Starz Sees Big Stock Jump in First Half-Year as Separate Company

7:17 PM PST 07/19/2013 by Georg Szalai
Starz' "Da Vinci's Demons"

Expectations of a potential sale to an entertainment conglomerate have contributed to the gains, but analysts have different takes on the stock's outlook.

The stock of Starz has risen 67 percent since it became a standalone company slightly more than six months ago.

Wall Street analysts have taken note of the early stock gains but have expressed different views on where the stock can go from here. On Friday, it closed at $23.72 after starting trading at $14.20 on Jan. 14. That gave the company, led by CEO Chris Albrecht, a market capitalization of $2.9 billion as of the end of the week, according to Bloomberg.

Wall Street observers say that investor expectations of a potential acquisition of Starz by an entertainment conglomerate have contributed to the stock gains. John Malone's Liberty Media, which spun off Starz in mid-January, continues to own a big stake in the company and is known for always being in the hunt for deals.

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But others have expressed concern about recent distribution deals with pay-TV companies that have come with weaker financial terms for Starz. Plus, they point out that management's increased focus on original series has inherent risks given that content is a hit-driven business.

Macquarie Securities analyst Amy Yong, for one, in a recent report maintained her "neutral" rating on Starz shares, summarizing her view by citing "below-average" revenue and operating cash flow growth compared to other industry players, "but robust free cash flow growth ... and optionality around M&A."

Some argue though that there is more upside in Starz's stock.

Sterne Agee analyst Vasily Karasyov recently initiated his coverage on the stock with a "buy" rating and price target of $26.50. Wall Street "consensus is too bearish," he said in the title of his report.

"We believe the consensus is too focused on the [revenue] challenges Starz faces and overlooks the positive trend in programming costs in 2013 and underestimates the management’s commitment to share repurchase," the analyst argued.

"Revenue headwinds are real," Karasyov acknowledged. "After an expected 2 percent decline in 2013, we forecast only 1-percent to 2-percent growth in revenue over the next few years at the networks. The pressure is due to the continuing cycle of affiliate contract renegotiations, during which Starz has seen the per-subscriber rate reset at minus 10 percent."

At the same time though, programming-cost reductions are offsetting that, according to Karasyov. "Savings from a higher proportion of cheaper films aired was $27 million compared to $13 million in revenue decrease" in the first quarter of 2013, he said, forecasting similar trends ahead.

"We believe this is the result of the management’s effort to create headroom for spending on original series," Karasyov said.

For 2014, he predicts an operating cash flow margin of 34 percent, "comparable to HBO, Starz’s bigger competitor and the dominant leader of the premium TV space." Pivotal Research Group analyst Jeff Wlodarczak also has a "buy" rating on Starz's stock and a $27 year-end 2013 target price.

"We believe the market misread recent first-quarter results focusing on overall [operating cash flow] growth, which includes volatile non-core Starz network revenue, rather than core Starz network," he said. That only fell 1.3 percent "despite the effects of the repricing of two large distributor contracts and the loss of Netflix revenue," he highlighted.

Like others, he believes that a recently struck new carriage deal with Time Warner Cable will provide opportunity for Starz as it provides incentives for the cable giant to sign up more subscribers for Starz.

Predicting an operating cash flow drop of only 3 percent for 2013, Wlodarczak argued that the Wall Street consensus for an approximately 10 percent decline was "likely materially too conservative given step-downs in programming costs, certain distributors (we believe Time Warner Cable) accelerating their push of the Starz/Encore product, contractual rate increases and possibly replacing Netflix digital revenue."

Others on Wall Street are less bullish though and recommend investors sit on the sidelines and see the Starz story play out further.

Maxim Group analyst John Tinker, for one, recently downgraded his Starz stock rating from "buy" to "hold," which is the equivalent of other observers' "neutral" rating but with a slightly higher price target.

"Our new $25 price target is not sufficient to warrant a "buy" rating with only 10 percent upside," he wrote. But on a positive note, he also emphasized: "Starz cash flow is growing slowly but predictably, and the stock is supported by a buyback program."

Tinker said his price target was based on a stock multiple that comes at a 10 percent discount to HBO parent Time Warner and Showtime parent CBS Corp. "We estimate Starz should trade at a slight discount to these larger players ... which can bundle the networks and can leverage its multiple networks to garner higher fees," he explained. "HBO charges about an $8 per sub per month fee, and Showtime about $3 to $4, compared to an about $2 per sub fee for Starz."

ISI Media analyst Vijay Jayant also has a "neutral" rating on Starz's stock along with a $21 target price.

In recent reports, he has highlighted a lack of major financial growth drivers, though he went on to write: "Better subscriber net additions, driven by the anticipated strong original programming future for the company, could help turn the business into a positive operating leverage model."

Evercore Partners' Bryan Kraft is one of the more bearish Starz analysts. He has an "underweight" rating on the stock and a target price of only $18.

"Starz is up 52 percent since the spinoff earlier this year, significantly outperforming other media stocks," he said in an investor note earlier this month. "Much of this, in our view, has been driven by investors' belief that the company will be sold amidst an accommodating credit market and an active M&A environment."

He also argued that Starz continues to face original-programming challenges. "Da Vinci's Demons premiered to strong numbers with 1.3 million viewers live plus same day and 2.1 million total viewers during its first weekend," he said, with an aggregate viewership of 6 million across all platforms. But after the second episode, "interest in Da Vinci's Demons seems to have faded from its strong debut," he argued.

However, data has since shown an average audience of 4 million per episode. While not Spartacus-type figures, that has been above other Starz originals.

Kraft also argued that Starz's stock market valuation "appears optimistic," highlighting that it "is currently trading in line with media peers." Said the Evercore analyst: "We believe, however, that the stock should trade at a discount to other media companies given the lack of [operating cash flow] growth, execution risk in original programming and potentially limited long-term pricing power with affiliates."

With a possible acquisition of Starz being mentioned by Wall Street on a recurring basis, what do analysts think?

Some have mentioned Comcast's NBCUniversal and Sony Corp. as possible acquirers, but most think Starz and Liberty aren't desperate to sell and would be just fine with the status quo.

"We put the odds of a sale of Starz at 50 percent given significant upside for the right strategic buyer, Liberty's desire to drive a sale and their historic success with sales," said Wlodarczak in a recent report.

And Tinker has argued: "A large buyer with multiple cable networks could better leverage its original product."

Yong recently wrote: "We continue to believe a Starz/Sony combo makes sense longer term."

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But Kraft has said: "While we agree that there is a willing seller, it's unclear to us currently who would be the logical and likely buyer for Starz. As such, we view a sale as unlikely over the next 12 months."

And Lazard Capital Markets analyst Barton Crockett, who has a "neutral" rating on Starz's stock, recently said: "Starz is currently trading at 9.6 times our 2013 estimated [operating cash flow], near peer Time Warner, which owns the stronger HBO network."

He concluded: "The market appears to see potential for better growth, which is possible if Starz were to be part of a larger conglomerate."

E-mail: Georg.Szalai@THR.com
Twitter: @georgszalai

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