Starz (STRZA) is a recent spinoff from Liberty Media and is the only premium TV channel that is independent. Starz is a great business with 26-28% ebitda margins and returning 90% on invested capital. I believe STRZA offers an attractive opportunity as an acquisition candidate as it only trades at 8.5x EV/EBITDA (ttm) compared to 10 precedent transactions (2002-2013) in the space that were purchased at an average of 18.3x EV/EBITDA. It may be acquired for around 12-13x EV/EBITDA. On its own as a high margin and strong cash flow business, I believe a reasonable valuation would also be around 11-12x EV/EBITDA. Thus, Starz is currently an undervalued long candidate with 30-50% upside over the next 12-24 months. The current price also serves a floor for the valuation as analysts currently do not give Starz much credit for its growing content.
Rebranding & Premium Content. Management understands the cable industry’s dynamics and trend towards digital-on-demand providers such as Netflix, Hulu, Amazon, etc. Ultimately, Starz wants to move away from being a pay-tv distributor to being a full-fledged premium content provider as a hedge. By becoming big content owners, Starz will not have to rely on signing deals (such as resigning Sony) but instead can sell their own premium content to digital providers. Starz CEO, Chris Albrecht, as former HBO CEO, was in charge of several hits including Sopranos, Entourage, Band of Brothers and the Wire. Management is experienced and is setting themselves up nicely ahead of industry trends. Starz is executing well and hitting home runs with “Spartacus”, “Da Vinci’s Demons” and “Boss”. Two new shows in the pipeline are “Black Sails” and “Power”. Understanding Starz’s new focus on its own premium content is imperative to determine its future potential. Additionally, Starz currently has 58 million subscribers compared to HBO’s 114 million subscribers. If it can expand its premium content, grow its pipeline and sign new deals there is a lot of room for growth.
Reason for Mispricing. Netflix and other digital providers have been leading the headlines as of late and are seen as the new frontier of the industry bringing demise to cable providers in the coming years and dealing directly with content providers. Additionally, Starz wasn’t able to resign a deal with Netflix a few months ago and also lost its deal with Disney. Disney then signed a deal with Netflix starting in 2016. The loss of Disney (and possibly Sony in the future) dampened Starz’s prospects in the eyes of investors as a TV channel slowly losing content. I believe these fears are likely overstated. Starz will still have access to Disney’s content until 2018 and Sony content into 2019 (even if they do not resign). Much more importantly, Starz is moving away from being dependent on other film studios for content and is building up their own arsenal of premium shows. Investors will see this transition as Starz from TV channel to premium content provider as it gets more headlines and reviews for its growing stable of content. Additionally, Starz was spun off in January and is still gaining traction with investors.
Catalyst & Valuation. Although spinoffs normally cannot be merged for two years to receive tax-deferred treatment, management has sidestepped this by keeping Starz the official “parent” company despite its much smaller size. John Malone, chairman of Liberty Media, has publically stated his view that Starz should be a part of something bigger and that management would be eager to listen to offers. Possible acquirers include CBS, Dish Network, Time Warner, DirecTV, and Comcast. Comcast does already own 6% of Starz. Due to economics of scale, it makes little sense for Starz to remain independent (and it is the only standalone premium TV channel left). All in all, management is interested and has positioned Starz to be acquired while a deal makes sense for a number of potential acquirers. Looking at ten precedent transactions in the space, (Outdoor Channel Holdings, A&E, Discovery Kids, Weather Channel, Sundance Channel, Travel Channel, Court TV, CSTV, USA Networks, Bravo) we see that they were acquired for an average of 18.3x EV/EBITDA. Although Starz’s situation is a bit different as it is still working on its pipeline and content. I believe Starz will shop itself once it believes it has built a stable content base and can command a respectable multiple. It may be acquired conservatively for around 12-13x EV/EBITDA presenting 40% to 50% upside. The only other independent network is AMC Networks which trades at 13.4x EV/EBITDA. On its own, an 11-12x EV/EBITDA valuation is very reasonable given the asset light nature of the business giving us 30% to 40% upside.
Insider & Major Ownership. Management owns 15% of the stock and is highly incentivized to maximize the stock price. For example, in 2012, 85% of CEO Chris Albrecht’s compensation consisted of options. In terms of major shareholders, Berkshire Hathaway owns nearly 5% of the company (one of his less publicized holdings). John Malone, CEO of Liberty Media, owns 43% of the voting power of Starz (he owns 88.8% of the B class). Fortunately, John Malone is considered one of Media’s greats and I believe Starz is in excellent hands. For example, John was instrumental in the turnaround in SIRI (resulting in a 3300% gain in about four years). Lastly, Comcast owns 6% of Starz. If a competitor of Comcast makes a bid for Starz, a bidding war could occur.
