If you want to invest in the movie business, never mind the studios behind Spiderman, Shrek and Pirates of the Caribbean. Look to the little lion instead. Wall Street has been mesmerized by the record-breaking summer blockbuster season powered by big-budget hits from the media titans like Disney ( DIS), Viacom ( VIA) and News Corp. ( NWS). When it comes to their stock prices, however, the success of these franchise favorites too often gets buried within the consolidated results of sprawling conglomerates coping with a host of problems in other businesses. That hasn't been an issue at Lions Gate Entertainment ( LGF), one of the last remaining pure-plays on filmed entertainment. Lions Gate is known for making cheap movies with a lower profile and turning them into highly profitable offerings, but in recent months something went wrong. While its huge media rivals enjoyed the biggest summer in box office history, Lions Gate suffered a losing streak for which it was punished by investors. Its films -- like Slow Burn, The Condemned, Delta Farce, Bug, Hostel 2 and Bratz -- fizzled. Its stock shed about 15% over the course of the season. "We didn't put our best foot forward this summer," conceded Michael Burns, vice chairman with Lions Gate, at a recent media conference in New York City. On a conference call following its first-quarter earnings release in early August, Burns estimated those six films will wind up costing the studio just $15 million. Meanwhile, he predicted the next batch of movies would pick up the slack and give the company its strongest fiscal year ever in 2008, with a domestic box office target of $400 million. So far so good. The company's offbeat comedy starring Jessica Alba and Dana Cook, Good Luck Chuck, in which Lions Gate only invested $19 million, opened last month and brought in a respectable $14 million at the box office in its debut. That exceeded expectations for Oppenheimer analyst Thomas Eagan, who predicts the company will earn $12 million to $14 million on the title. Good Luck Chuck followed the strong opening of Lions Gate's Western remake 3:10 to Yuma. That movie led the box office in its early September debut with $14.1 million and continues to be strong. In August, the company released the action movie War, another solid performer.
Those films, plus its upcoming releases -- Tyler Perry's Why Did I Get Married and Saw IV, the fourth installment of Lions Gate's horror franchise -- should reap at least $175 million in revenue, according to Eagan. That would allow Lions Gate to hit its target of $400 million for fiscal 2008 and should lead to a rebound in the stock. "Assuming Tyler Perry's film grosses $60 million, this translates to the latter four films generating $29 million each," says Eagan. "To us, this is not necessarily optimistic. It is not, however, as conservative as Lions Gate's budgeting often is." Lions Gate's strict cost discipline coupled with its ability to invest in a large number of films that are usually profitable has generally yielded huge rewards for investors. "If most of their titles perform relatively in line over time, that allows them to have profits on most titles if they can keep to their budget," says Eagan. "When they produce a movie for $10 million with marketing
expenses of $10 million or $20 million, they wind up with a great return if the movie does roughly $50 million in box office, because they sell the international rights to cover half the production costs and then home video profits exceed the box office profits." Shares of Lions Gate have quintupled since Jon Feltheimer took the helm as CEO in 2000, and while it has been stagnant over the last couple of years, it looks cheap now. On a recent earnings call, Feltheimer signaled the company would be repurchasing its shares. Last year, Carl Icahn bought a 4% stake. Investors were turned off after Lions Gate missed Wall Street's profit expectations for its first quarter of fiscal 2008 that ended in late June. It reported a loss for the quarter of $53.1 million, or 45 cents a share, compared with the loss of $3.6 million, or 3 cents a share, in the year-ago period. The miss stemmed from higher marketing costs and investments in the company's TV shows, but judging a film company's performance by its quarterly accounting numbers is a fool's game. Up-front costs on films and year-to-year differences in the company's release schedule lead to wild gyrations in revenue and earnings from quarter to quarter. Lions Gate's profits have always come in the back half of its fiscal year.
Also, Eagan says the company has been punished for higher expenses on its books that will really be shouldered by its film fund, which it formed over the summer with investors lined up by Goldman Sachs ( GS). The film fund will put up roughly half of Lions Gate's production and marketing costs, and while it will limit the company's upside on profits, it will also help shelter its shareholders from risk. "The film fund gives them higher probability of being profitable on their films," says Eagan. "They'll break even on a lower box office then they would before." In addition to its film, television and home entertainment businesses, Lions Gate has the added bonus of owning the second-largest movie library in the industry, with more than 8,000 titles, including classics like Dirty Dancing, On Golden Pond and It's A Wonderful Life. Lions Gate has already been monetizing the library by selling titles to consumers as DVDs and as downloads on Apple's ( AAPL) iTunes. It has also experimented with digital delivery channels of its own, and it sells titles for use by cable operators and TV networks. Meanwhile, other such film libraries have been sold to deep-pocketed investors for huge premiums. "There are so many different ways we can make money in this game," said Burns.