Lions Gate: Worth More Than Icahn’s Offering

Lions Gate Entertainment (LGF), a motion picture and television programming studio, is at the center of an increasingly contentious takeover attempt by activist investor Carl Icahn. For starters, Icahn already owns about 19% of the company, but he is unsatisfied with the current managements’ plans for a merger with fellow movie studio Metro-Goldwyn-Mayer, Inc (aka MGM) which put itself up for sale after failing to make interest payments last year. So, on March 19th Icahn offered $6 per share to buy the rest of the studio, only three cents better than the previous day’s closing price. The Lions Gate board has roundly rejected that offering price from Icahn calling it “financially inadequate and coercive,” and urged investors to reject the bid as well.

Icahn, never one to shy away from a fight, issued a statement this morning where he says Lions Gate management has failed investors as evidenced by the stagnant stock price. The company’s stock has been in a holding pattern, as the rest of the market has rallied over the last year Lions Gate has returned a measly 11% in the last twelve months.

“Unfortunately, as is often the case, hand-picked boards let self-proclaimed ‘visionary’ CEOs chase their vision indefinitely, even when years pass and their vision is clearly a delusion… The road to bankruptcy is littered with companies whose CEOs – under the banner of ‘vision’ – have been permitted by lax board oversight to gamble their companies into oblivion.” – Icahn’s Open Letter to Lions Gate

Icahn vocally opposed LGF’s recent $255 million purchase of TV Guide, and he does not want the company to make another, even bigger deal. Icahn may not have to work too hard to derail Lions Gate’s attempted takeover of MGM, as a person familiar with the deal was quoted in Bloomberg saying that Lions Gate’s offer is less than a rival bid by Time Warner, Inc (TWX) for at least $1.5 billion. So, LGF management will have to really press the issue and raise their bid for the rival movie studio or it can simply let its offer lapse. Second round bids are due by Friday, but most experts assume that TWX and Access Industries will remain the highest bidder. For Lions Gate’s sake, we hope that this does not become an ego driven bidding war that pushes the price for MGM above a reasonable level because and would not be a good use of resources.

Assuming Lions Gate does not press the issue and bid higher for MGM, we think that the standalone company is worth a much better price than what Icahn has offered. It is no surprise that the board rejected his bid, but we would almost guarantee shareholders will do the same thing because they can now get a better price on the open market. The analyst community is positive on the stock with the consensus opinion among 9 Wall Street firms is a “Buy”, with a median price target of $8.50.

At Ockham, our own analysis suggests Lions Gate is Undervalued; in fact, LGF is one of the most undervalued stocks in the media industry based on our methodology. The stock currently trades well below its historically normal levels of price-to-cash earnings and price-to-sales. For example, a historical analysis of the past ten years shows that LGF has traditionally traded in a price-to-cash earnings range of 2.33x and 4.38x, but the current valuation is only 1.19x or roughly half of the low end of the historical range. Even though current EPS estimates show a slight loss, our calculation of cash earnings adds in non-cash events such as depreciation. Similarly, the historical price-to-sales per share range is .65x to 1.22x, but based on this fiscal year’s sales estimates (ends this month) that metric is currently only .49x.

Clearly, the stock fell out of favor with the market, but the underlying fundamentals have improved quite a bit recently. They are responsible for recent hits such as television’s Mad Men and the Saw horror movie franchise. Based on the current fundamentals, we believe the stock would have to trade at about $10 per share just to come into line with the low end of the historical ranges mentioned above. We cannot blame Icahn for trying to purchase the company for a song, but if he really wants control of Lions Gate, he will need to crack open the piggy bank for a little more coin.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

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