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Expecting Lionsgate to Maintain Year's Guidance

The only indie studio has its share of issues, but it's worth the risk in the long run.

Editor's note: This column by Steve Birenberg is a special bonus for and RealMoney readers. It first appeared on Street Insight on Feb. 9 at 11:28 a.m. EST. To sign up for Street Insight, where you can read Birenberg's commentary in real time, please click here .

Lionsgate Entertainment


reports after the close on Thursday, with a pre-open conference on Friday. Quarterly results for LGF can be quite volatile due to the vagaries of film accounting and the significance that a hit or miss at the box office can have on the numbers.

Added volatility can occur relative to expectations as the financials are difficult to model and there are relatively few analysts from which to create consensus estimates. In other words, there can be a wide range of estimates around the consensus estimate. For this reason, LGF shares have tended to be volatile following the release of quarterly earnings, with the most recent quarters exhibiting a decline in the shares as the headline figures missed estimates.

Despite some of the issues outlined below, I do not expect this quarter to disappoint investors. I also expect the company to maintain its full-year guidance. (EBITDA guidance was slashed in December, while revenue and free cash flow, FCF, were left unchanged.) If LGF can make it by this quarter, I think the path is clear for a rally in the shares to

over $10. The company should have strong March and June quarters, and a series of positive news items began with the recent surprisingly successful release of the

Lord of War

DVD and will be followed by the release of the

Saw II

DVD on Feb. 14 and the theatrical release of

Madea's Family Reunion

, the sequel to the hit

Diary of a Mad Black Woman

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, on the last weekend in February.

LGF does not provide quarterly guidance but has offered annual guidance. Presently, the company is projecting revenues of more than $850 million, EBITDA of $35 million and FCF of more than $100 million for its fiscal year, which ends this coming March 31. The revenue and FCF guidance has remained very stable, but EBITDA guidance has come down sharply. Analysts initially thought the company could produce $90 million in EBITDA this year, but in its initial guidance, LGF suggested $65 million. This past December, following the flop

In the Mix

, EBITDA guidance was slashed to $35 million. The poor EBITDA performance has weighed on the shares despite management's opinion that FCF is the relevant metric. I believe management has a point, but the difference between EBITDA and FCF is not sustainable, so there is risk in the company's ability to sustain or grow FCF without an EBITDA pickup.

The reason for the variance in the two figures is that film accounting uses the balance sheet aggressively. One significant impact on FCF comes from the difference between LGF's investment in films and amortization of films. In general, LGF has greater amortization, adding to FCF, because of ongoing amortization of the acquired Artisan film library at $20 million per year. However, so far this year, the big sources of FCF have been working capital and film obligations. Accounts receivable dropped sharply earlier this year when cash was received on DVD shipments. Film obligations (residuals, minimum guarantees and production loans) have risen sharply, and since they are a liability, they have added to FCF. The rise has been caused by two factors: 1) LGF is producing more films; and 2) the financing arrangements for the films seem to be more dependent on participation and backed by the talent and production partners.

LGF will lose this benefit once the growth of the production slate and the financing arrangements stabilize. Consequently, I remain concerned that little margin for error exists in the upcoming film and TV slate. Anything that serves to negatively impact EBITDA, such as the current performance of a new film or TV series, could lead to a cut in FCF guidance. FCF supports not only the current valuation but also the buyout valuation. As an obvious buyout target, LGF shares are supported by speculation on the downside even when movies flop. Thus, a reduction of FCF generation capabilities not only hurts current valuation but it lowers the floor that supports the shares.

Remembering the wide range of estimates, here is the consensus estimates for the December quarter. Revenues are projected $227 million in a fairly tight range. EBITDA consensus is $23 million, but I see a couple of estimates at $30 million. EPS consensus is 16 cents, but I see an estimate as high as 24 cents. I only found one analyst with a FCF estimate, which is $32 million.

Other things to look for in the press release and on the conference call include commentary about the


deal for the promotion of

Akeelah The Bee

, an update on the formation of a horror channel, whether the library margins are stabilizing in the low 20% range, possible interest in the acquisition of United Artists and a preview of the fiscal 2007 movie slate.

At the time of publication, Birenberg was long LGF.

Steven Birenberg, CFA, is president and chief investment officer of

Northlake Capital Management, LLC. Northlake specializes in managing equity portfolios using a combination of exchange-traded funds and special situation stocks. Prior to forming Northlake, Steve was a principal, director of research, and portfolio manager at Gofen and Glossberg, LLC. Prior to that, Steve was a trust investment officer at Star Bank in Cincinnati, Ohio. Steve has been managing portfolios and researching stocks for more than 22 years. Steve's research experience has included almost every economic sector with special emphasis on the media sector. Steve earned his Bachelor of Science in Business Administration from Miami University, Ohio. From 1987 through 1992, Steve taught at the CFA preparatory program the Study Seminar for Financial Analysts in Windsor, Ontario.