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November 17, 2005

Mixed Quarter For Lions Gate But Results Set To Improve

Lions Gate Entertainment (LGF) reported a mixed quarter with revenue and free cash flow slightly ahead of estimates and EBITDA and EPS at the very low end of the range of analyst estimates. The disparity among theses figures is due to film accounting which often leads to mismatches between cash and non-cash expenses and the timing or revenue and expenses related to recent theatrical releases.

Overall, the results were not good enough to support the stock after the recent run related to the box office success of Saw II. However, the damage is fairly limited as in concluding remarks just prior to Q&A, management raised free cash flow and revenue guidance for the fiscal year ending June 2006.

LGF is a tricky stock. On the one hand, overall success on an increasing number of theatrical releases is creating long-term value for shareholders. On the other hand, the rising number of wide releases increases near-term spending on prints and advertising which pressures results against year-ago results, particularly at the EBITDA line. Ultimately, as the release schedule stabilizes at the higher level and assuming that the overall success rate is maintained, the financial results will catch up and near-term results will be more reflective of the value being created at LGF. There should be some evidence of this in the next two quarters based on the increased free cash flow guidance.

Unfortunately, these conflicting trends make LGF a tough stock to own. You have to have patience to let asset value build through the volatile quarterly results. Since I believe that LGF is a valuable asset not likely to remain independent over the next couple of years, I am sticking around but staying small. A takeout on current free cash flow would probably occur in the range of $13-$17, providing plenty of upside reward. Downside support is around the $8 level if there is a continuation of poor quarterly results.

Other highlights of the quarter and the conference call include:

# Ongoing strength in the TV business with four successful shows on four different networks and five pilots in production.

# Weakness in profitability of library catalogue sales. Management reduced margin expectations from the historical 25% level to 21%. This relates to weakening in the DVD market with pricing pressure particularly evident on family titles without major brand franchises. This costs the company $8 million in operating profits this fiscal year against EBITDA guidance of $63 million.

# Strong management and good results in new release DVD markets. Management ships cautiously and follows up with replenishment orders. This may reduce but potential profits for a hot title but in a weakening overall market the downside protection is much more valuable. DVD sales of Crash, High Tension, Barbie, Devil's Rejects, and the original Saw are all performing well.

# Lord of War, Waiting and Devil's Rejects lost money in the September quarter but will be profitable for the year after DVD releases.

# The Nov. 23 release of the Usher film In The Mix is expected to do $10 million at the box office in its opening weekend. LGF bought out its partner for domestic rights which will result in an extra $9 million of P&A expense in the current quarter. Another Usher film is in production.

# Upcoming releases include Madea's Family Reunion, Hostel, and Akeelah the Bee. Made is the sequel to Diary of A Mad Black Woman. Management is expecting domestic box office of $40 million. Excluding Akeelah the Bee, the other releases are projected to total $90-100 million in domestic box office.

# In response to a question, management would not comment on whether the increase in FY06 free cash flow guidance should be rolled forward to FY07. Management said visibility was not high enough to make that commitment.

Posted by Steve Birenberg at November 17, 2005 10:09 AM in LGF