The AMC Networks (NASDAQ:AMCX) you know today hardly resembles the network that introduced us to Breaking Bad and Mad Men. For investors, that's probably a good thing.
Walk slow and make enough money to fund the zombie apocalypse
In the television business, there are producers and there are distributors. AMC started out as a distributor. In Web terms, you might think of the company as a curator with a budget: find some movies and programs, pay license fees, and set up a programming schedule. Cable companies would then buy that package as a channel customers could tune into, paying what are known as retransmission fees.
That was good enough for a while. Then The Sopranos changed our idea of what TV could be and YouTube introduced original Web programs. Suddenly it wasn't enough to have the televised equivalent of an interesting playlist. To compete, networks needed original programming.
So, in 2007, AMC's national networks team purchased the exclusive distribution rights to Mad Men from Lions Gate Entertainment . A year later, the company brokered a similar deal with Sony for Breaking Bad.
Getting more than a taste
Both shows had enjoyed critical and commercial success by the time AMC acquired The Walking Dead in 2010. Only this time, AMC didn't negotiate with a studio, choosing instead to work directly with creator Robert Kirkman and his Skybound imprint, which publishes "The Walking Dead" comic books. AMC wanted to control production and distribution in order to earn income from licensing, syndication, and DVD, download, and Blu-ray sales. This was a prudent move, it turns out.
According to data supplied by S&P Capital IQ, AMC national networks' revenue nearly doubled from $776.5 million in 2008 to $1.485 billion in 2013 and operating income more than doubled over the same period. Zombies were chewing up growth wherever they could find it.
Now AMC wants more, and that means owning more shows. Here's what CEO Josh Sapan told analysts during last week's second-quarter earnings call:
I'd like to emphasize that our approach today and going forward differs a bit from our approach in the past. Our current strategy is to increasingly, where we can, own our content. There's more investment at the outset with this strategy, and you're seeing how that impacts our financials. However, the strategy enables us to constantly adapt to the changing ways people consume content. It allows us to maximize the return on our investment through new sources of distribution revenue, and it allows us to widely exploit new markets internationally.
A bold strategy? No doubt. Original productions are anything but cheap.
Rent vs. own
For evidence, return to the second-quarter results. National networks' operating income decreased 4.5% despite an 11.3% gain in ad revenue. Distribution revenue was up 7% to $234 million on higher licensing, digital, and home video revenues, as well as affiliate fees.
What makes those figures doubly interesting is that ad revenue came in at $164 million in the second quarter, which means AMC earned 30% more from distribution than it did advertising. Ownership isn't cheap, but it's already paying off with The Walking Dead. Future bets are aimed at cashing in similarly.
There's risk, of course. AMC pays more upfront to acquire production and distribution rights for new shows such as Turn: Washington's Spies and Halt and Catch Fire. In the current quarter, those payments -- along with expenses related to the Chellomedia subsidiary, which didn't exist a year ago -- help push costs of good sold up nearly 69%. Call it the price of executing a broader, more ambitious strategy that should allow AMC to better control and profit from distribution of owned properties. Margins should improve as these changes take hold.
In the end, that's what makes AMC more like HBO than other cable channels. Rather than thinking about the next hit show he can acquire for cheap, Sapan -- like a studio boss -- is focused on developing franchises, as he should be. After all, the next Walking Dead is out there. Isn't it better for investors if AMC develops it first?
Editor's note: A previous version of this article referred to Robert Kirkman as "co-creator" of "The Walking Dead." The Fool regrets the error.