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Lionsgate Seeks Greater Scale in Risky Marriage With Starz

Lionsgate, Starz Deal Comes With Big Hurdles

The marriage of Lionsgate and Starz unites two smaller media fiefdoms, creating what the new couple believes will be one mighty content kingdom.

On Thursday, Lionsgate CEO Jon Feltheimer crowed to analysts that by combining forces the studio behind “The Hunger Games” and cabler that is home to such dramas “Outlander” and “Power,” will become a “global content powerhouse.” That may be a bit of a stretch, given that Lionsgate still has to compete with sprawling media giants such as Disney, Time Warner and Comcast. Still there’s no doubt that by acquiring Starz in a deal valued at $4.4 billion, Lionsgate will be better fortified.

“What we’ve seen in Hollywood is that there’s definitely a penalty to being a smaller player,” said Marla Backer, an analyst with Research Associates. “It’s not easy to come up against these super-large conglomerates”

It also means that the enlarged Lionsgate would be too big to be easily sucked up by a larger suitor. If a new wave of media mergers comes to pass, Lionsgate will likely be a buyer rather than a seller.

“It allows them to better navigate a highly consolidated landscape,” said Tuna Amobi, an analyst with S&P Capital IQ. “It positions them to be viewed as a potential acquirer rather than a target company.”

Bernstein analyst Todd Juenger was among the Lionsgate observers expressing skepticism about the long-term benefits of the deal to shareholders.

“The bullish argument is that a new, steady, dependable subscription revenue stream greatly smooths out the inherent lumpiness in Lionsgate’s production business, and diversifies the sources of revenue,” Juenger wrote.

“The bearish argument is that now a significant portion of Lionsgate’s revenue depends on the success of one particular service, which operates in the highly and increasingly competitive space of premium networks,” he continued. “If investors wanted to smooth out Lionsgate’s revenues, they could buy shares of both (Lionsgate) and Starz. We see no reason why the market should pay more for those two sets of cash flows together than apart.”

On a call with investors, Lionsgate touted the pact as one that gives them much greater scale in production and global distribution. The idea is that Lionsgate can produce TV series for Starz’s cable channels and then sell them around the world. But there are macro trends that getting bigger may not fully guard against. Namely, the digital disruptions taking place across the media landscape. Netflix, Hulu, Amazon and others continue to change the way people are consuming shows. In the process they could continue to siphon off cable viewers, resulting in cord cutting and jeopardizing the financial underpinnings of pay television players such as Starz.

On the film front, fewer films, most of them from bigger players like Disney or Fox, are accounting for a greater percentage of the box office. Now that “The Hunger Games” is over and the “Divergent” series has lost its luster, Lionsgate’s film business is a shadow of its former self. Upcoming releases such as “Deepwater Horizon” or “Boo! A Madea Halloween” may turn a modest profit, but they won’t make up for the loss of Katniss Everdeen. Recent bombs such as “Gods of Egypt” have raised troubling questions about the studio’s creative direction.

“They have to get things right on the original programming side,” said Matthew Harrigan, an analyst with Wunderlich Securities. “As long as they can stabilize the movie side they’re in a reasonably good position to make this work.”

Beyond artistic considerations, there are difficult financial realities that Lionsgate will have to master. If it closes, the deal will leave Lionsgate heavily leveraged. On the call with Wall Streeters, studio execs said Starz will throw off enough cash to chip away at its obligations, but it is still predicting that it will be dealing with a debt ratio of five to five and a half times earnings.

Getting bigger also came with a steep price tag. The $32.73 that Lionsgate is paying for Starz represents a hefty 20.6% premium on the stock’s closing price on Wednesday.

“If it works it’s transformational, but I personally would have wished they’d paid a lower price,” said Harrigan.

(Pictured: “The Hunger Games”)

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