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February 09, 2006

Lionsgate Earnings Preview

Lionsgate (LGF) reports after the close on Thursday with a pre-open conference call on Friday. Quarterly results for LGF can be quite volatile due to the vagaries of film accounting and significance that a hit or miss at the box office can have on the numbers. Added volatility can occur relative to expectations as the financials are difficult to model and there are relatively few analysts from which to create consensus estimates. In other words, there can be a wide range of estimates around the consensus estimate. For this reason, LGF shares have tended to be volatile following the release of quarterly earnings with the most recent quarters exhibiting a decline in the shares as the headline figures missed estimates.

Despite some of the issues outlined below, I do not expect this quarter to disappoint investors. I also expect the company to maintain its full year guidance (EBITDA guidance was slashed in December while revenue and free cash flow were left unchanged). If LGF can make it by this quarter, I think the path is clear for rally in the shares to over $10 on the basis of what should be strong March and June quarters and a series of positive news items that began with the recent very successful release of the Lord of War DVD to be followed by the release of the Saw II DVD on February 14th and the theatrical release of Madea's Family Reunion, the sequel to the hit Diary of a Mad Black Woman on the last weekend in February....

LGF does not provide quarterly guidance but has offered annual guidance. Presently, the company is projecting revenues of more than $850 million, EBITDA of $35 million, and free cash flow of more than $100 million ofr its fiscal year that ends this coming March 31. The revenue and FCF guidance has remained very stable but EBITDA guidance has come down sharply. Analysts initially thought the company could produce $90 million in EBITDA this year but in its initial guidance LGF suggested $65 million. This past December, following the movie flop In The Mix, EBITDA guidance was slashed to $35 million. The poor EBITDA performance has weighed on the shares despite management's opinion that FCF is the relevant metric. I believe management has a point but the difference between EBITDA and FCF is not sustainable so there is risk in the company's ability to sustain or grow FCF without an EBITDA pickup.

The reason for the variance in the two figures is that film accounting uses the balance sheet aggressively. One significant impact on free cash flow comes from the difference between LGF's investment in films and amortization of films. In general, LGF has greater amortization, adding to free cash flow, because of ongoing amortization of the acquired Artisan film library at $20 million per year. However, so far this year, the big sources of FCF have been working capital and film obligations. Accounts receivable dropped sharply earlier this year when cash was received on DVD shipments. Film obligations (residuals, minimum guarantees, and production loans) have risen sharply and since they are a liability they have added to FCF. The rise has been caused by two factors: LGF is producing more films and the financing arrangements for the films seem to be more dependent on participation and backend by the talent and production partners. LGF will lose this benefit once the growth of the production slate and the financing arrangements stabilize. Consequently, I remain concerned that little margin for error exists in the upcoming film and TV slate. Anything that serves to negatively impact EBITDA, such as the current performance of a new film or TV series, could lead to a cut in FCF guidance. FCF supports not only the current valuation but also the buyout valuation. As an obvious buyout target, LGF shares are supported by speculation on the downside even when movies flop. Thus, a reduction of FCF generation capabilities not only hurts current valuation but it lowers the floor that supports the shares.

Remembering the wide range of estimates, here is the consensus estimates for the December quarter. Revenues are projected $227 million in a fairly tight range. EBITDA consensus is $23 million but I see a couple of estimates at $30 million. EPS consensus is 16 cents but I see an estimate as high as 24 cents. I only found one analyst with FCF estimate which is $32 million.

Other things to look for in the press release and on the conference call include commentary about the Starbucks deal for promotion of Akeelah The Bee, an update on the formation of a horror channel, whether the library margins are stabilizing in the low 20% range, possible interest in the acquisition of United Artists, and a preview of the FY07 movie slate.

Posted by Steve Birenberg at February 9, 2006 09:40 AM in LGF