), down 25% and 50% over the last year, respectively.
But there are certain companies that are just too cheap to ignore. With the Starz, Lions Gate and AMC saga, it looks as if Starz is the best play. It’s the one of the cheapest media stocks – trading at less than 8 times earnings – has a double-digit return on invested capital and has the luxury of being a potential buyout candidate.
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