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February 12, 2007

Lionsgate Finally Reports A Good, Clean Quarter

Lionsgate (LGF) reported a good quarter. EPs of 19 cents matched estimates, while revenues of $255 million did not fall materially short of the $258 million consensus. Free cash flow of $50 million was very strong. Management opened the conference call by stating it was raising guidance to revenues of $950 million and free cash flow of $100 million. LGF left its pretax income guidance of $30-35 million unchanged but said that non-cash stock compensation charges were the only thing keeping it form going higher.

I think the shares will be well supported by the quarter and could move marginally higher on the basis of the guidance increase and confident talk of the FY08 outlook, which begins on April 1st. However, it still bugs me that such a huge gap exists between operating income and free cash flow. This means that free cash flow is being driven by working capital items. My analysis, which may be wrong, is that the gap exists because LGF consistently ups the portion of its film investment that represents residuals and participations. Eventually, this line item will stabilize year over year thus requiring operating income to drive free cash flow....

Over the next several quarters successful acquisitions of a library company and an international distributor will provide growth if the working capital contribution to free cash flow flattens or reverses. This fact, along with what I believe is growing confidence in management on the part of the analyst community, should be enough to support the shares. In other words, the outlook is strong enough and visible enough for a few quarters that sellers have little to hang their hats on. That should be enough to at least support the shares at current prices, with upside of 5-8% plausible.

The current quarter is likely to be supported by several major DVD releases even though year over year theatrical release revenue may be weak. It is unclear if the big boost LGF received from the sale of movie TV rights in the December quarter will be repeated. International revenues should grow again due to the acquisition of a UK distributor. The TV production business also should continue to grow as LGF has more and more programs on various cable network outlets. These factors balance out to the likelihood of a modest uptick in estimates.

Several other items of interest for LGF investors include discussion of an upcoming film financing deal, continued viewer interest in the FearNet VOD channel launched with Comcast, and a forecast of over $200 million in FY08 TV revenue at 15% margins.

LGF has about 116 million shares outstanding leading to a market cap of $1.3 billion. Net debt is just $80 million and all of the gross debt of $325 million is a convertible bond that has a strike price of $14.28. An enterprise value of $1.4 billion compares favorably to free cash flow of $100 million. I'd just be a lot happier if operating income were a lot closer to that $100 million figure and if growth in FY08 was organic as opposed to acquisition driven.

For the next few quarters, I don’t think my concerns will matter. LGF is performing better after a series of misses and Wall Street wants to believe. I've been wrong with my cautious view. Recent good sentiment toward the shares is likely to continue.

Posted by Steve Birenberg at February 12, 2007 01:18 PM in LGF