Why Did John Malone Invest in Lions Gate?

June 2, 2015 Moats 15 Comments

Just like making movies. God help us if we think we can pick winners and losers when it comes to making movies. Even the good guys don’t know how to do that. There are certain fields, in my experience, that it’s good to stay out of. One can be a good investor in them, if one’s prudent, but one shouldn’t fool oneself into thinking one knows how it really works.”

–  John Malone, “John Malone Talks of His Past and Future,” Denver Business Journal, 4/29/09

On February 10, 2015, Lionsgate Films (LGF) announced that John Malone would swap stock in Starz (STRZA) for LGF shares and a board seat.  The equity was valued at $150 million.  As we continue our look at Malone’s media properties, we turn our attention to this recent transaction.

For all its glamour, film and TV production is a lousy business to be in.[1]  None of the standard building blocks of competitive advantage are found in content creation:

  • Limited free cash flow. Making movies is highly capital intensive.  Even worse the producer must incur the full costs of production before being able to predict the potential market for the product with any certainty.
  • Highly variable cash flow with no easily identifiable drivers to forecast future earnings.
  • No brand value. None of the studios, with the possible exception of Pixar, have any customer loyalty.
  • No customer captivity. Except for certain franchises, each product must win customers anew.  But even with franchises the company is much less likely than the talent to reap the benefits.[2]
  • No economies of scale. The size of a studio does not reduce the cost of making a motion picture.

Consequently, profit margins for even the largest and most efficient content producers can be volatile and average ROIC is lower than that of other players int industry.

With these issues in mind, why would Malone, an Outsider CEO and a savvy deal maker, invest in a content studio of all things?

Background

Before we dig into the rationale for this deal, some background on the industry structure is required.

The Traditional Video Value Chain

For the past decade or two, the fundamental value chain of the TV ecosystem has been relatively stable (See Figure 1).  What are the major segments?

Figure 1

Value Chain

Content Creation – Content creation involves the development and production of video and film content.  The structure of the production segment is very top-heavy.  Six “major” studios represent 70% of the US box.  Four “mini-majors,” including LGF, represent a further 17%.  The six majors are Warner Bros., 20th Century Fox, Columbia, Universal, Paramount and Buena Vista.  They are all divisions of much larger media conglomerates.  As discussed above, this is a very tough segment of the industry.

Aggregators – Aggregators are in the business of aggregating content created by other companies and presenting it to consumers.  Aggregators have three revenue models: ad-supported (broadcast TV networks), ad-supported plus cable retransmission fees (cable networks) and subscription-supported (Starz, Netflix).  Aggregation has strong economies of scale.  Aggregation requires a large fixed-cost infrastructure to collect, manage, market, and redistribute content.  Many aggregators enjoy high degrees of customer captivity.  Traditional media aggregators, such as cable channels, structurally act as wholesalers, whose customers are not the individual consumers but the cable operators who manage the pipe to the home.  Newer aggregators such as Hulu, Netflix and Amazon deal direct with the customer.

Distribution – Distributors provide the infrastructure through which media content reaches consumers.  Distributors pay for the programming and charge consumers for access to the programming.    The traditional mechanism by which consumers access video content is via a subscription to a package of channels from a pay-TV distributor (cable company, telco or satellite provider).  For example, TWC offers 6 bundles ranging from 20 channels to over 200.

The Traditional Video Profit Pools

Under the traditional system, content creators received a small slice of the pie (See Figure 2).   All of the major studios have found it advantageous to be part of a larger conglomerate rather than to try to go it alone.

Figure 2 – EBITDA Margins of Entertainment Industry Participants

EBITDA Margins

Aggregators have done well in the traditional industry structure.  They have been able to extract large retransmission fees from the pay-TV distributors.  They have also benefitted from the cable bundle which effectively acts a mechanism to transfer money from the most popular channels to the less popular.

Distributors, particularly the cable operators, reaped outsized rewards.  Such superior value creation has been based in large part on three cable industry structural advantages: superior technology (Cable is the most efficient / fastest way to get a 2-way data connection to a house to consume video and internet.); a content distribution model ideal for content creators to monetize their product (number of subscribers makes it the best way to monetize their product at scale); and a favorable regulatory environment.   Showing the power of their local monopoly, media-distribution companies have among the worst customer relations in any industry: J. D. Power ranked the cable companies 18th out of 19 industries in service.  Yet, they continue to make money.

Vertical Integration

As alluded to above, the filmed entertainment industry has always been characterized by high levels of vertical integration.  Vertical integration is the combination in one company of two or more stages of production normally operated by separate companies.  The large media conglomerates have all followed strategies of vertical integration.  The benefits of vertical integration are fairly clear.

Specifically with regard to content producers, despite the unfavorable risk-return profile, content producers have been regarded by media and entertainment companies as valuable strategic assets.  Why?  Secured access to their current content and the content libraries can give vertically integrated companies an advantage in launching or defending virtually all downstream distribution platforms.

More broadly, by capturing as much of the value chain as possible, it creates a natural hedge against any shifts in the relative power of industry players. In substance, vertical integration stifles competition and creates a moat.

The Rise of the Cord Cutters?:  The Impact of Technology on the Traditional Value Chain

For a variety of reasons[3], a competing distribution model, known as “Over The Top” or “OTT,” has appeared in recent years.  OTT comes in several different forms but it fundamentally involves video content going over the top of the traditional TV distributors and to the consumer via the Internet.  These streaming services charge a recurring subscription fee and allow subscribers to watch as much content as they want.  The rate of “cord-cutting” (switching to streaming Internet sources of video content) is accelerating.[4]  In Q1 of 2015, the pay-TV operators suffered a net loss of 31,000 customers – equivalent to a .5% annual contraction rate.  The Q1 2015 decline follows the loss of 1.4 million households in calendar year 2014.[5]

Among the potential scenarios playing out in the next few years, is one where OTT becomes the norm rather than the exception.[6]  Such a change would have profound effects on the ecosystem.  One such effect, already being seen, is that fragmentation and new technologies will make mediocre content a commodity.

As discussed more below, video content is not about the long tail.  It is about the hits. In the OTT world, the aggregator can no longer count on their service being promoted by the distributor.  OTT demands a strong link between the consumer and the aggregator.  An OTT aggregator (NFLX, AMZN, HBONow) must have compelling content to attract attention in the newly crowded field.  There is no doubt that an aggregator like ESPN has sufficient must-see content that they could successfully go direct.  HBO is in a similar position and unveiled their OTT service earlier this year.  On the other end of the spectrum are aggregators that benefitted enormously from being part of the cable bundle. If the cable bundle falls apart, they could desperately scramble for premium content.  In sum, OTT could drive a shift in the value chain from the traditional distributors to the content creators.

As a result, we already see the beginning of a seller’s market for content with many outlets competing for must-see productions.  A growing number of digital platforms with a strong appetite for content continue to emerge alongside traditional customers.  Netflix, Amazon, HBO, Showtime and others are all hungry for content and pushing up prices (See Figure 3).

Figure 3 – Major Purchasers of Filmed Entertainment

Buyers Landscape

Source:  Internal Sony Presentation via WikiLeaks

What remains to be seen is just how much the market will skew even more to the benefit of content creators.  How aggressive will the new aggregators be in terms of acquisition of exclusive content rights?

In the most extreme case, we may see a “no holds barred” price war break out in an attempt to grab “exclusive” content to distinguish one’s package. DirecTV already pays $700 million per year to the NFL to have an exclusive offering of every NFL game on every weekend, and they recently coughed up over $4 billion to extend this deal.[7]  Netflix reportedly pays $4 million per episode of “Orange is the New Black.”  And HBO pays even more for “Game of Thrones” at $6 million per episode.[8]  What if other aggregators look for unique differentiation and an increasingly expensive arms-race breaks out? If this happens, any aggregator without deep pockets will be holding a knife at a gun fight. A winner-take-all dynamic could take hold whereby consumers coalesce around a few aggregators.

What Business Is LGF In?

LGF is a primarily a film and television production company.  It is a top-tier studio with a successful track record of creating hit TV series and motion pictures.  Like most studios, LGF is essentially a vehicle for financing the production, marketing and distribution of filmed entertainment.  LGF operates in two segments:  Theatrical Motion Pictures and Television Production.  It derives most of its profits from the home entertainment channel.  Its also participates in a number of JVs and partnerships that are of limited materiality (See Figure 4).

Figure 4

LGF Overview2

The Motion Picture Segment

The motion picture production process begins with an idea which is either pitched to the studio by an outsider and then purchased or developed internally by the studio’s internal staff. Over the next 3-4 years, at an average cost of $63M, the idea is nurtured, developed and finally produced into a feature length film.  The film is then distributed to the public through different channels in a process known as “windowing” (See Figure 5).   In general, the economic life of a motion picture consists of its exploitation in theaters and in ancillary markets such as home entertainment, pay-per-view (“PPV”), video-on-demand (“VOD”), electronic-sell-through (“EST”), subscription video-on-demand (“SVOD”), advertiser-supported video-on-demand (“AVOD”), digital rentals, pay television, broadcast television, foreign and other markets.

Figure 5

Windows

Revenue from theatrical releases has declined in importance over time.

The Television Production Segment

The Television Production segment includes revenues derived from the licensing and syndication to domestic and international markets of one-hour and half-hour series, television movies, mini-series and non-fiction programming, and home entertainment revenues consisting of television production movies or series.  We generate revenue principally from the licensing and distribution of such programming to broadcast television networks, pay and basic cable networks, digital platforms and syndicators of first-run programming, which license programs on a station-by-station basis.  LGF currently produces, syndicates and distributes 34 television shows on 22 networks and distribute hundreds of series worldwide.

Results have been inconsistent over the past 10 years but with a market improvement recently (See Figure 6).

Figure 6 – Ten Years of LGF Free Cash Flow

FCF

Channels

The primary channel owned by LGF is EPIX.  EPIX is a joint venture between LGF, Viacom/Paramount and MGM.  EPIX is distributed via pay-TV operators and OTT.  EPIX was established in 2008 but it did not begin generating meaningful returns until 2014 (See Figure 7).  It is unclear how EPIX will coexist alongside Starz.

Figure 7 – Rapid Growth of EPIX Earnings, 2013-2105

EPIX

Recent results have been middle of the pack of all major content studios (See Figure 8).

Figure 8 – OIBDA Margins for the Major Studios

OIBDA Margins

What Business is Starz in?

Starz is a content aggregator.  It enters into agreements with studios for the rights to show their content over the Starz and Encore channels. This includes a combination of recent box office movies, older movies from studio libraries and original content. Starz must then sell its product, thereby entering agreements with various pay-TV distributors such as Comcast, DTV, Dish, Cablevision, Time Warner Cable, Verizon, etc. to distribute the Starz service to consumers in exchange for a monthly fee.  Starz makes money when cable and satellite TV consumers subscribe to the Company’s channels in addition to a basic cable package.  The cable and satellite affiliates are incentivized to sell the Starz package as the affiliates collect a significant portion of the subscription revenue.

While Starz on the surface may not appear to own a meaningful piece of the value chain as a wholesaler, the Company in fact enjoys a nice competitive based on scale.

What Is John Malone’s Strategy? 

Malone’s strategy in investing in LGF is based on the benefits of vertical integration.  Malone has always believed in vertical integration.[9]   Most famously, as owner-operator of cable company Tele-Communications Inc. from 1973 to 1996, he took ownership interests in a number of the cable networks he distributed over his system.  Similarly, this is not Starz first venture into content creation.  In 2006, it launched Overture Films which produced theatrical motion pictures. The studio never made much money and was closed in 2010 after it failed to fetch an adequate price from potential buyers.  A third example is the current operations of Liberty Global (LBTYA) and Discovery Communications (DISCA), two other Malone controlled companies.   Discovery is a vertically integrated content company that owns domestic and international channels and produces most of content that airs on its channels (See Figure 9). Liberty Global is a vertically integrated cable company that owns non-US cable systems, international channels and produces some of the content that it airs. Recently, Discovery and Liberty Global together acquired All3Media, a producer of unscripted content.  David Zaslav, the CEO of Discovery, described the acquisition as a “bit of a hedge on IP” if there is a future land rush on exclusive content rights.  “…(R)ight now All3 sells content to anyone, if the marketplace started to get more competitive where our competition was buying content and restricting that content would be produced only for them, we have some content that’s a big provider to us in Europe that we know that won’t happen to.”

Figure 9 – Discovery Communications Content Model

DISCA Content

Thus, Malone’s investment in LGF as a response to the potential rise of the content creators.  As Malone himself said:

It all has to do with access to content. It really is about access to content. The content that people care about, the content that will really move people, is pretty much controlled by big programmers like Disney, who are not about to shoot themselves in the foot. And so they are going to exploit it across all platforms in a very orderly and well thought through way. You know, right now cable has been a very effective monetization scheme for cable networks … [10]

Similarly, Greg Maffei, Chairman of Starz, stated:  “I think John, who has been a keen observer of trends in the media business, is of the belief. . . that content creators are getting new power through new platforms.”[11]

Starz could certainly strengthen its position through vertical integration.[12]  By controlling distribution as well as production, he argued, entertainment companies could synergize their product endlessly and thus ensure a solid return from a volatile business.  Starz was getting squeezed at both ends as higher programming costs and lower fees paid by affiliates trimmed operating income from $297 million in 2002 to $163 million in 2006.

Why Is LGF Itself a Good Investment?

Successful Risk Mitigation Model

Perhaps what attracted Malone to LGF is their risk mitigation model.  The content business is famously uncertain and unpredictable and based upon the tastes of a fickle public.  Entertainment is clearly a risky, high-stakes game with both enormous payoffs and calamitous failures that playout in an environment of maddening uncertainty.  Yet, LGF has a well thought out strategy and multiple revenue streams that help to counter the inherent volatility of the business.  Has LGF been able to move far enough along the continuum from art to science to reassure Malone that money will not be wasted?  There are several facets to LGF’s risk mitigation mode.

Two-Prong Business Strategy

In the film production business, LGF pursues a two-prong strategy.  It goes after both broad-based franchises and highly targeted niche movies.

Niche Movies

Until 2012 or so, LGF was the smaller, scrappier younger brother of the six major studios.  It released such distinguished films as “Crash,” “Monster’s Ball,” and “Away from Her,” but it has made its reputation with edgy, low-budget action and horror movies, particularly the five “Saw” films.  It was also strong in the urban niche due its relationship with African American filmmaker and actor Tyler Perry.

But its biggest earners, “Monster’s Ball” and the first “Saw” film, each netted a relatively modest forty to fifty million dollars, and its distribution deal for Tyler Perry’s comic melodramas—sizable hits, all six of them—has made the studio only about a hundred and twenty million dollars in all. The larger studios can lose more than a hundred million dollars on a film fairly easily, yet their occasional tent-pole blockbusters can generate six hundred to eight hundred million dollars in profits. And tent poles spawn sequels that give the studio some assurance of profitability in years to come.  As a result, beginning with the Summit acquisition in 2012, LGF moved aggressively into the tent-pole business.

Yet, LGF has continued to focus on genres and specific affinity groups.  This foundational niche business continues throw off reliable profits.  LGF has a 49% interest in Pantelion Films, the first major Latino Hollywood studio.  In fiscal 2014, Pantelion Films theatrically released Instructions Not Included, the highest-grossing Spanish-language film ever at the domestic box office.  In May 2012, we announced that we entered into a partnership with CodeBlack, a company dedicated to producing, marketing, and distributing quality content that appeals to the African American and urban consumer market.  LGF’s deep knowledge of these niches allows them to run hyper-efficient, targeted marketing campaigns.  Still even a hit like Addicted grossed only $17 million.  You need an awful lot of niche hits to equal one blockbuster.  But, LGF’s deep domain knowledge and efficient operations allow the niche films to provide a steady flow of profits and ease the variability of the movie business.

Event Films

The tent-pole strategy pursued by LGF and the other major studios is fundamentally misunderstood.  The studios increasingly rely on bigger bets on fewer movies. On the surface, this strategy would seem to increase risk by decreasing diversification and heightening the probability of a destabilizing flop.

Harvard Business School Professor Anita Elberse articulates this skepticism perfectly in her book Blockbusters:

Why would film or television executives choose to put themselves in a position where their company’s overall performance – or even survival – rests on a few big product launches each year, and let spending on those products reach levels that make recovering costs appear almost impossible?  Especially in an industry in which audience demand is fickle and failure rate is so high, would it not be more sensible in the long run to forgo these kinds of outsize investments and instead place a larger number of smaller bets, closely guarded costs, and “manage for margins”?

But, just the opposite is true.  Somewhat counter-intuitively, the bigger budget films tend to out-gross their cheaper brethren.  It makes more sense to produce four or five movies per year with the broadest appeal – so-called tent-pole or event films – and support those films with a disproportionately large percentage of its total production and marketing budget.  As a result, over the past 10 years, we have seen a dramatic decline in the number of films produced by the major studios (See Figure 10).

Figure 10 – Number of Films Produced By Major Studio Dropping Over Time

Sellers Landscape

Source:  Internal Sony Presentation via WikiLeaks

Why does this strategy work?  A number of characteristics have been found to reduce the risk of a movie and increase its consumer appeal but they all cost money.  For example, risk is reduced  by basing the movie on widely recognized IP (Spiderman, Harry Potter).  But the rights to these properties cost a lot of money.  Audiences respond to big starts, but they cost a lot of money.  Audiences respond to special effects, but they too cost money.  Finally, promotion and advertising campaigns drive up revenues, but they too cost money.   In a busy world, a movie must be an even to get to the top of the consumer’s to-do list.  By spending more money, the studio is actually reducing risk.

Further, a winner might turn into a franchise and generate cash for years and years through sequels, prequels, and ancillary revenue.  This further decreases risk and uncertainty.

LGF’s Transformation

LGF went through a complete and utter structural transformation, where it went from a small, independent producer, as described above, to the owner of a number of blockbuster franchises.   The turnabout came in 2012 with the acquisition of Summit for $412.5.  Summit owned the rights to the Twilight series.  The strategy has clearly been successful.  Since that time, LGF has built three global franchises – The Hunger Games, Insurgent in addition to Twilight.  Further, the stock has nearly quadrupled, going from $8.67 to $32.43 (See Figure 11).  Further, motion picture segment operating profit has grown at a 40% CAGR over the past five years.

Figure 11  – LGF Stock Price, 2012-Present

big

The event film strategy can be seen in the slate of movies LGF released in fiscal 2014 (See Figure 12).    The top 4 movies in terms of budget (The Hunger Games, Ender’s Game, Divergent, and Red 2) represent 54% of the production budget and 65% of the box office gross.  They expensive movies outperformed at the box office even with Ender’s Game somewhat flopping.

Figure 12, 2014 LGF Film Slate

Slate

In all, 12 of Lionsgate’s 25 upcoming films can be classified as franchises, Feltheimer said. He told analysts that the strategy makes sense because of the studio’s ability to minimize risk through cost control and use of incentives.

Can They Keep It Going?

There is no doubt that LGF has had a very good development run over the past 5 years with such projects as Mad Men, Orange is the New Black, The Hunger Games, Twilight and Insurgent.  But, can they keep it going?  The problem with the entertainment industry is that even with multiple income streams, there is a need to always refill the franchise pipeline.  The key question then becomes, can they keep it going? 

A key factor driving their consistency is that successful content producers want to work with them.  Once a company establishes a pattern of success, it becomes to some extent a self-fulfilling prophecy as success begets more success.  For example, the Company recently announced a new series of films based on the Odyssey by the director of the Hunger Games.

In this respect, LGF is a bit like Apple.  I am skeptical of Apple.  Like the movie business, consumer electronics is famously unpredictable.  Can Apple really continue to introduce products that sell at a premium and are gobbled up by consumers?  It seems unlikely, but at some point, you have to start giving them credit for their track record to date and their ability to keep it going.  Perhaps the same is true of LGF.

Strong TV Production

Another risk mitigant is the TV segment.  TV generates much more stable cash flow than the film segment.  This particularly true as LGF as focused on selling to cable companies rather than more seasonal broadcast networks.

TV had a disappointing 2014 with significant topline growth but margins dropping to just 4% (from a peak of 14% in 2012).  Nevertheless, management projects dramatic profit growth.  Management has stated several times that they expect unit operating profit (before depreciation, amortization and overhead) to rise from $17 million to $100 million in a few years.  How can they possibly grow this quickly?:

  • Consistency of renewals – LGF is running a 90% renewal rate for shows currently in production
  • Shows heading toward syndication – LGF has four shows hitting syndication between now and 2017
  • Increased ability to place new shows based on LGF’s track record as a producer of high quality content and the seller’s market

Management expects revenue to increase 50% and margins to increase to 14%.

Library of 16,000 Properties

The studio’s film is a countervailing factor that provides a limited degree of stability. The LGF library of past films and television shows is extensive.  Its titles include: Mad Men, Weeds, and Orange is the New Black.  These assets continue to provide revenues well past their actual release date in the form of home entertainment (DVD, downloads, streams)  and licensing (consumer products and TV licensing rights) revenue.  Its library produces a steady amount of growing revenue and FCF.    Results for the past 10 years are shown here[13]:

Library

The Company tends to overstate the extent to which the library serves as a reliable floor on earnings.  “Lionsgate handles a prestigious and prolific library of approximately 16,000 motion picture and television titles that is an important source of recurring revenue and serves as a foundation for the growth of the Company’s core business.”[14]  While there are 16,000 titles in the library, the vast majority of library revenue comes from a tiny minority of titles.   As we would guess based on the blockbuster discussion above, the long tail is not particularly profitable.  In fiscal 2014, just 10 films individually generated 2% or more of motion picture home entertainment revenue.[15]  Further, the revenue drops off quickly after theatrical release.  Only 2 of these 10 titles were released in 2012 or earlier.  Most of the titles in the library generate no revenue at all.[16]  LGF must continually add new titles to the library to maintain current revenue levels.  Nevertheless, library revenue can fill the hole in a particularly but should not be viewed as anything akin to an annuity stream.

Limited Financial Risk

LGF greatly limits the amount of financial risk it takes on any given film.  LGF has 4 primary tools for reducing its exposure:  (1) sale of international rights, (2) tax credits, (3) product placement sales and (4) gap financing.  According to management, the production capital at risk after taking these steps but before marketing spend averages less than $15 million per film.  To cite but one example, Gods of Egypt, an upcoming film, has a stated budget of $140 million.  But, after the pre-sale of international rights, Australian tax credits and other production initiatives, the amount at risk is just $11 million.

Of course, limiting the downside risk comes at a price.  The upside is also limited.

Thus, while the probability of a flop remains high for any content production company, LGF has taken steps to safely absorb the impact. A diversified portfolio both niche movies and wide release event films, steady library revenue, a robust TV business, and limited financial risk combine to reduce the impact any single flop or even a series of flops can have on the Company.

Risk Mitigation

Valuation

Our guiding premise within media is that the value of video content continues to increase even as the aggregation and distribution segments mutate.  Further, LGF is in the enviable position of having multiple revenue streams and is not overly dependent on new event films.

Other positives include high cash generation.  In large part, this is driven by the Company’s low tax rate due to having a Canadian parent.  Management believes a mid-teens tax rate is sustainable which seems reasonable to me.  The Company is using the cash wisely.  It has paid down debt, bought back shares and instituted a dividend.  It has also resisted any value-destroying acquisitions.  I would expect smart capital allocation to continue into the future with Malone on the board.

LGF currently (6/1/15) trades at a 4.76% FCF/EV yield.  A 5% growth rate in FCF going forward is certainly not unreasonable.  Management has guided for $1.2B of EBITDA over 2015-2017 with most of it backloaded.  This would mean an average EBITDA of $463 of EBITDA for 2016 and 2017.  EBITDA is higher than FCF but this gives you an idea of the type of growth they foresee.

That being said, I find it very difficult to value a content production company.  This is primarily due to the lack of identifiable profit drivers.  The drivers we have to work with are:

  • Film segment growth
  • TV segment growth
  • Library growth
  • EPIX growth

All of these drivers are speculative to some extent.  TV and Library seem the most reliable as discussed above.  Film growth represents a bet on LGF continuing to feed the franchise pipeline.  While they have an exemplary record in this regard, I have trouble betting on it.  EPIX growth seems completely uncertain due to its lack of scale.

A catalyst for the stock price would be an acquisition.  But, gambling on LGF being a takeover target is not my investment style.

Conclusion

While I do not think an LGF investment does not makes sense as a passive investment, there is strategic logic behind the investment for Malone and Starz.  As a content aggregator it certainly makes sense for Starz to have a closer relationship with the management of a key content creator as well as enhanced access to their output.  A small strategic investment like this is a nice hedge on a content bidding war.

[1] As the New York Times recently asked, “For the cost of ‘Men in Black 3,’ for instance, the studio could have become one of the world’s largest venture-capital funds, thereby owning a piece of hundreds of promising start-ups. Instead, it purchased the rights to a piece of intellectual property, paid a fortune for a big star and has no definitive idea why its movie didn’t make a huge profit. Why is anyone in the film industry?”  Adam Davidson, “How Does the Film Industry Actually Make Money?”, New York Times, 1/26/12

[2] See:  Drama Behind ‘Mad Men’ Creator Matthew Weiner’s Contract Talks, The Hollywood Reporter, March 29, 2011; ‘Friends’ Cast Returning Amid Contract Dispute, Los Angeles Times, August 12, 1996; How Lions Gate Won ‘Hunger Games,’ Reuters, March 23, 2012; Can SiriusXM Survive Without Howard Stern?. BloombergBusiness,  March 11, 2015.

[3] These reasons include frustration with linear TV, poor customer service from traditional distributors, improving access to broadband and a proliferation of viewing devices beyond the living room TV.

[4] Cord-Cutting Alert:  Pay-TV Business Declines for First Time During Q1, Variety, may 11, 2015.

[5] Full Disclosure:  I am a cord-cutter.

[6] This is not to suggest that this is the most likely scenario.  There are powerful forces in favor of the status quo.  Content owners absolutely prefer to be aggregated in a bundle of channels and, as a result, to receive affiliate fees. They also have little interest in “a la carte” packaging, a concept dreamed up by regulators in Washington but not desired by the heads of the content studios. Simply put, there is adequate value provided in distribution and revenue collection. To launch a direct channel (and forgo these fees), and then attempt to regain your customers one by one is a harrowing experience. Why earn your customers one by one when you can get to mass volumes, and a fixed amount of recurring revenue, through a distribution partner? If you create a new piece of camping equipment would you sell it online or try to obtain distribution through REI?    Further, the traditional distributors benefited from providing the platform that connects content to consumers.  A detailed exploration of the other scenarios is beyond the scope of this post.

[7] http://www.sbnation.com/nfl/2014/5/19/5730776/nfl-sunday-ticket-package-att-directv-merger-uverse-mobile

[8] http://mic.com/articles/87169/here-s-how-much-it-costs-to-make-a-game-of-thrones-episode

[9] “Oh i think pardon the expression I think Brian took the pants off GE when he bought NBCUniversal. It was a brilliant move for Brian. It was well timed and it is a great asset and it gives Brian enormous flexibility in developing U.S. business so yeah i think it was a brilliant move.”

[10] John Malone, “Unleashing Liberty: Malone Muses on Global Cable, Content, U.S. Economy,” Multichannel News, 10/24/12

[11] Deutsche Bank Media, Internet and Telecom Conference, March 9, 2015.

[13] LGF does not regularly disclose library FCF.  The few years it has done so, the margin has been 36% or so.  Accordingly, I have assumed a 36% margin for all years.  I don’t understand why the FCF margin is just 36%.  I would think that it takes very little activity to administer a film and television library.

[14] This sentence appears frequently in LGF communications.  It most recently appears in the February 11, 2015 8-K announcing the deal with John Malone.

[15] To be clear, home entertainment revenue is broader than library revenue.  LGF does not disclose the number of years after theatrical release a film is categorized as a library asset.  However, other studios use 3 or 4 years.  By contrast, a title can begin generating home entertainment revenue at any time.  Nevertheless, the same principle should apply.

[16] 10-K page 24