Starz Entertainment (STRZ) – Assuming Coverage
Lessons from a successful 2015 short pitch that apply today
Starz ($STRZ) is AGAIN an independent public company, after completing its spinoff from Lionsgate Entertainment. If this setup feels eerily familiar, this is the second time the company has been divested in less than 20 years.
Here’s a truncated timeline of Starz’s ($STRZ) history as a public company.
2009 (16 years ago) spun-off from Liberty Media, going “public” for the first time
2016 (9 years ago) acquired by Lionsgate Entertainment
2021 (4 years ago) Lionsgate first publicly considers a spinoff
2025 (1 month ago) Starz spun out
I want to differentiate myself from other value investors by doing deep dives on STRATEGY, and not diving straight into EBITDA, FCF and P/E multiples. To begin my coverage of Starz, I’m trying something different. To understand where Starz is going, let’s take a moment to understand where it has been.
Back in 2015, the submission that won me membership to the Value Investors Club (VIC) message board, was a short pitch on Starz. I never ended up turning it to “public”, because while at the time I thought STRZ was likely to underperform the market, I wanted to build a reputation posting longs.
I’m going to reproduce my write-up below so we can analyze why I was skeptical of the company before, and how it compares to the current situation.
Let’s dive in!
VALUE INVESTORS CLUB APPLICATION - STARZ - $37.74 (4/20/15)
Summary Thesis (April 2015): Starz ($STRZA) is a 3rd place premium movie channel package (Starz & Encore) with no “must-see” content that’s facing multiple headwinds to subs and ARPU. The cable video bundle is in secular decline, as customers are looking to purchase fewer channels, lower their cable bills, and stream online.
Starz has exhausted its ability to add profitable new subscribers. With HBO Now, and soon Showtime, going direct to consumer, Starz won’t as easily be able to ride their coattails. In 2014, the company changed their financial reporting to obscure their sub growth. They can’t cut costs because they need more original programming in the hopes of maybe finding a hit. They have no negotiating leverage to raise ARPU, as their lack of hit programming and (more importantly) independent status gives them declining bargaining power as cable companies take money from lower-value channels to pay for higher-value channels, rising broadcast fees and sports rights.
Every major U.S. media company passed on buying Starz, despite John Malone’s best efforts to sell the asset, citing “overvaluation”. Malone proceeded to sell 40% of his personal shares (4.5% of the company) to Lionsgate, in a deal that brings zero economic benefit to Starz, but has been completely misunderstood by overly-enthusiastic sell-side analysts who call it a partnership, when it is not.
Finally, with the stock up ~30% since the Malone sale, the sell-side is starting to make increasingly far-fetched arguments to argue for further upside. On 4/15, Deutsche Bank bizarrely launched coverage with a new $48 price target, which was +23% above the 2nd most bullish analyst despite modeling earnings only slightly better than consensus. In an act of desperation to be bullish, the analyst adopted a DCF framework (instead of P/E) and basically gets to his price target through multiple expansion and back-loaded margin expansion in 2017/2018, which is highly unlikely given that is precisely when Starz will lose its high-quality Disney films. If anything, Starz could have its rates cut.
At 15x earnings, Starz doesn’t deserve to trade near-parity with other media names given its many, and serious, strategic weaknesses and earnings headwinds that are only accelerating. Negative subscriber growth is a very strong possibility given the explosion of new original TV shows by a large host of premium video/online competitors at a better value.
Price Target (April 2015): $28/share, or 13x normalized earnings of $2.15 per share. This is not precise, but I model Starz losing about 1 million of their approx. 22.5 million high-margin variable subs will be at risk over the next 2 years, as customers can buy HBO or Showtime directly and won’t be forced to pay $10/month for Starz in their package. (Given high fixed costs, any loss of paying subs brings down earnings quickly) $28 is also about the same stock price after news broke that Starz failed to sell itself, and basically the price at which John Malone sold his shares. There is zero reason why the stock should be up 30% from there.
Investment Thesis Discussion (April 2015):
1. Starz’s sub growth has been riding on the coattails of HBO and Showtime. With HBO going OTT now (April 2015) and Showtime (“in the not too distant future”), Starz will lose its biggest growth driver for new subs.
In Q1, cable distributors (MSOs) have been heavily promoting Starz and their bundled premium channels through promotional discounts. I believe that with the launch of HBO Now in April 2015, they are trying desperately to keep the 3-channel bundle together. MSOs are basically paying people to keep Starz, because they earn above-average margins on Starz to subsidize lower-margins on HBO and SHO. For ex; MSO’s earn about $8 out of $10 (retail) for a Starz/Encore sub, about ~$4 -$5 out of $10 for SHO sub, and only $2-$4 out of $12-$15 (retail) on an HBO sub. Basically, MSO’s earn above-avg margins on Starz/SHO to make up for lower margins on HBO.
The vast majority of Starz’s growth over the past 4 years has come from fixed-payment deals with MSOs that are not based on sub trends. This differs from variable rate subs, which are basically sold on consignment where the MSO and Starz split the fee (as detailed above). The sellside bulls conveniently “forget” that despite adding 6 million subs over the past 4 yrs., Starz’s revenue has been almost flat. That is because they have gone from 60/40 variable vs. fixed subs to 40/60. In early 2014, the company changed their reporting and stopped breaking out the sub mix. I believe they deliberately “hid the ball” to make it more difficult to notice that their sub growth is not bringing them any new revenue. This is also why I believe that any subs that may come from the new promotions, still won’t bring much of any new revenue for Starz.
In Q4-14 the Starz bulls positively focused on the fact that the Starz channel had strong sub growth, but ignored the fact that Encore subs have been decelerating steadily for almost 8 quarters. So even with a good Q4, total subs were barely positive (+0.4%) for the full year. This rate was far below the +4.4% sub growth HBO had in 2014, implying fewer users were co-bundling HBO with Starz. Again, the company stopped breaking out the fixed/variable mix 4 quarters ago. I suspect that is intended to hide from investors that the growth is coming from $0 fee earning subs added on fixed contracts.
A tangential point that is worth noting, is that a large percentage of the 6.5 million subs HBO has gained in the past 3 years have also been non-revenue generating to TWX. HBO has made it 100% clear they will seek payment from distributors for these subs in future affiliation deals. While this is not a direct negative for Starz, it will however mean less money in the pot to pay SHO and Starz.
In 2025, Starz is using the same strategy of riding the coattails of more successful channels as a “complementary” service. They don’t aim to be #1 - just to be "good enough" to get you to pay $5-$10 a month for an R-rated "add-on" while you use Netflix or Amazon Prime Video as your main streamer
Growing as an “add-on” premium channel is a strategy that can work!
BUT, I am a little disappointed that after a decade of shows, Starz still does not have enough brand value to grow subs AT LEAST 5%-10% per year. Mgmt is guiding towards relatively flat, 1% - 3% revenue growth.
2. Online and traditional cable companies are beginning to offer smaller and cheaper video bundles ($20 -$55/month), that have fewer channels, and let customers buy HBO directly, without forcing them to take Starz as well.
The shaving of excess channels has been well discussed on this message board so I won’t be repetitive here. If you believe that cable bundles are getting smaller, you should be very concerned for Starz, because typically a customer has to purchase $65 worth of channels just to get Starz. Distributors are trying their best to offer packages below this price point. Verizon just became the first major telco/cable distributor to finally break the bundle last week. It remains to be seen who follows them, but the trend is clear. Starz does not have nearly enough brand value, and not enough high-quality content, to sell a standalone streaming-video service to customers. It is no mistake that MSO’s are bundling HBO + internet, and not Starz + internet.
Starz in 2025 is still negatively impacted by cord cutting even though most of its growth comes digitally. New streaming subs are less profitable than the lost cable subs.
Customers are now cutting back on subscription streaming services and watching more free, advertising supported television (FAST). This will be a headwind for some time.
3. CEO Albrecht was meant to transform Starz into a market leader – but he has underperformed expectations. Five years into his tenure and still no hit shows under his watch. This is unlikely to change anytime soon. Fundamentally, I believe that the U.S. market for premium scripted TV is oversupplied.
CEO Chris Albrecht was hired in Dec 2009, and during his five years at Starz he has yet to produce any shows that could be categorized as commercial, or critically acclaimed, hits. Albrecht was CEO at HBO and head of original programming for seven years. He is widely credited with producing many of HBO’s most popular shows in history, such as Sex and the City, The Sopranos and Entourage.
The consensus predicted that his Hollywood connections would help build Starz into to a mini-HBO. Not only has he failed to produce hit content, but Starz’s biggest hit to date, Spartacus, was produced before he was even hired, and ran from 2010 to 2013. I think his inability to replicate the HBO model is because the market is far more competitive than when he was at HBO. Albrecht has publicly acknowledged that creatives can (and will) shop around their content to multiple channels and internet portals. Starz must compete with:
3a. Traditional competitors such as HBO and Showtime – both of which have the backing of larger corporate entities (Time Warner and CBS) and more brand cachet
3b. Online SVOD services such as Netflix , Amazon and Hulu– whose public shareholders do not expect them to generate the same profit margins as pure-play cable networks so they can do deals that would otherwise be uneconomical for Starz
3c. Basic cable channel such as AMC, FX & FXX (both FOX) and WGN – Basic cable channels such as AMC (Mad Men, Breaking Bad) have demonstrated they can also produce critically acclaimed shows (often with mature subject matter) that can rival HBO or Showtime
3d. Traditional broadcast networks such as FOX, NBC, ABC and CBS – In an effort to compete with cable, the Big 4 networks have also been copying cable by attracting top creative talent to produce more niche and edgy shows often with shorter seasons (8 to 12 episodes) just like cable
Time has proved my pitch correct that Starz cannot simply hire its way into becoming the next HBO. I do not think the current CEO / leadership makes a difference.
Starz got lucky that their most successful franchise - POWER - ran for 6 seasons and created several spinoffs. I am not confident in their programming slate past 2026.
In 2025, I think making hit shows is still a relatively random process. But the advantage will go to larger media companies that can pay more for creative talent.
4. Time is running out for Starz to prove they can produce enough worthwhile content to replace the loss of their Disney movie catalogue, which expires in late 2016. Given the future uncertainty, Starz won’t be able to get rate increases from MSOs. At worst, the MSO’s could force Starz to take painful cuts. As an independent, Starz doesn’t have any leverage to fight back.
Back in Dec-2012, it was reported that Netflix beat out Starz for the right to show films from Disney, Marvel and Pixar. It was rumored Starz wasn’t willing to pay the $300M annual price for Disney content. At the time investors were negative on Starz, because this was the first time that a big studio had chosen web streaming over pay TV.
Starz will continue to have films from Sony (through 2021), but the absence of Disney movies in late 2016 will be a hole in its offerings. Management has put an optimistic spin on this and said they will take the money they used to pay to Disney and invest in more original content. They say that years ago, Showtime did a similar strategy. The bulls often point to Showtime’s ARPU (~$5-$6/sub vs. about $2 for Starz) to argue Starz is a bargain, or to the fact that MSO’s earn higher relative margins on Starz. Also, it is worth noting that in terms of total gross ratings (not accounting for age demo, time of day, etc.), both networks actually do post very similar numbers. However, I think any likening of Starz to Showtime is false for several reasons:
4a) Despite similar total ratings, Starz’s brand value is still a very distant #3 to Showtime’s #2. (Everyone agrees HBO is #1 and in a league of its own) Showtime has had years to prove its ability to produce both critically acclaimed and commercially successful original programming (Homeland, Dexter, House of Lies). And 4b) much more importantly, Showtime will always earn a higher ARPU for its ratings due to its negotiating leverage thanks to CBS. I spoke with CBS and they publicly acknowledged that the network arm of CBS bargains on behalf of SHO. (Note – HBO is so strong that they can negotiate their industry-leading rate without Time Warner’s help.)
During due diligence, I spoke with multiple former employees with Starz. On the topic of programming, they explained to me that even if Starz debuted a hit show today, it would be insufficient to drive new sign-ups, because viewers typically need to see multiple hit shows before they decide to commit to adding a network. Thus it would still take several more years to raise Starz’s brand, even if things go well (and I argue they have not been going all that well). Starz management has been hyping two recent shows that have indeed shown some promise. First, the bulls would point to good ratings for the show “Outlander”. I would argue that these figures are inflated because Starz deliberately ran the show heavily during free-preview periods for subscribers and even took the unusual step to offer the show free on its Starz Play online portal. Also, management has been using the juggernaut success of “Empire” (FOX) to hype the new season of the Starz show “Power”, produced by rapper/actor/Vitamin water millionaire 50 Cent. Ratings have also been good for this show, but other than the fact they both have predominately African-American casts, the similarities to the show stop there.
(Note - You could very much hear in their tone of voice a very obvious skepticism on Starz’s ability to get any earnings growth in the near term. While I realize there is nothing abnormal for former employees to be a cynical of their old employer, I just thought this qualitative point was worth noting given how particularly negative they sounded.)
In 2025, Starz still relies on acquired movies for ~50% of viewing. Fortunately, they will still have access to good theatrical content.
Top 2 franchises, POWER and Outlander, are now over a decade old, as both shows started in 2014. The spinoffs are getting stale.
My take that viewers need to see multiple hit shows before committing, applies today. Without a 3rd legitimate hit to replace POWER and Outlander I am worried about the 2026 revenue forecast.
5. Sellside analysts are wrong in cheering the John Malone’s stock swap with Lions Gate (LGF). The deal was a private, tax efficient way for Malone to sell 43% of his Starz stake and invest in LGF and join its board. The deal did nothing to enhance the strategic value or create any new business prospects of Starz.
Malone sold ~43% of his Starz stock in return for a 3.4% economic stake in LGF. In return LGF will gain a 4.5% economic stake in Starz. The sellside bulls have failed to even acknowledge that the swap has neutral to negative implications for Starz’s valuation. I assume John Malone is acting rationally and would not give up so much stock if he thought it was undervalued. Bulls incorrectly point to Starz ~12x -13x P/E multiple at the time of Malone’s sale at $29 as evidence that Starz was “cheap”. However, none of them commented that despite trading at a large discount to LGF’s ~15x-16x P/E multiple, Starz had to give up a higher proportion of its equity relative to LGF, despite both companies being of similar size.
(Note: Last week LGF’s chairman sold 20% of his stake in LGF. I assume this to at the very least indicate he does not view his Lions Gate shares as particularly cheap either.)
Any partnership talk with Starz is highly unlikely for 2 reasons.
The way the industry works, channels and internet video distributors can buy TV shows from any number of production studios at any given time. Just because LGF now owns ~4.5% of Starz, they can and will continue to make shows for Starz competitors. Also, Lions Gate (along with Viacom and other movie studios) owns a stake in EPIX, the #4 premium cable movie network and upstart competitor to Starz. Cable companies can and will use Epix as bargaining leverage against Starz.
If LGF was going to purchase Starz, they would have done so already. As I said before, the stock tanked from $33 to $28 when it was announced that every major media company passed on the opportunity to purchase Starz. If Lionsgate only wanted to purchase 4.5% of Starz at $29, it is illogical to think they would buy the other 95.5% at $38 (or higher).
Starz’s CEO has been trying the best he can to put a positive spin on this deal which brings no economic benefit to his company. To drive home the point that this deal was between Malone-Lionsgate and NOT Starz-Lionsgate, Mr. Albrecht admitted at an investor conference that he had not even talked to the LGF CEO about the deal. The best he could do was offer some vague language about wanting to work more closely together, but the Starz sellside has glossed over this point. Lastly, Epix is also a Starz competitor. They announced this year that they too, will also be investing in original programming.
In 2025, I think the market is correct to no longer apply a John Malone premium. It has not proved wise to blindly follow the top media investors of the 2000-2010’s.
Today, investors are still afraid to give Starz a high multiple. It will always get a discount.
I think Starz has no real M&A value today to put a floor on valuation. “If someone was was going to purchase Starz, they would have done so already” still applies in 2025.
6. The sell-side is really starting to have to “stretch” to argue for upside above the current $37. The most recent DB report basically had to switch to a DCF (when everyone else in media uses earnings multiples), and back-loaded a lot of earnings growth in 2017-2018 just to have a reason to call this a “buy”.
I could do a second write-up on all the problems I have with the DB report, but here I’ll just focus on a few big flaws on page one. First off, the roll-off of the Disney programming will NOT lead to margin expansion, because Starz mgmt. has repeatedly stated that any savings will be reinvested in order more original programming. Secondly, as described earlier, I believe the analyst is very much wrong in saying the LGF swap will lead to something bigger. Third, Starz is not “well positioned relative to evolving consumer behavior”, because they have sub-par shows, especially when consumers can pay $10/month for significantly more content on Netflix. And fourth, the analyst argues that a 5% unlevered FCF yield is cheap for a company that has exhausted its ability to grow earnings, major programming risk once Disney content leaves in 2016, and every major media company passed on buying it 30% lower.
I will talk about Starz current (2025) valuation in future posts…Please subscribe!
My April 2015 short at $37 was correct, as Starz was acquired for $32.73 June 2016. Acquirors never wanted to pay big premium
Here are some common points the bulls often make. I will acknowledge them here, but am happy to take more questions in the comments section.
Risks to the short case / Mitigating Factors
1. The MSO’s have a strong financial interest in Starz being successful because they earn a much higher profit margin on each incremental Starz sub than they do for either Showtime or HBO; effectively subsidizing the other two networks.
Mitigating Factors:
i. This is the reason why cable companies have been aggressively running discount promotions on Starz, alongside HBO and SHO in Q4/Q1-15. With consumers now able to pick and choose parts of the bundle, cable companies realize that Starz subs are at risk if HBO and SHO customers leave (or don’t sign up). With these promotions, Q1-15 earnings may show positive sub growth. However, I think these new subs will be in the fixed bucket, and thus have $0 incremental revenue to Starz.
In 2025 it is actually very profitable for Amazon and Roku to sell Starz as an “add on”. I do expect this (and bundling) to be a positive driver of subs
But in 2025, Amazon and others are not as good as the cable companies at driving subs
2. Relative to Comcast, Starz is underpenetrated in Time Warner Cable’s (TWC) footprint. If the two companies eventually merge, it would be margin accretive for Comcast/TWC to grow subs in TWC markets.
Mitigating Factors:
i. Yes, the penetration rats are different, but what bulls misunderstand is that this argument has nothing to do with the merger. As mentioned above, Starz subs bring the highest margins to everyone, so TWC has been incentivized to sell more Starz regardless of any merger. Back in May 2013, TWC already signed a multiyear deal with Starz to take more of its networks and allow online/mobile access to Starz content. TWC has already been aggressive in offering promotions to drive subs. There is no reason to think a merger with Comcast accelerates this strategy.
ii. Continuing consolidation amongst the pay TV landscape is a net negative for Starz because it only increases the MSO’s bargaining leverage against the channel. After failing to find a buyer, Starz negotiations will become even more difficult with larger, more powerful, MSOs.
No longer relevant, as most new Starz subs come from digital.
3. Starz could launch an OTT offering in the U.S. and gain subscribers outside of the cable bundle. They could either go directly to consumers like HBO or Netflix, or they could be sold by the cable companies alongside internet only packages. For example, on March 16, 2015 Cablevision said it would offer HBO’s internet streaming service to their internet-only customers.
Mitigating Factors:
i. Some news outlets report this incorrectly. Starz has said they will not be going over the top to consumers in the U.S. anytime soon. The pushback from the cable companies will be far too difficult. Several MSO’s punished Starz a few years ago when they licensed some of their content for Netflix to use. After the negative backlash, Starz will not pull something similar again.
ii. Any internet co-packaging in the U.S. is unlikely because there is little demand for $10 Starz when consumers can get more value than ever before from Netflix or Amazon.
In 2025, everyone agrees that while Starz launched their own streaming service, its growth has stalled and it needs other streamers as complements.
4. Starz could have success selling an OTT service internationally. They announced on April 1, 2015 that Starz Play Arabia streaming video would be available in 17 countries in the Middle East (e.g. Egypt, Bahrain, Kuwait, Saudi Arabia, Qatar, etc.) for $13.99/month.
Mitigating Factors:
i. Starz does not have the international rights for the majority of its content. They can’t stream most of their movies abroad. The same is true for some of their original series. By co-producing content with other studios, they lower their costs and financial risk, but they give up future control and limit future monetization opportunities. To fill the gap in content, they are partnering with several Hollywood studios and locally produced content. Even if this is successful, it is unclear how profitable these subs would be to Starz.
ii. Netflix has a very large head start on Starz and its competitors when it comes to expanding internationally. NFLX currently has 57 million subscribers in more than 50 countries, and is on track to reach as many as 200 countries by 2017 (by their estimate). Local media countries in many foreign markets have already been expanding their streaming options to compete with Netflix (e.g., Vivendi’s Canal+ expanded its streaming video service when NFLX came to France). I would imagine Starz will find it very difficult to compete internationally against NFLX or the local incumbent providers.
In 2025, nobody thinks Starz can drive international sub growth. The company has a clear ceiling in 2025, which leaves little room for error in the competitive US market.
Upside risk to Starz – Low $40’s/share: I think the risk to upside to Starz is that its P/E multiple fully expands to match that of Scripps (SNI), which trades at about ~16x earnings. At 16x consensus 2015 EPS of $2.55 gets to about $41/share. Again, I think any new sub growth will bring almost no incremental revenue to Starz. Therefore, if subs stay flat they could maintain their EBITDA of $500M, and generate about $250-270M in FCF. At $38/share, Starz’s strategy of buying back stock has diminishing returns when you are buying stock at 15x instead of 12x, as was the case in prior years. Plus, Starz’s leverage is close to its target, and they will need more cash to invest in more programming.
My pitch was correct in that Starz upside was low, as it was taken private at $33, less than the $37 at the time of writing
I do not think Starz is worth 15x PE or 15x FCF in 2025. Will talk valuation and price targets in future posts, but it will be lower than 15x!
Catalyst: Not one hard catalyst, but a lot of both macro & micro forces increasingly working against Starz: 1) 2016 negotiations with cable providers (MSOs) should not go well, as Starz has failed to prove their new original content can replace what they are losing with Disney in late 2016, 2) original programming continues to underwhelm, 3) cord cutters/shavers continue to move to cheaper/no-video bundles, 4) Netflix, HBO Now and other video options are an increasingly better value, 5) any sign at all of weakness in sub growth, 6) market wakes up and realizes there will be no merger with Lionsgate and John Malone was just unloading stock
I will double-down and say that $STRZ does not have M&A as a catalyst in 2025+
STRZ catalysts going forward will be primarily 1) quarterly earnings, 2) the market will react (good or bad) with each new show release in 2025.
I think the only way STRZ re-rates higher in 2025, and keeps its gains, is if we see evidence of a strong 3rd tentpole show, outside of POWER and the Outlander franchises.
Check back for more on Starz as I will be covering the stock going forward!
-Accrued Interest