We are recommending a buy on MGM studios (MGMB) because it offers 72% upside and 16% downside, with the prospect of an IPO or a take-out. This post-reorganization equity trades OTC and is inexpensive in both relative and absolute terms. MGMB (Metro-Goldwyn-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 and owns the MGM cable network and a 19% interest in the EPIX cable network. It has co-production arrangements with Sony (SNE), New Line/Warner Brothers (TWX), and Paramount.
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Buy MGMb because the stock has 72% upside and 16% downside as well as a risk/reward ratio of better than four-to-one. MGMb (Metro-Goldwyn-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 network each add stability to lumpy profits from the movie business. The studio formed in 1924 and releases film and television content under Metro-Goldwyn-Mayer, United Artists, and Orion Pictures. Today, MGMB has a 75/25 partnership with Sony (SNE) on the James Bond franchise until 2015, 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 September 13, 2013, management adopted a poison pill and announced a $75 million buyback. Each quarter, the company posts recent financials to its website 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 $5 billion to an LBO consortium backed by Sony, Comcast (CMCSA), 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 $590 million.
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.
MGMB has 58.2 million fully diluted shares outstanding at $55.00/share for a market cap of $3.2 billion. Net debt is negative $44 million ($97 million debt – $141 million cash), and so TEV is $3,156 million. In addition, MGMB has $600 million of federal NOL and $700 million of California State NOL. If we convert the NOL to its present cash value, we can subtract that amount from TEV. So $600 million x 35% tax rate = $210 million tax credit and $700 million x 10% state tax rate = $70 million tax credit, or $280 million cash value on a combined basis. To be conservative, we can discount $280 million by roughly one-third, leaving $200 million. Adjusted TEV would then be $3,153 million – $200 million = $2,956 million—call it $3 billion.
MGMB generated $286 million 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 $310 million. LTM EBITDA was $383 million because of a boost from the theatrical release of Skyfall in 4Q12 and The Hobbit in 1Q13.
Today, the stock trades today at $3 billion / $310 million = or 9.6x 2013E EBITDA (technically $2,956 million / $310 million = 9.5x). If MGMB priced at 17x, in line with its closest peer, LionsGate (LGF), the shares would be worth $95. If MGMB were to continue to trade on the same 9.5x but missed $50 million of forecast EBITDA because of a cinematic flop (and added $50 million 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 because the company has no net debt, limited cash taxes, and little or no capex requirement. For example, capex was less than 1 million both in the first half of this year and in the first half of the prior year.
The Market Realist Take
In September, the company’s board authorized a $75 million share repurchase plan and adopted a stockholder rights plan. The company said by taking these steps, it intends to maximize shareholder value and thwart any “coercive and discriminatory takeover attempts.” The company said in 2012 it had made a confidential filing for an IPO but refused to provide further details. News reports on the company’s first quarter 2013 earnings call quoted chairman and chief executive officer Gary Barber as saying that an IPO is one of many options the company is considering.
In 2010, MGM had reportedly attracted bids from Lions Gate Entertainment Corp. (LGF), the Indian conglomerate Sahara India Pariwar, Reliance Big Entertainment, Summit Entertainment, Liberty Media (LMCA), News Corp. (NWS), and Time Warner Inc. (TWX).
According to a recent study by Ernst & Young, media and entertainment stocks are expected to outperform other major stock market categories. The study stated that film and television production companies will see growth due to revenues from paid digital platforms such as Amazon, Hulu, Netflix, and YouTube channels. The study said that by releasing fewer films, these companies are cutting down on production costs.
With the holiday season around the corner, the outlook for diversified media and entertainment stocks appears to be positive. Time Warner Inc. (TWX) reported 3Q 2013 earnings that beat analysts’ estimates due to growth in subscription and advertising revenue from its cable entertainment networks. CBS Corp (CBS) also reported earnings that matched analyst expectations, with revenue up 11% in 3Q 2013 as it benefitted from content licensing and distribution to online outlets like Netflix (NFLX) and Amazon.com (AMZN).