Andrew Arons sends: Lionsgate Entertainment (LGF) is the most misunderstood media company on the planet. Here, I present my reasoning and analysis on why I think the shares are particularly cheap, and why I believe they will appreciate in value over the next few years, despite remaining in a tight range over the past three years. For disclosure, I have been a long time bull on Lionsgate, which has been dead money in the past. I think LGF is ready to break out of this trend, and that is why I have decided to put my thoughts to words.

For overview purposes, Lionsgate is a producer and distributor of original and purchased content. In the past 5 years, Lionsgate has amassed an enormous library of content to distribute: according to its most recent proxy, as of March 31, 2008, Lionsgate distributes a library of approximately 8,000 motion picture titles and approximately 4,000 television episodes and programs. Lionsgate refreshes this massive library with about 18 to 20 new box office pictures per year, approximately 80 direct-to-DVD movie features, and countless new television episodes, including Showtime’s hit series Weeds, AMC’s new award drama Mad Men, ABC Family favorite Wildfire, USA’s former top show The Deadzone, NBC’s new horror anthology Fear Itself and coming soon to Starz, Lionsgate’s Best Picture winning Crash is being adopted for a new TV series. These titles are just a few of what Lionsgate puts out each year, and will be discussed later on.

Often, investors in Lionsgate believe that one particular movie or show will have a significant effect on the company’s value; but this is no longer and not even close to the case. While the Saw franchise and Tyler Perry movies continue to provide support to LGF’s release slate, the company is more diversified than people realize. The company has taken steps to reduce the concentration of profits by:
1) expanding their slate
2) taking on new and larger financing partners
3) diversifying their business to include a larger television and international segment
4) often pre-selling foreign rights, and most importantly
5) budgeting their movies in a cost-effective way to prevent large losses

In these ways, Lionsgate has dramatically minimized their risks to any one picture or title. It is also true that they have minimized their gains to any one particular title as well, keeping in mind that if a success leads to a new franchise, it can still be dramatic. Lionsgate’s management has described this as “swinging for singles and doubles.” Taking their analogy further, by “swinging for singles and doubles” rather than home runs, Lionsgate doesn’t strike out much. In fact, by taking their conservative approach, even many of their box office flops eventually become profitable via DVD, television, etc. Some examples of this over the years have been Lord of War, Good Luck Chuck, Larry the Cable Guy (including his Delta Farce) and recently Jet Li and Jason Staham’s War. In fact, Lionsgate’s DVD to Box Office ratio, during calendar 2007 was a full 20% above the industry average. Below, I break down the analysis into certain categories that reflect my reasoning:

1) Lionsgate’s Valuation

OVERALL: Currently, LGF has an enterprise value of only $1.12 billion. As a result of a large increase in the size of their cash pile in fiscal 2008 (which ended on 3/31/08) and a mediocre performance of its stock price, LGF is trading at an ultimate value close to its lowest range over the past 3 years. In my opinion, this doesn’t reflect the performance of the company. For the past four years, Lionsgate has consistently produced near or above $100 million in Free Cash Flow (FCF) per year, with its most recent year being at $137 million in FCF. At $137 million, Lionsgate is currently trading at an enterprise value over trailing FCF of close to 8, which is close to 1/3 the value of Marvel, and lower than any other studio I have looked at (understanding the fact that most studios are part of conglomerates, it is hard to identify). Given Lionsgate’s performance, which I will discuss, and the fact that they are a pure-play, LGF should be trading at a premium, not a discount. Over the past 3 to 4 years, LGF has produced average revenue gains of over 30%, including a 39% gain over the past year, and CEO John Feltheimer recently said he expects double-digit revenue growth to continue this year. FCF has increased from $95.5 million in 2005, to $137 million in 2008, or a greater than 40% gain in 3 years, with proven consistency.