Jennifer Lawrence stars as Katniss Everdeen
Murray Close—Lionsgate
By Taylor Tepper
June 1, 2014

The Pro: Lawrence Creatura, co-manager of the Federated Clover Small Value fund

The Fund: Federated Clover Small Value invests in shares of undervalued small- and medium-sized U.S. companies. Under Creatura, the fund has beaten more than 70% over the past 15 years.

The Pick: Lions Gate


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The Case: Lions Gate has gone from a bit player in Hollywood — a decade ago it was mostly known for small, independent films such as Dogville and Monster’s Ball — to the king of the young-adult heroine blockbuster.

The film and TV production company purchased Summit Entertainment, which included the Twilight franchise and library rights, in 2012. Throw in The Hunger Games and Divergent, its newest franchise, and you have potentially more than 10 films and dozens of branding opportunities going forward.

In television, Lions Gate also has big hits on its hands such as Netflix’s Orange is the New Black and AMC’s Mad Men. Such shows have helped the production company increase revenue by 66% since 2011.

There is a downside, though, to hitting the big time: Investors constantly want to see big results. And when the company announced late last week that revenues had fallen in the recently ended quarter and fiscal year, the stock lost more than 10% of its value in a day.

Nevermind the fact that in its most recent fiscal year, Lions Gate had only 13 wide release films compared to 19 in the prior year — and that the most recent quarter only included about 10 days worth of Divergent’s box-office.

Federated’s Creatura says investors misunderstand the nature of Lions Gate’s business. “They think it’s a hit-driven volatile business,” he says, “when it has a portfolio of evergreen property which will produce dependable cash flows for years and years and years to come.”

These are franchises such as Twilight, The Hunger Games, and Divergent, which just started filming its sequel.

The Hits Go On
Lions Gate’s dive into young adult franchise films gives the company a seemingly endless number of movies to produce. “The first Hunger Games starts with the 74th annual Hunger Games — what happened to the first 73?” asks Creatura.

And if Lions Gate decides to make 73 prequels, there’s reason to think they’ll be profitable. The most recent Hunger Games, for instance, took home more than $860 million in theaters, per BoxOfficeMojo.com, and cost $130 million. Divergent made more than $266 million and cost just $85 million.

Not only are Lions Gate films profitable, they generate a ton of so-called free cash flow, which is the amount of money left after paying all the bills and making all necessary investments in the business. (See the chart below.)

Lions Gate's free cash flow yield beats that of rival Dreamworks Animation

Relative Value
Lions Gate is a play on fast growth. But that doesn’t mean the stock is necessarily expensive, says Creatura. Lions Gate’s price/earnings ratio based on estimated profits, for instance, is 20.3. That’s not considered cheap, but compare that to the 33.3 P/E for Dreamworks Animation. Plus the company’s earnings are expected to grow 17% annually for the next five years.

“The stock is not expensive if you consider the likelihood and longevity of future cash flow,” says Creatura. “These properties are evergreen – they can be reused and reformed again and again.”

Box office risks
While Lions Gate may have valuable franchises in the canon, there is a limit to what one brand can get you. Is Lions Gate more than The Hunger Games?

Divergent did perform well, but took in about a third of the box office of the first The Hunger Games film. Ender’s Game, another book based on a young adult novel (although this one featuring a male lead), failed to develop an audience and only made $125 million worldwide –limiting it’s potential for a viable franchise.

Ender’s Game wasn’t the blockbuster that some believe it could have been and that hurt the perception of the stock,” says Creatura.

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