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October 26, 2005

Lions Gate Entertainment Update

Lions Gate Entertainment (LGF) rose almost 4% on Monday, enjoying its best day since early September when it popped 10% in four days to $10.60 on the back of reports of insider buying by about a dozen top executives. Since then the shares have pulled back steadily, reaching a closing low of $8.36 last Thursday.

It appears the reason for the pop yesterday was the announcement that Harry Sloan, founder of SBS Broadcasting (SBTV) has been appointed Chairman and Chief Executive of Metro-Goldwyn-Mayer. The SBTV buyout closed on October 18th so Harry was a free agent. The interesting tidbit for aficionados of LGF is that Sloan resigned as Acting Chairman and member of the board of LGF on June 30, 2005....

MGM is now controlled by Sony in partnership with Comcast with the backing of private equity funds that have a history of deals in media. I suspect some folks are speculating that with his insider knowledge of LGF, Sloan might be interested in expanding MGM by acquiring LGF. The fact that an Icahn prot�g� acquired over 7% of LGF this summer helps feed the speculation.

Any discussion of an MGM buyout of LGF is pure speculation. However, from the point of view of Sony and Comcast, the MGM deal was all about controlling premiere content. In that context, adding another significant studio to the mix makes sense strategically.

LGF's guidance calls for $90 million plus in free cash flow this year against an enterprise value of about $1.4 billion. A buyout of LGF would not require immense capital and would start from a solid financial footing. Or at least as solid as one can get in the hit-driven movie production and marketing business.

LGF shares reached their recent lows amid a string of poor to average box office results for key releases upon which the company's guidance is predicated. Additionally, investors are concerned with the bear hug the company is putting on troubled DVD distributor Image Entertainment. Meeting September quarter earnings estimates could prove dicey, especially if any of the recent films require write-offs.

On the positive side, Crash has performed very well in DVD sell-through and rental markets since its release in early September. This is very profitable revenue and could easily carry the quarter. Crash has lots of Best Picture buzz for the Oscars which could add another boost if the nomination is secured. In other news, LGF also appears to have made a smart acquisition of a small UK film distributor.

The bid for Image Entertainment looks to be moving toward conclusion although the outcome is unclear. I suspect the market will be happy if LGF loses out and walks away. However, I continue to think this is a reasonable and likely quite accretive deal for LGF.

Most importantly for the immediate future of LGF shares is the release of Saw II this coming weekend. Saw was a surprise hit that went on to pull in $100 million in domestic and international box office (evenly split). Saw II needs to do greater than $30 million in domestic box office to give comfort to LGF's full year guidance. So far reviews are mixed as can be expected for a horror flick. Worth noting, both Variety and Hollywood Reporter, who split on the critical front, expect a strong box office performance.

For now, I am going to hold the remaining positions in LGF and hope for a good weekend out of Saw II.

Posted by Steve Birenberg at October 26, 2005 09:44 AM in LGF