What Investors are Missing with Lionsgate

One of the negative consequences of the recent success of blockbusters "Twilight" and "The Hunger Games" for Lionsgate (NYSE: LGF  ) has been that investors have forgotten what has made Lionsgate so successful over the years.

What's even more unfortunate is that investors have rewarded Lionsgate for the larger franchises while largely ignoring the wild success of the niche markets the company has so effectively penetrated.

A couple of the more impressive niche franchises on the film side have been "Saw" and Tyler Perry's "Madea." Both of these are excellent examples of not only successfully targeting a niche, but doing it with very low-cost, profitable execution.

Here's a look at the production costs and revenue generated by "Saw" to give an example of how Lionsgate has performed in targeted, under-served markets.

 

Date Film Production Costs Domestic Revenue International Revenue
10/29/2004 Saw $1,200,000 $55,185,045 $103,096,345
10/28/2005 Saw II $5,000,000 $87,025,093 $152,925,093
10/27/2006 Saw III $10,000,000 $80,238,724  $163,876,815
10/26/2007 Saw IV $10,000,000 $63,300,095 $134,528,909
10/24/2008 Saw V $10,800,000 $56,746,769 $113,146,769
10/23/2009 Saw VI $11,000,000 $27,693,292    $61,259,697
         
Totals   $48,000,000 $370,189,018 $728,833,628

Scale is always the subject talked about by major content providers. Lionsgate chose to grow by targeting numerous niches across a variety of platforms. This is why I say that it's unfortunate for those investors who are rewarding Lionsgate because of a couple of larger hits when its bread and butter has been the niche markets it has so successfully served.

On the positive side of that is the possibility that Lionsgate will be as successful with its larger franchises as it has been with its niche markets. If it is, this could easily become the fastest-growing company in the world among media companies its size, and larger.

To give an example of Lionsgate's track record with its film choices, as of the latest quarter 22 of its last 24 films have generated a profit.

Partnerships
What's also important to the growth of the company is the partnerships it has engaged in with streaming sites such as Netflix (NASDAQ: NFLX  ) , Amazon (NASDAQ: AMZN  ) and Hulu. Netflix and Amazon are particularly important to the international growth of Lionsgate, according to CEO John Feltheimer:

This is a portion of the market that will continue to grow significantly in the years ahead because of the demand for original content from Netflix, Amazon, Hulu, and other streaming companies.

As it relates to Lionsgate, Netflix will probably be the big winner in the long run because of its Pay-TV deal for the rights to all "The Hunger Games" films. There are other smaller deals in place as well, such as "Orange Is the New Black."

Amazon's Prime Instant Video has a long-term deal with Lionsgate's EPIX HD videos.

Hulu has also entered into a deal with the content company to create a 10-episode comedy called "Deadbeat," which tells the story of a medium who helps out ghosts located in New York.

The point of all of this is that Lionsgate may be the best-positioned media company to take advantage of this growing streaming content demand because of its cost structure and the number of films it releases annually. Streaming video also does well with niche audiences, playing to Lionsgate's strengths.

Investors still catching on to Lionsgate
To this day investors continue to undervalue the cornerstone strategy of Lionsgate, even though from fiscal 2003 through fiscal 2012 it grew market share from 0.6% to 11.4% and increased revenue from $54.4 million to $1,239.1 billion. During that time the share price of the company meandered between about $4.50 a share to just under $7.00 per share in October 2011. It finally started taking off in 2012 and has soared since then to over $35.00 per share.

The introduction of "The Hunger Games" after the completion of the last installment of the "Twilight" series appears to be the main catalyst. Investors seemed convinced that the company was committed to releasing potentially larger franchise series (Lionsgate's acquisition of Summit Entertainment brought "Twilight" into its fold). Quickly paying off debt has also been a big positive for the company.

Even so, the business model of Lionsgate is still not understood or appreciated by investors, or the company would have been rewarded much quicker than it has been, and for better reasons.

Conclusion
I really like Lionsgate over the long term, even though it has soared by over 100% over the last 12 months. This has been in anticipation of the ongoing success of "The Hunger Games" franchise and the potential for new franchises going forward, starting with "Divergent" in March 2014.

However, the bottom line for long-term investors in Lionsgate isn't its commitment to potentially larger franchises, but its expertise in story selection and cost containment. That is its real competitive advantage, and the introduction and success of "The Hunger Games" and "Twilight" highlight this fact to the discriminating investor who digs deeper into the reasons behind the growth of this media company.

If Lionsgate can be successful in its selection of large franchises as it has with its smaller franchises, it will continue to reward investors handsomely for many years to come. Add its TV and streaming video content success, and it's a very compelling company to consider. Lionsgate is looking at growing its TV content to account for about 30% of its overall content.

The major question now is whether this is a good entry point. Since Lionsgate has pulled back by a couple of dollars a share since September 2013, it could be a good time to get in before the second installment of "The Hunger Games" hits theaters.

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