|Shares Out. (in M):||58||P/E||0.0x||0.0x|
|Market Cap (in $M):||3,200||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||-44||EBIT||0||0|
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Buy MGMb (http://www.MGMb.com/) because the stock has 72% upside and 16% downside, a risk/reward ratio of better than four to one. MGMb (Metro Goldwin Mayer) is a so-called mini-major movie studio that produces a handful of films each year and maintains no physical production facilities. The company also makes TV projects, owns the MGM cable network, and a 19% interest in the EPIX cable network. In addition, MGMb owns a content library that includes 4,100 movies and 10,000 TV episodes. The content library, TV production and EPIX each add stability to lumpy profits from the movie business. The studio was formed in 1924 and releases film and television content under Metro-Goldwyn-Mayer, United Artists and Orion Pictures, respectively. Today, MGMb has a 75/25 partnership with Sony on the James Bond franchise, and a 50/50 partnership on The Hobbit trilogy.
In July 2012, MGMb filed a private S-1 under the Jobs Act. No word yet on the timing of an IPO, but on 9/13/13, management adopted a poison pill and announced a $75mm buyback. Each quarter the company posts recent financials to its web site and hosts a conference call. Management then removes the prior quarter financials and the replay of the previous call.
Kirk Kerkorian has bought and sold the studio numerous times over the past thirty years. The company filed and then emerged from a pre-packaged bankruptcy in 2010. The 2010 reorganization followed Kerkorian’s 2004 sale of MGMb for $5bn to an LBO consortium backed by Sony, Comcast, TPG and Providence Equity Partners. While the company was in Chapter 11, Carl Icahn made two separate (rebuffed) offers to buy up MGMb debt in order to merge with LionsGate. Icahn was also a major shareholder of MGMb until around the time of the S-1 filing, when he sold his stake back to the company for $590mm.
Today, Highland Capital and Anchorage Capital each own over 10% of the company and have two of the seven board seats. Bloomberg reported last month that Third Point (Dan Loeb) had become a top five holder. See the most recent NYT article on MGMb for additional background (http://www.nytimes.com/2013/09/09/business/media/latest-overhaul-of-the-MGMb-studio-appears-to-be-a-moneymaker.html?pagewanted=all&_r=0).
MGMb has 58.2mm fully diluted shares outstanding at $55.00/share for a market cap of $3.2bn. Net debt is negative $44mm ($97mm debt - $141mm cash) and so TEV is $3,156mm. In addition, MGMb has $600mm of federal NOL and $700mm of California State NOL. If we convert the NOL to its present cash value we can subtract that amount from TEV. So $600mm x 35% tax rate = $210mm tax credit and $700mm x 10% state tax rate = $70mm tax credit, or $280mm cash value on a combined basis. To be conservative we can discount $280mm by roughly 1/3, leaving $200mm. Adjusted TEV would then be $3,153mm - $200mm = $2,956mm, call it $3bn.
MGMb generated $286mm of EBITDA in 2012A and management has guided to a high single digit increase in 2013, so at just shy of 9% growth, 2013E EBITDA would be $310mm. LTM EBITDA was $383mm because of a boost from the theatrical release of Skyfall in 4Q12 and The Hobbit in 1Q13.
Today the stock trades today at $3bn/$310mm = or 9.6x 2013E EBITDA (technically $2,956mm/$310mm = 9.5x). If MGMb priced at 17x, in line with its closest peer, LionsGate, the shares would be worth $95. If MGMb were to continue to trade on the same 9.5x but missed $50mm of forecast EBITDA because of a cinematic flop (and added $50mm of leverage), then the stock would be worth $46 (-16%). Given the 7.5x discount between MGMb and its peer it’s difficult to make a multiple contraction argument, so I’ve chosen to think about the downside in terms of leverage and the major uncertainty surrounding any movie business – box office success.
EBITDA and Free Cash Flow are similar here business because the company has no net debt, limited cash taxes and little or no capex requirement. For example, capex was less than 1mm both the first half of this year and in the first half of the prior year period.
Six ‘major’ studios produce 10-30 films per year, and account for an estimated 90% of gross domestic film rentals. MGMb, as mentioned earlier, seeks to produce only a handful of films, and has co-production arrangements with Sony, New Line/Warner Brothers, and Paramount respectively.
To produce a blockbuster film requires $100mm-$250mm on average. Iron Man 3 and John Carter (neither were MGMb pictures) serve as reasonable case studies. Iron Man 3 had a $200mm production budget and generated $1.2bn globally at the box office. John Carter, however, cost $250mm and Disney had to take a $117mm write down. Aside from having negative net debt, MGMb has $750mm available under an undrawn revolver facility and so has plenty of capital to selectively finance/co-finance projects.
Gary Barber (CEO) grew up on the production accounting side of the business and enjoyed tremendous success as co-founder of Spyglass pictures before being asked to run MGMb (http://www.filmbug.com/db/344022). Barber prefers what he considers lower risk-projects and likes to bring in a financial partner to protect the balance sheet.
During the balance of 2013 MGMb will release the second installment of The Hobbit (opening 12/13/13) and the remake of Stephen King’s Carrie. In 2014, the studio will release the third Hobbit movie, the remakes of Robocop and Poltergeist, and the sequel to 21 Jump Street (Jonah Hill/Channing Tatum). Also in 2014 MGMb will release the story of Hercules, featuring action star Dwayne Johnson. The next James Bond film is planned for release in 2015, after which Sony’s contractual rights to any new Bond movies expire.
It’s not accidental, given the CEO’s conservative strategy, that the 2014 slate includes a franchise film (The Hobbit), two remakes of existing commercial successes, an inexpensive comedy sequel and a universally known myth likely to translate well abroad (and featuring a star with box office appeal).
Film Library & EPIX
The company’s film and television library generates EBITDA of roughly $200mm, again, with little or no capital spending requirement, so on say 8x the library accounts for $1.6bn of the value of the $3bn equity value. If the movie business went away the library would eventually degrade and would lack the ability to bundle old films with new (matched sets DVD of The Hobbit, James Bond anniversary editions etc.). So, the library is more valuable when attached to the production business.
Income from the EPIX cable channel is not part of EBITDA, but rather equity income. MGMb records approximately $20mm a year from EPIX and as a 19% holder that implies overall net income of roughly $105mm. Cable channels such as SNI, DISCA, STRZA and AMCX trade 15-20x earnings. So, EPIX should be worth $1.5-2.0bn, and MGMb’s 19% stake should be worth $285-$385mm or $4.90-$6.53 per share. So, to be conservative let’s say it worth $300mm, or about $5.00/share.
So, from a fundamental perspective 2/3 of the value of the company comes from relatively stable sources ($1.6bn library + $300mm EPIX = $1.9bn, and $1.9bn/$3bn = 63%, or just shy of 2/3).
MGMb currently produces Vikings on the discovery channel and Teen Wolf, now in its third season on MTV. Content creators such as MGMb enjoy a secular tailwind because cable channels understand that the key to higher affiliate fees rests with having a show people see as a must have (Boardwalk Empire on HBO, Homeland on Showtime, Mad Men on AMC, House of Cards on Netflix etc..).
In a TV contract, the acquiring network pays for the cost of the production of a pilot episode. If they like what they see, then the buyer pays for the series ratably over time. Unlike feature film investment and financing, there is minimal speculative capital risk to MGMb when it creates and sells a TV series.
Insiders have 9.7mm options (of 12.9mm available in the plan) with struck at an average price of $37/share. Options immediately vest upon a change of control. So, management is already (($55-$37) x 9.7mm) = $174.6mm in the money in the event of a sale. Every point of share price appreciation generates $9.7mm of pre-tax gain for the options pool.
Buy MGMb because it has 72% upside and 16% downside, a risk/reward ratio of better than four to one. The business has no net debt, $750mm of liquidity and a solid 2014E slate of projects in addition to profits from its library, EPIX and TV production. An S-1 has already been submitted privately and management’s recent filing of a poison pill suggests takeover activity. Recall that this studio has traded hands numerous times, and that the largest holders today are hedge funds that would welcome the opportunity to report gains to their investors.
1. IPO at any time and from time to time, given valid S-1
2. Takeout - given smaller size relative to major studios and recent adoption of poison pill
3. Release of the 'The Hobbit part two' and Stephen King's 'Carrie' in 4Q13, respectively.
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