Mini-major movie studio Lions Gate Entertainment (NYSE:LGF.A) is merging with premium cable channel Starz (NASDAQ: STRZA) (NASDAQ: STRZB). According to a Bloomberg report this morning, Lions Gate was in "advanced talks" and close to sealing the deal. And then the two companies issued a joint press release.
The deed is done. Depending on your point of view, Lions Gate is entering the cable broadcasting game, or Starz is getting into the movie business. Either way, it's a merger of equals.
Details of the deal
Starz and Lions Gate are nearly the same size, whether you're counting by simple market caps or weighing debts and assets to arrive at their enterprise values. Lions Gate's annual revenue is about 40% higher, but Starz catches up again when you look at free cash flow. So we have a high-volume business with a modest cash margin merging with a smaller but more efficient sector peer.
Technically, Lions Gate is the buyer. Each Starz Series A share will be exchanged for $18 in cash and 0.6784 shares of a newly created non-voting class of Lions Gate shares. In a similar arrangement for Starz Series B stock, those shares will morph into $7.26 in cash plus both voting and non-voting Lions Gate shares. This structure ensures that investors who hold voting power in Starz today will also have votes in the reformed Lions Gate, without giving free votes to vote-deprived Starz Series A owners.
Meanwhile, current Lions Gate shares will be exchanged for equal numbers of the new voting and non-voting stocks.
Both boards of directors have approved the merger, which is expected to close by the end of 2016. Lions Gate will take on new loans to cover the cash portion of the agreement, but expects to pay back the additional debt quickly via the combination of two billion-dollar cash flow streams.
The deal values Starz at $4.4 billion. All three stocks rose by double-digit percentages on the news, though Lions Gate shares then fell back to a less breathless 4% gain.
What can the new Lions Gate do?
The deal lifts two second-tier content producers into the industry's highest echelon. Together, the two studios have produced 16,000 pieces of content for TV and the cinema, with $7 billion in global box office sales over the last four years and 30 cable networks around the world. The merger should unlock economies of scale thanks to synergies and cost savings.
"By bringing together complementary resources, premium quality intellectual property and exceptional management, this strategic transaction positions us extremely well to unlock the underlying value of our content to create substantial lasting value for our shareholders," said Lions Gate board chairman Mark Rachesky in a press statement.
The deal has been a long time in the making, starting with a cross-investment between Lions Gate and Starz in February 2015. Lions Gate was already the cable broadcaster's largest shareholder, and Starz placed among the 10 biggest Lions Gate owners. When that stock swap was performed, Starz CEO Chris Albrecht called the two companies "kissing cousins."
The merger comes at a low point for both companies. Lions Gate shares fell 19% in February due to a disappointing third-quarter report. Starz's stock first jumped thanks to another round of Lions Gate merger rumors the same month, only to come in 11% lower as a result of Lions Gate's gloomy view plus Starz's own low-key earnings report. In spite of today's jumps, shares of both Starz and Lions Gate have declined in 2016 and underperformed the S&P 500 benchmark.
So this is a true giant of premium cable content in the making, with a hefty side of big-ticket movies. We'll soon know more about the new Lions Gate's plans for 2017 and beyond, as both companies are slated for earnings reports in August. All three stocks are trading far below their 52-week highs.