Hunger Games Not Lions Gate's Only Blockbuster

NEW YORK ( TheStreet) - Lions Gate Entertainment ( LGF) investors may have more important prey to feast on than Friday's release of The Hunger Games.

When - or if -- The Hunger Games excitement wears off investors may recognize that Lions Gate's stock surge began when the film studio acquired Summit Entertainment, the maker of the Twilight vampire movies. That deal may one day be seen as a driver of Lions Gate's profits as the studio broadens its revenue on improved international distribution, a larger movie library and the final installment of the hit vampire saga.
The Hunger Games, based on books by Suzanne Collins, arrives in theaters today.

In January, a vampire-hungry Lions Gate bought Summit Entertainment for $412.5 million in cash and stock, finalizing what was a long-rumored deal that gave the producer of Mad Men the rights to produce the last "Twilight" installment, in addition to library rights to its previous four blockbusters, which netted $2.5 billion in global box office receipts.

But according to the terms of the deal, Lions Gate only had to put up $55 million in cash, $50 million in stock and a $45 million debt offering. Most of the remaining price was paid with cash on Summit Entertainment's balance sheet, with Lions Gate also refinancing a $500 million term loan collateralized by Summit's assets. It means that earnings benefits may far outweigh the leverage increase that Lions Gate incurred with the deal.

"We think the recent acquisition of Summit Entertainment is complementary to the many strengths of each company (film and TV production, global entertainment distribution, and film libraries) and adds critical mass, as well as expertise in film production and international distribution," wrote BMO Capital Markets analyst Jeffrey B. Logsdon in a Mar. 20 note upgrading the company's price target to $14, but downgrading its outlook to "market perform."

Lion Gate's 2012 share rally began the first trading day after the Summit Entertainment deal, rising to its highest levels since Oct. 2008. In February, shares rallied to new all-time records as excitement began to mount on strong early ticket sale numbers for first installment of The Hunger Games movie trilogy based on a series of books written by Suzanne Collins and published by Scholastic ( SCHL). The Hunger Games fever hit a crescendo in March, with both companies' shares rising nearly 20% in the past month.

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While on a current price-to-earnings basis Lions Gate may look expensive, many analysts project The Hunger Games-based earnings to justify higher stock prices. Overall, Lions Gate warrants a price target of $15.57, according to consensus estimates of analysts polled by Bloomberg.

"We believe the shares warrant a premium on strong growth prospects and dominance of the young adult audience. We believe key risks include execution on the Summit integration and execution on the launch and maintenance of its first truly major movie franchise," wrote Hudson Square Research analyst Marla Backer in a Mar. 20 note, who gives Lions Gate shares a $18 price target.

Even with a successful Hunger Games opening weekend, Lions Gate isn't expected to post big numbers in its upcoming quarterly earnings. The company is expected to see its revenue grow over 80% to $588 million on the movie release; however not everyone expects the company to a profit as it absorbs production and marketing costs. Analysts polled by Bloomberg expect Lions Gate to earn $19 million in first quarter profits, with some expecting a quarterly loss.

Summit Entertainment won't immediately drive Lions Gate's profits, according to BMO Capital Markets estimates. Instead, Summit Entertainment's library of movies, upcoming films and its distribution channels gives Lions Gate new long-term earnings benefits.

Summit Entertainment's library includes best-picture winning The Hurt Locker, RED, Knowing, Letters to Juliet and the Twilight Saga of films. It also brought adds the upcoming releases of the final Twilight film called Breaking Dawn Part 2 and a sci-fi film called Ender's Game, among others.

But there are other benefits aside from the revenue generated by Summit Entertainment's movie library and upcoming releases.

Combined, Lions Gate and Summit Entertainment will grow to have a movie-making revenue prowess that will be a rival to Hollywood majors like Warner Bros ( TWX), Sony/Columbia ( SNE) and Universal. Meanwhile, Lions Gate will benefit from a better ability to distribute movies internationally for a higher fee.

"We expect continued strength in the US box office, as well as more favorable terms with exhibitors now that Lions Gate has acquired Summit to help drive theatrical revenues in future years. In addition, Lions Gate should also enjoy better leverage and profitability downstream as it increases the number of branded films it produces with its larger slate," wrote JPMorgan analyst Monica DiCenso of the acquisition in a Mar. 20 note initiating an "overweight" rating for Lions Gate and an $18 price target.

Summit Entertainment's ability to wrench out international revenue from its Twilight franchise could give Lions Gate upside as it monetizes its three part Hunger Games epic. Because revenue from Summit Entertainment's movies like Breaking Dawn will be used to pay down the loan that came with the acquisition it's still unclear how movie revenues will benefit Lions Gate shareholders.

Management said that earnings tied to Summit Entertainment's films will help Lions Gate pay down its loan in three years, some expect the deal to essentially pay for itself in a quicker fashion. "We expect the term loan to be fully repaid within three years, if not sooner," wrote DiCenso.

The acquisition was Lions Gate's first big move after surviving a multiyear battle with Carl Icahn, which included him sweeping up over 30% of the company's shares and launching =hostile takeover and merger campaigns.

In 2009, Lions Gate tried to buy MGM Studios only to be opposed by its large shareholder Carl Icahn, who also was a big holder of MGM debt. After quashing an early merger attempt, Icahn pushed for a 2010 tie-up as MGM sorted through sale and restructuring options. While talks were underway, Lions Gate sued Icahn and in Nov. 2010, MGM opted for a pre-packaged bankruptcy sale to Spyglass Entertainment.

Lions Gate then turned its focus to Summit Entertainment and rid itself of Icahn. In Aug. 2011, Icahn liquidated most of his over 30% stake in the Lions Gate as part of a settlement. Now the company's largest shareholder is MHR Fund Management, a fund run by a former Icahn partner that may see the company's strategy more favorably. "We believe that MHR is in agreement with the recent strategic decisions by management (shedding non-core assets, Summit acquisition) and does not present the same overhang on shares that Mr. Icahn's involvement in the company did," noted DiCenso of JPMorgan.

Lions Gate will look to have a big 2012 as it taps Twilight and Hunger Games viewers and tries to turn its first post-recession annual profit. Watch for the company's Summit Entertainment acquisition to be paid down quickly as it provides long-term benefits to the movie studio that may help it drive better than expected Hunger Games revenue.

Partnerships with Relativity Media, Roadside Attractions and a co-ownership of pay TV channel Epix are other recent Lions Gate deals that may also help revenue. Those deals bolster Lion's Gate's ability to distribute video on demand movies for Web services like Netflix ( NFLX) and cable providers like Comcast ( TWX).

For more on Lions Gate Entertainment, see top rated media stocks and why moviegoers are starving for The Hunger Games.

-- Written by Antoine Gara in New York

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