RealMoney Silver - Optimistic Outlook From LGF

Optimistic Outlook From LGF
By Steve Birenberg
RealMoney Contributor
2/12/2008 1:06 PM EST

Updated from 1:57 p.m. EST on Feb. 11.

Lionsgate (LGF) reported another typical quarter: some good stuff, some bad stuff and some confusion. Also, as usual, management spoke glowingly of the company's prospects.

Guidance for fiscal 2008 (ending March 31) was affirmed, and initial commentary on 2009 was constructive. Most important to the near-term direction of the shares, management indicated that the March quarter is going to be very strong -- of course, it had to be to make guidance for free cash flow. The basis for the good March quarter is that January was the best ever month for Lionsgate in DVD sales. DVD sales are very profitable and produce lots of cash flow.

My bottom line is that the likelihood of a very strong March quarter along with constructive comments on 2009 means that Lionsgate shares are a decent trading long for the next three to four months. For me, that is saying a lot as I don't like Lionsgate. I don't like the accounting. Or maybe I should say I can't reconcile it and don't like the discrepancies it creates between revenue, operating income, earnings before interest, taxes, depreciation and amortization (EBITDA), free cash flow and EPS. This makes me not trust management, which always says everything will be fine even when the numbers aren't. But I think the good March quarter is real. And the idea that the accounting discrepancies will narrow in 2009 is real. Put it together and you got a decent trade.

In the December quarter, Lionsgate's third quarter 2008, the company reported EPS of 2 cents on revenue of $290.9 million. EPS missed consensus by 5 cents, although revenue was slightly higher than expected. The miss was caused by rapid expense growth. While revenue rose 14%, direct operating expenses rose 24%, and distribution and marketing rose 26%. As a result, operating income was just $5 million vs. $24 million a year ago. Below the operating line, nothing looked unusual, so the EPS miss was due to the expense growth.

The expense growth was most likely directly related to a heavy slate of movie releases in the December quarter and January. Movie expenses come ahead of revenue, especially revenue from the DVD window. Lionsgate has not had any flops recently, so the March quarter should see the revenue benefit from the box office of these films and the huge month of January for DVD sales. This will flow through the income statement and cash flow statement in the March quarter, allowing Lionsgate to meet its 2009 guidance for at least $110 million in free cash flow. Revenue in the March quarter was guided to $400 million, which is way ahead of the current consensus of $296 million.

For 2009, the key commentary was about expenses. In response to analyst questions, management said that marketing spending in support of the movie slate would be flat with 2008. Management also said that movie production costs should be flat to down slightly. Together, these items should cause EBITDA and free cash to converge in 2009, a point reiterated by management several times on the call. It is also an important point if Lionsgate is to boost analyst and investor confidence in its outlook.

One other takeaway for me is that the combination of the good March quarter and constructive 2009 commentary suggests that Lionsgate has moved to a new, higher level of financial performance. The $110 million in free cash flow is the new base. The question for long-term investors is, How does Lionsgate kick that up to the next level? I don't have a good answer, for that is not without risk; the only answer I can think of is a dramatic increase in movie and TV production or more acquisitions. Maybe the victory for Blu-Ray in the DVD wars could provide a boost, but I view that as an incremental positive not a game changer.

LGF Preview: Accounting, Growth Come Into Focus

Lionsgate (LGF) reports after the close tonight with a conference call tomorrow morning. The numbers are usually very volatile due to the complex accounting for movie and TV production and a steady stream of acquisitions.

Earnings are projected at 7 cents per share on revenue of $289 million. A year ago, EPS came in at 17 cents on revenue of $254 million. Operating income is expected to be down significantly despite the higher revenue, due to a heavier movie-release schedule that brings marketing and production into the current quarter ahead of the full cycle of revenue from the films.

All of these estimates should be taken with a grain of salt. The range of EPS estimates for the quarter is 8 cents on the upside, to a loss of 23 cents. Revenue estimates range from $266 million to $303 million.

Lionsgate had a good December quarter at the box office, led by Saw IV, Why Did I Get Married, 3:10 to Yuma and Good Luck Chuck. The current quarter is off to a mixed start as Rambo and The Eye are at the low end of expectations.

While box office is the sizzle at a studio, this studio's strength is in converting box office to DVD. All of the recent titles have performed well enough in theaters that conversion to DVD sales should allow the company to be profitable on the slate.

Lionsgate's TV business is also growing, thanks to acquisitions and increased production. TV revenue this quarter should be around $50 million, up considerably from $32 million a year ago. TV can smooth out the lumpiness in films. TV also can help the multiple on the shares, given that it is more predictable.

The two things that keep me away from Lionsgate shares are the accounting and my inability to see how current earnings before interest, taxes, depreciation and amortization (EBITDA) and free cash flow take the next step up without the large risks associated with a substantial increase in movie production or the acquisition of a library or studio.

On accounting, what I want to see is a closing of the gap between EBITDA and free cash flow. On growth, I'd like to hear management explain how the company is going to take free cash flow from its recent resting level of $80 million to $100 million, up to $120 million or more. Clarity on these issues is what I think investors should be looking for on the conference call.

One final question I'd like to hear an analyst ask is how to replace the growth that had been driven by the Saw franchise. Saw II represented the peak in the franchise, with a box office receipt of $87 million. Saw III dropped to $80 million, and last year's Saw IV was just $63 million. The franchise has value, but it is no longer a growth driver.