While some questions remain, Wall Street sees the Lionsgate-Summit deal as a generally low-risk proposition for both indie studios, bringing Lionsgate a reliable stream of cash in exchange for a minimum outlay of its own.
Combining two powerful young-adult franchises could give a combined Lionsgate-Summit more clout with exhibitors. Also, with Summit lacking much of a television or digital footprint, Lionsgate can start aggressively exploring “Twilight’s” potential beyond the bigscreen.
The total $412.5 million cost of the acquisition, completed Friday, consists of $342.5 million in cash, $50 million in stock and another $20 million to be paid in either cash or stock at Lionsgate’s discretion in 60 days. Lionsgate’s cash contribution is $35 million-$55 million, with the lion’s share coming from Summit in what is essentially a leveraged buyout.
Summit’s owners, including toppers Rob Friedman and Patrick Wachsberger, will end up controlling 4%-5% of the expanded company depending on how many shares Lionsgate issues to complete the deal.
The company was said to be averse to issuing much stock, particularly right before the release of its highly anticipated film “The Hunger Games,” to avoid diluting shareholders. Issuing new shares raises the total number outstanding, so existing stockholders can see their stake, and earnings per share, diluted.
Lionsgate said, in fact, that it expects the transaction to be significantly accretive to earnings for the 2013 fiscal year starting in April.
The deal also keep Summit’s $500 million in borrowing off Lionsgate’s balance sheet, with Summit to pay it down using cash flow from “Twilight.” The $500 million loan matures in 2016, but Lionsgate said it anticipates repayment “well before” the maturity date due to the significant cash flow expected from Summit’s business — about $1 billion still to come from the “Twilight” franchise over the next five years.
Stifel Nicolaus analyst Ben Mogil estimated last week that Summit’s five “Twilight” films will collectively churn out $1.4 billion in revenue through 2017. Backing out royalties and participation obligations and marketing and distribution costs, it would mean net free cash flow of $1 billion for Lionsgate over those five years.
That doesn’t include unspecified millions in merger-related synergies, and it leaves plenty of cash for Lionsgate even after Summit’s debt is extinguished.
Lionsgate’s filing with the Securities and Exchange Commission detailing the entire purchase agreement and all the fine points of the deal will come out Tuesday morning before the stock market opens.
“I don’t think anyone could argue with it. It’s almost a financial investment, a set of receivables” from ‘Twilight,'” said RBC Capital analyst David Bank. “It’s what financial investors do, and these guys are good at that,” he added, referring to Lionsgate co-chairman and CEO Jon Feltheimer and vice chairman Michael Burns.
“Time will tell if there were better things to do with the cash” than buy Summit, Bank said.
The urgency for Lionsgate to complete the deal, which it has kicked around since 2008, has raised some questions.
“One would have to ask, ‘Why is it so important for them to buy this financial asset?'” Bank said. “Is Lionsgate worried about its own cash flow going forward?”
Cash will start streaming in from Summit profits on the most recent “Twilight” release (“Breaking Dawn — Part 1”), as well as the upcoming final installment (“Breaking Dawn — Part 2,” due in theaters in November), and from the “evergreen” benefits of a series that is fairly predictable. Because cash outlays for “Twilight” will conclude with the final pic, all subsequent revenue becomes free cash flow for the studio.
“There are always nuances in movies in terms of pay contracts and all that. But you take out a lot of overhead (by combining operations), and intuitively that ($400 million) feels like a reasonable number,” said Matthew Harrigan of Wunderlich Securities.
A number of analysts said, however, that without any more financial details on Summit’s business, it’s impossible to value the agreement with any certainty.
Mogil estimated that the three final “Twilight” films will generate revenue of $200 million between 2012 and 2017. The last two will churn out first-cycle revenue of about $1.2 billion — minus $200 million from costs associated with the theatrical release of “Breaking Dawn — Part 1” and minimum foreign guarantees. He sees the two pics generating additional second-cycle revenue of $200 million.
Harrigan has a “buy” recommendation on Lionsgate and has been predicting a big uptick in cash flow with or without Summit, partly because of former Sony television exec Feltheimer’s success on the TV side. He said he sees 2012 as something of a transition year with a potential triple-digit uptick in cash flow in 2013.
Lionsgate is the studio behind cable staples “Weeds,” “Mad Men” and “Nurse Jackie.” Its new Epix pay TV partnership with Paramount and MGM is profitable thanks to its well-timed and groundbreaking output deal with Netflix.
All agree that the security of Summit cash is timely as a hedge against the possibility of a disappointing performance by “The Hunger Games.” Lionsgate is counting on the hugely hyped film opening in March and based on the Suzanne Collins trilogy to rake in the bucks and launch a powerful new franchise.
It’s a good risk, but still a risk. Publicly traded standalone studios like Lionsgate and DreamWorks Animation are unusual in the media space, and investor sentiment — and their shares — can ricochet on the success or failure of one big film. Lionsgate management is sometimes pilloried when it moves away from modestly priced pics, most aggressively by corporate raider Carl Icahn, who recently tried but failed to install a new board to remake the executive suite.
The studio had three high-profile duds last year with a “Conan the Barbarian” reboot, “Abduction” and “Warrior.”
“The Hunger Games,” at $80 million, is the costliest pic ever for Lionsgate. But Hollywood and Wall Street are both keeping the faith that it will be the bonanza everyone expects.
Harrigan said: “It’s kind of crossed the point where there’s a lot of doubt, in the sense that it’s got so much attention pop culture-wise that it’s almost impossible it won’t do a big number.”