The film production market
Six “major” studios produce ten to 30 films per year and account for an estimated 90% of gross domestic film rentals. MGMB, as we saw in the previous article in this series, seeks to produce only a handful of films, and has co-production arrangements with Sony (SNE), New Line/Warner Brothers (TWX), and Paramount respectively.
To produce a blockbuster film requires $100 million to $250 million, on average. Iron Man 3 and John Carter (neither were MGMB pictures) serve as reasonable case studies. Iron Man 3 had a $200 million production budget and generated $1.2 billion globally at the box office. John Carter, however, cost $250 million, and Disney (DIS) had to take a $117 million write-down.
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. Barber prefers what he considers lower-risk projects and likes to bring in a financial partner to protect the balance sheet. Aside from having negative net debt, MGMB has $750 million available under an undrawn revolver facility and so has plenty of capital to selectively finance/co-finance projects.
During the balance of 2013, MGMB will release the second installment of The Hobbit (opening December 13, 2013) 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 are likely to translate well abroad (and featuring a star with box office appeal).
The MGMB Film Library and EPIX
The company’s film and television library generates EBITDA of roughly $200 million—again, with little or no capital spending requirement. So, say, 8x the library accounts for $1.6 billion of the value of the $3 billion 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 set DVDs of The Hobbit, James Bond anniversary editions, et cetera). So the library is more valuable when attached to the production business.
Income from the EPIX cable channel isn’t part of EBITDA, but rather equity income. MGMB records approximately $20 million a year from EPIX, and as a 19% holder, that implies overall net income of roughly $105 million. Cable channels such as SNI, DISCA, STRZA, and AMCX trade 15 to 20x earnings. So EPIX should be worth $1.5 billion to $2.0 billion, and MGMB’s 19% stake should be worth $285 million to $385 million or $4.90 to $6.53 per share. So, to be conservative, let’s say it worth $300 million, or about $5.00 per share.
From a fundamental perspective, two-thirds of the value of the company comes from relatively stable sources ($1.6 billion library + $300 million EPIX = $1.9 billion and $1.9 billion / $3 billion = 63%, or just shy of two-thirds).
MGMB TV production
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 (long-term) 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 (TWX), Homeland on Showtime, Mad Men on AMC (AMCX), House of Cards on Netflix (NFLX), et cetera.
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 over time based on ratings. Unlike feature film investment and financing, there’s minimal speculative capital risk to MGMB when it creates and sells a TV series.
Insiders have 9.7 million options (of 12.9 million available in the plan), which struck at an average price of $37 per share. Options immediately vest upon a change of control. So management is already ($55 to $37) x 9.7mm = $174.6 million in the money in the event of a sale. Every point of share price appreciation generates $9.7 million of pre-tax gain for the options pool.
Buy MGMB because it has 72% upside and 16% downside—a risk-to-reward ratio of better than four-to-one. The business has no net debt, $750 million 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 the largest holders today are hedge funds that would welcome the opportunity to report gains to their investors.
The Market Realist Take
The company reported a 167% increase in revenue to $820.6 million in the six months ended June 30, 2013, compared to $307.8 million for the same period last year. It attributed this increase to the successful performance of its new film and television content. During the first half of 2013, it recognized revenue from its theatrical distribution and home entertainment releases of its franchise films, Skyfall and The Hobbit: An Unexpected Journey. Plus, it generated higher television licensing revenue led by strong VOD sales of Skyfall and television licensing of the series Vikings. Overall revenue for the six months ended June 30, 2013, also benefited from higher home entertainment revenue from catalog content—primarily due to targeted Skyfall promotions—as well as higher net revenue from co-produced films.
The company said industry revenue from the DVD distribution has declined in recent years due to changes in consumer behavior, increased competition, and pricing pressure. Although the decline may continue, it may be increasingly offset by growth in Blu-ray, subscription video-on-demand (or SVOD) and EST as well as from other forms of electronic delivery.
The company licenses its content for video-on-demand (or VOD), pay-per-view (or PPV), and pay or free television exploitation under various licensing agreements with customers worldwide. In the pay television market, it licenses content to channels—such as HBO, Starz, and Epix—that generally require subscribers to pay a premium fee to view the channel. In the free television market, it typically licenses both theatrically released films and television content through output agreements and on an individual basis to channels globally. It’s continually establishing output agreements with worldwide digital platforms.
Also, MGM licenses film and television content to various SVOD streaming services, such as Netflix and Amazon, and for transactional VOD distribution via cable, satellite, IP television systems, and online services. The company believes future increases in broadband penetration to consumer households, as well as shifting consumer preferences for on-demand content across multiple platforms and devices, will provide revenue growth.