Q1 Revenue Pops 37%: Why AMC Networks Shares Took a Hit Anyway

AMC Networks (AMCX 2.69%) reported earnings early on Thursday, beating expectations on revenue but widely missing the mark on earnings per share. Shares got hammered when the market opened, falling more than 12% in early trading before settling in for a 8% loss at the close. Today we'll quickly address the analyst estimates before digging deeper into the first-quarter earnings for the cable network family.

The Walking Dead is keeping AMC Networks very much alive. Photo credit: Frank Ockenfels 3/AMC

Analyst summary
Though quarterly analyst estimates don't mean much for the long-term health of the stock, they can explain short-term movements, as they did Thursday. Here's a look at what analysts were expecting, and what AMC Networks actually delivered for the first quarter of 2014:

Source: Yahoo! Finance and company release

The network easily surpassed revenue estimates but came up quite short on earnings per share, which grew from $0.85 a year ago to $0.99. A 31% rise in expenses totaling $64 million ate up much of the 37% rise in revenue.

Now that the analysts are out of the way, let's dig into the actual results.

Revenue and costs both climb
The company has slightly restructured its business segments after the Chellomedia acquisition, grouping revenue from AMC Canada, Sundance Canada, and AMC Networks' Broadcasting & Technology into "National Networks," while everything else falls under "International and Other." The former segment accounts for the bulk of the company's revenues right now.

The big first-quarter boost came as advertising revenues for the company's national networks segment climbed 26.8%, topping out at $208 million. Chellomedia drove growth in the international segment, where revenues climbed 634% year over year. There is some overlap between the two segments, and this quarter that amounted to roughly $704 million that was backed out from the final revenue calculation.

Despite the 37% increase in total revenue, adjusted operating cash flow only increased 11%. Management attributed this to two factors: higher programming and marketing expenses in the national networks segment, and Chellomedia expenses.

Cause for concern?
To be sure, the network's key numbers -- advertising revenue, distribution revenue, operating income -- are all moving in the right direction; it's just that operating costs are also moving in that direction, and it's giving investors pause.

Analysts on the network's earnings call were particularly concerned with the adjusted operating cash flow margin, which was lower this year than the first quarter of 2013. Here's a look at the numbers:

Source: Company press release

What we see here is that the quality of programming has been a boon for advertising revenue and pushed net revenue straight up, but adjusted operating cash flow lags way behind on a relative basis, so far behind that as a percentage of net revenue it's actually lower than it was last year. What does management have to say for itself? We have this excerpt from the earnings call:

This is a multi-year evolution for each of the channels. ... AMC being more mature ... has a very healthy margin. As we're investing in WE, IFC and Sundance, it obviously is going to take several years to recapture and capture the investments that [are] related to the shows that we're investing in. So to the extent you're seeing margin pressure in the near term and historically in the near term, it has a result of us significantly investing in the shows on those three channels.

Management declined to give guidance on costs going forward, other than we can expect to see something similar next quarter.

The power of original programming
All of the costs the network is incurring are because AMC is investing heavily in its original programming so that it can maintain the success of programs like The Walking Dead, which is the highest rated show on television in the coveted 18 to 49 demographic. It is also intent that its new content be wholly owned, which will increase revenue in the long term. How does this work exactly? Here's some more color from management:

First quarter results reflected a strong double-digit year-over-year increase in non-affiliate revenues due to increases in revenue related to scripted original programs most notably the international and home-video distribution of The Walking Dead, as well as the SVOD [Subscription Video On Demand] availability of Rectify and the international distribution of The Red Road.

When you own your own content, you reap rewards via multiple channels, including digital viewership and international licensing. AMC's vision on this is supported by the Chellomedia acquisition, which gives the network its own international distribution channel.

Bottom line
Unlike many tech stocks you can find on the market these days, AMC Networks is actually profitable as it invests in the long-term health of its business. If you believe in this long-term vision, that is that it will develop and own its original programming, then there is a lot to like about the path the company is taking, especially now that it is expanding its footprint to include comedies. Television development is very expensive, and there may be a short-term squeeze on earnings as costs rise, but the network's ability to increase advertising revenues across channels and grow internationally may be a real opportunity for investors in it for the long run.