How 'Hunger Games' Box Office Haul Impacts Lionsgate's Bottom Line (Analysis)
Last week, a group of investors led by a Wall Street analyst from J.P. Morgan visited Lionsgate headquarters in Santa Monica. They screened the highly-anticipated film The Hunger Games and met with senior management, including executives from recently acquired Summit Entertainment.
That visit holds symbolic significance because until recently, the big New York investment bank didn’t provide its clients any coverage of Lionsgate.
“It was a relatively small market cap (stock), sort of below the radar,” explained Monica Dicenso, the J.P. Morgan vp of equity research, who led the group. “Since the recent run, it’s gotten to the size where it’s a little bit more interesting.”
Lionsgate has turned an important corner as a company, thanks in no small part to the record-smashing success of Hunger Games, which grossed $152.5 million in its first weekend of domestic release. That tally, plus the series-best premiere ratings Sunday of the Lionsgate-produced Mad Men on AMC and the continued success of the Twilight Saga films (Breaking Dawn sold an impressive 3.2 million units in its first weekend in home entertainment release), has marked a turnaround for a company that a year or two ago had struggled with a series of flops and was under siege by investor Carl Icahn, who wanted to break it up. Icahn agreed to sell the majority of his nearly one third interest in Lionsgate last August for $7 a share, less than half what the stock traded for on March 23.
While Icahn was still a factor, “no one was even interested in evaluating this [company] for the last couple years,” said James Marsh, senior media and entertainment analyst for Piper Jaffray. “It wasn’t until Carl decided to get out that people decided to come back and take a fresh look at it. The timing of Hunger Games made that a lot easier. Lionsgate is going to go where Hunger Games goes. It’s like taping a frog onto a model rock. Resistance is futile.”
Reaching this point is the culmination of a dozen years of effort since Jon Feltheimer took over as CEO and Michael Burns as vice chairman. “Burns is a former investment banker and together they have done a lot of deals,” said David Joyce, market analyst for Miller Tabak. “It’s a partnership that has really paid off now. You can see that in the stock price.”
Of course, even with the blockbuster success of Hunger Games (its estimated opening weekend box office gross is more than $200 million worldwide), some analysts were quick to caution that it might now be fully valued; and there were more than 12 million short-sale stock orders from those betting it can’t sustain its lofty new market cap. “Do I think this stock is going to continue to be volatile in the short term? I absolutely do for a lot of reasons,” said analyst Marla Backer of the New York research boutique Hudson Square. “There’s a lot of people who have gotten in this just to play Hunger Games.”
Backer provides that caution even as she praises Lionsgate for finally delivering “the franchise strategy they always talked about,” for pulling off the acquisition of Summit Entertainment in January and for its “significant success” in television, which she says “people often don’t give them credit for.”
Since it acquired TV syndicator Debmar Mercury in 2006, Lionsgate has built a significant TV business while investing less capital and taking fewer risks than most studios in television. They have done it with cable TV series like Mad Men, Showtime’s Weeds and Boss on Starz, where they have started with smaller orders and grown the business over time. They have another potential hit in Anger Management starring Charlie Sheen, which will air a 10 episode test run this summer on FX Network that, if successful, will trigger a full 100 episode order. “To go from zero to almost $500 million in (TV) revenues,” said Burns, “that’s a hard thing to do without money.”
Lionsgate has also been frugal in the theatrical business. The Hunger Games, after production rebates from North Carolina, cost only about $80 million to make, and all-in the studio says the marketing cost is about $55 million through opening weekend. On the revenue side, there is not only box office (with roughly half the gross ticket sales coming back to the studio) but also surprising success for the merchandising, with Hot Topic, whose target audience is teens, reporting significant sales of Hunger Games TV shirts, and some merchandise quickly selling out. There are toys coming as well from Hasbro and Mattel.
And the real licensing and merchandising bonanza will be tied to the second Hunger Games movie, set for release in November 2013. Retailers like to see a brand succeed before making big buys, and now Lionsgate has that level of success to trumpet. The franchise will also pay off in foreign sales, where Lionsgate’s conservative approach has been to pre-sell about 60 percent of international rights in advance, to make sure it has a financial cushion no matter how a movie performs. With new foreign sales leadership by Summit’s Patrick Wachsberger and others, the rest of the Hunger Games movies will now bring in significantly higher returns.
“Lionsgate’s strategy has worked well for the company so far,” according to March 20 report by J.P. Morgan tied to launching coverage of the company. “It has had only four films in the past 10 years that lost over $10 million and the company has never lost over $30 million on a film.”
The Summit deal was another example of how to grow the business. It brought in the lucrative Twilight franchise, with two more home entertainment cycles and one more movie to release in November. Lionsgate made the $415 million deal without diluting its own stock, using the cash Summit has on hand to partially fun the deal. “Effectively it was a leveraged buyout,” said Matthew Harrigan, analyst for Wunderlich, adding: “If they had to do it over again I would guess Summit would have insisted on a higher price.”
The Summit deal did come with a cost, however. There has been a painful consolidation, which still continues. The marketing and PR departments are next, having been put off until Hunger Games opened. The release of the movie also triggers the departure of Joe Drake, who with Alli Shearmur (who has also been pushed out) was responsible for bringing in Hunger Games long before it was an obvious hit, and for managing its launch.
It will now be up to Summit's Wachsberger and Rob Friedman, who have been given oversight of the motion picture division, to keep the franchise on track.
“There’s a lot of risk here,” said Backer. “This is the first major megahit they’ve ever launched. There is risk to their growing it…(that) is higher for them than it would be for a company that has a longer track record. There is also risk because they are integrating Summit. That’s all very new.”
There is another distraction that Lionsgate must address. It has hired an investment bank to seek the sale of the TV Guide Network—or, if it can’t get their price, to possibly buy out its partner. Lionsgate acquired the network for $225 million but sold 49 percent to JP Morgan’s One Equity Partners for $125 million With more than 85 million subscribers, the hybrid channel of TV schedules and programming is expected to fetch over $400 million.
Some of that may go to help pay down the corporate debt of over $1.2 billion, which until recently was a concern to investors as well. With the success of Hunger Games, and the Summit deal, that fear has faded. “That used to be a huge question in people’s minds: How are they going to pay down the debt? Is it too high?,” said Marsh. “Now you start looking at the profit from Hunger Games and it’s a non-issue. It used to be something I would spend 10 minutes discussing on every (investor) call. Nobody’s asked me about it in six months.“
Burns said bringing down the debt remains a priority “unless we have a better place for the cash.”
That could mean more acquisitions as well as investment in more movies and TV shows. The upcoming movie slate is expected to expand from about 10 or 11 movies a year to about 15. That includes not only more Hunger Games and Breaking Dawn 2, but also The Expendables 2, more Tyler Perry movies, a sequel to Lincoln Lawyer and the romantic comedy/drama What to Expect When You’re Expecting, among others.
“The movie business is always one where you have hits and misses, so there’s an interesting amount of volatility in the stock and in their business models,” said Marsh. “What Hunger Games should do for the company over the next six years though is provide a lot of ballast.”
“We have taken a great deal of that volatility out of the equation,” said Burns, adding: “Our strategy for years has been finding franchises. They’re just damn hard to find.”