Lionsgate Studios Corp. (LGFA) Earnings Call Transcript & Summary

All right. I think we can kick this off. Just a quick note for important disclosures, please see the Morgan Stanley website. If you have any questions, please reach out to your Morgan Stanley associate. With that, my name is Thomas Yeh, analyst at Morgan Stanley. And I'd like to welcome back to our conference, James Barge, CFO of Lionsgate.

It's great to be here, Thomas. Thank you.

So maybe we could just start at the high level with the separation that's still pending. We've seen a few delays on the planned separation of Lionsgate Studios and Starz. Can you just give us an update on where we are today and why you believe April might finally be the date that this gets done?

Well, we've been on this path for quite some time. We started that journey. We didn't know there would be a pandemic, writers' strikes and somewhere along the way, we made a fantastic acquisition of eOne. So there have been quite a few things. But we are definitely there. We're on track for mid- to late April close. We filed the S-4 last Monday, premarket with the SEC. Hopeful -- this is the fourth amendment -- hopeful that's the last amendment. I think the questions and comments were just very manageable. We turned them around very quickly. But the September financials, which was in the previous draft, were stale. So we had to refresh with the December numbers, which took a few weeks and we refiled and expecting comments back, and that should hopefully be the last term. And then there's 30 days, you mail your definitive proxy and then we have a shareholder vote meeting, and we're on our way.

So those are really just the final steps, an SEC approval, a waiting period and a shareholder vote?

Exactly. And then we -- and the financing is already lined up. It's ready to fund as soon as we close.

Great. Well, can we maybe just start with revisiting the rationale for the deal to begin with? What kind of strategic optionality are you hoping to unlock for either side? Maybe we can start with Studio and then talk about Starz as well.

Well, the rationale is still there, in fact, more maybe evident and important than ever. You're seeing a lot of people in the industry starting to segregate out their linear business. The good news is, is we don't really have a linear business. We have Starz, which is premium. It's digital first, 70% digital revenues as of the end of this fiscal year or calendar year. So really a strong business. And the studio is legendary, as you know, the 20,000-plus titles in library, picked up another 6,500 titles with the eOne acquisition. So just an incredible asset there with the library, then TV and film production capabilities, and we own 76% of probably the world's preeminent talent management company, ThreeArch. So this has been all about valuation, helping drive shareholder value where we don't feel as a combined company that we're getting the valuation, we look like a conglomerate media company in the space that is competing with the Discoveries and the Viacoms and the Comcast and the Disneys when in reality is Starz is a completely unique business, totally misunderstood. I think our library and our studio is better understood. But when it's attached to a misunderstood asset, I don't think either side we've been able to tell the story and we've been able to achieve the valuations that we can when we're trading on a stand-alone basis. So this is all about unlocking shareholder value, and we're very happy to be able to do that next month.

Got it. I want to touch on the -- and dive deeper into the future of both of those businesses. Maybe just to start on the capital structure once this deal gets done, you mentioned some refinancing that you've done ahead of the separation. including some library-backed facilities at the studio, I believe. So how should we think about your view on the pace of deleveraging and maybe the appropriate long-term leverage that you think both of those assets should be sitting at over time?

Yes. I think it's probably easiest to start with Starz because I think it's just a fairly straightforward capital structure. You have -- we've already completed $450 million of pro rata financing, which would be $300 million Term Loan A and $150 million revolver, okay? And on top of that, they have the bonds because we've had the bond exchange, they'll have $325 million of bonds that 5.5% coupon due 2029. So you really have your financing and your capital structure lined up for 5 years. That's -- what I said on the last earnings call is I think when we separate that the net debt will be right around $600 million at Starz, which $200 million of EBITDA, that's our guide, and we feel good about that. That's a 3x multiple. And Jeff has said, and I believe they're nicely set up to delever, okay? You do $200 million of EBITDA a year. You really only cash that you need to -- off of that as a cash negative would be your interest expense, cash interest, okay, which is manageable at the -- given the capital structure I just laid out. You have cash taxes. Remember, as we've said before, there's about $200 million to $300 million of NOLs going over from our structure with Starz, okay? So you don't have much in the way of cash taxes, and they don't have much in the way of CapEx. Everything else is a zero-sum game when you talk about working capital shifts, pluses and minuses in your business, which, of course, occur, but it's a zero-sum game. So you really have only those 3 things to really back out of EBITDA. And if you're doing $200 million plus EBITDA, you can immediately see that you can start to delever significantly. So Jeff's talked about 2.5 midrange, below 2.8. And again, they're set up to delever fairly quickly.

Got it. Studio...

And on the studio side, Studio side, you're absolutely right. We've been planning for this all along. We have actually already taken out the Term Loan Bs that previously existed and our current credit facilities and all will pay that off at closing. But we've layered in -- we layered in $340 million of an IP facility financed largely off the back of the eOne library. So we paid $375 million for eOne. We put in an IP library supported by their library, a little bit of Lionsgate library, too, right? It was a good deal, but you can't -- it's kind of hard to buy the entire company off of the LTV that you would get in an IP financing. But we layered in $340 million SOFR plus 225 financing. And since then, we've layered in another $850 million using the IP and the Lionsgate library. So we'll top that up a bit more between now and closing, which is pretty well circled. And then we have already a committed $800 million asset-backed facility revolver, if you will and that's at SOFR plus 250. So all of that together and then, of course, at separation, $390 million of the bonds in the exchange will come over at a 6% coupon due 2030. So again, the studio, all the financings lined up. Again, you've got no maturities for 5 years plus. This is all 5-year paper and at very attractive rates. And hopefully, with rates declining as we move forward in the future.

Yes. I mean is there any update on the minority bondholder litigation process that we might be looking out for in terms of an expectation of a resolution there that kind of -- should it be on our radar? Is anything that might...

Really nothing to update there. I think I don't see that affecting the separation or the timing of the separation at all. Again, those bonds are actually trading quite well. And the gap between those bonds and studio bonds is only, I think it's less than $0.10. They trade where they trade because it's a 5.5% coupon. We hit the market quite nice. Again, there's 5 years, 4.5, 5 years left on those bonds, and we'll pay every $0.01 of principal and interest.

Got it. You talked a little bit about the free cash flow conversion at Starz. I wanted to go back to Studio just in terms of the working capital needs and the free cash flow that we should expect from that business. Because I think the pandemic and then the Hollywood strikes drove some increased volatility in the timing of production and free cash flow. So how should we think about what normalized looks like in more of a steady-state period if there actually is one...

No, good question. The biggest expenditure, of course, in the studio business would be our content spend, right? So I think of it as like -- we've been at $2 billion, but that's with Starz on a combined basis. So think of the studio like $1.5 billion of content spend. That's about 50% of our revenues or $3 billion-plus revenues or $3 billion to $3.5 billion. So that feels right and very manageable. That supports our TV and film production, both of which is very healthy and doing well. And that's constantly replenishing library. Remember, the library -- is we just finished a quarter with record trailing 12 months over $950 million of revenues. That has about a 50% cash margin, okay? Now that cash margin is just a nice steady continuous library, even though $950 million was a record. So think $900 million, $850 million to $900 million, but really a nice steady stream of cash and then that supports the productions, okay, and your content spend. So it has been -- in terms of cash flow, there has been a use of cash in the content world as we were exiting through the strikes and the pandemic as you build back up. And then as you -- actually, what I think of is hold the inventory, right, you're waiting for the right time to release it like during the strike, talent really wasn't out promoting or able to go out and promote the films. And so a lot of that kind of backed up as well as television series deliveries. So that has kind of come through the pipeline, if you will, and we've ramped up the spend. So I think we now kind of start to top out at that kind of steady level of spend. And likewise, in addition to the pandemic and writer strike, we've been in a very high interest rate environment. And I know it's prolonged a little longer than probably any of us maybe had thought. But I mean, I think ultimately, that's a downward projection as well. So the studio can throw off a lot of cash. Again, you have 3 things that basically you back off EBITDA in the long term when you set aside the zero-sum game and working capital, which the content spend is that, okay? Cash taxes will have $800 million to $900 million of NOLs at the studio, okay? So there's minimal cash taxes. There's almost no CapEx, okay? And it's cash interest. And as you delever and as rates start to come down, you power through that. And again, we've kind of steadied out at level content spend.

So that $1.5 billion to $2 billion that we're seeing this year at the studio ex eliminations, that's the right number going forward in terms of...

Yes, I wouldn't think it's going to be $2 billion for the studio on a stand-alone basis. Look, we greenlight project by project, right? And we're very focused on NPVs and investment rate of return and modified investment return. And look, I love nothing more than be able to greenlight more because that means you've got a great investment in IP. But I think just given our cadence, again, we're focused on 10 to 12 wide releases a year on the film side. We've got P&A spend that goes with that. We have another 30 to 40 films that are direct platform that do quite well, nice high-margin business, but doesn't require significant investment. And we have a significant television production business. So we've -- that we fund. But I think we can do all of that, call it, $1.5 billion, kind of $1.7 billion, something like that.

Good. That's great. So let's focus on Motion Picture a little bit. You had a tough summer box office, which led to a reset in the earnings expectations earlier this fiscal year. What gives you the confidence that this was an under-earning moment and that your annualized run rate for Studio should be kind of higher than that?

Sure. Well, for one reason, historically, that's the first time we've ever, ever seen that in our business. Borderlands was, as we spoke to, in a day wasn't derisked and didn't deliver -- by the way, it's doing great in home video and other ancillary markets, but not enough to recoup. So yes, so we took a write-off and we move on. But it's all about a portfolio approach. Again, that was an outlier, have nothing in the pipeline at all that looks like that. Again, we follow a derisked model of pre-licensing the international revenues. So we're only picking up self-distribution in the U.K. and U.S. and only responsible for the P&A in those territories. So we've got a really good slate coming up. And actually, we bounced back quite nicely with best Christmas paging ever, flight risk, den of these 2, all of which outperformed our kind of internal projections. As you know, we don't project out major hits, but it's nice when we overperform our projections. They all did nice in the market. That's more akin to the kind of the portfolio approach that we're known for. And we've got 3 really strong tentpoles coming out next year. We have Ballerina, which, of course, is a spin-off of John Wick. Keanu Reeves is in this film -- cameo. And so we're excited about that. We have Now You See Me 3, and then we have the Michael Jackson project. So -- and then we have a lot of mid-budget films more along the lines of the ones I just mentioned a minute ago, The Long Walk, The Housemaid. So we've got a nice slate for fiscal '26.

Is fiscal '26 then a little bit more representative of what you think would be a more normalized level of big tent poles and smaller films and that's how we should think about going forward...

That's right. Yes.

You also did a recent expanded Pay-1 deal where you increased your partnership and renewed with Starz, but also signed an opportunity with Amazon. And then I think on the earnings call, you mentioned that you believe that, that should be driving meaningful earnings upside relative to the prior deal. How should we think about the opportunity to monetize the movie windowing and where there might be additional opportunities to unlock that further?

Right. Well, that's a great opportunity, and it is a win-win. And Jim Packer and his team and Starz working with Starz, working with Amazon and you find a way just to divide the window up slightly different. Starz gets a product out through the end of calendar year '28 and -- which is great, and they get it earlier. So they get it earlier where you can really leverage the P&A spend that has happened theatrically. And so that's excellent. And then you carve out a window then for Amazon. And Amazon can pick it up and leverage their big prime video base and again, and then it ultimately comes back to Starz at a later date. So it's just a creative way to take the window and make more out of it. And so we think it's a win-win for everybody. We have about 4 films that will be delivering in our fiscal '26. And mostly, you'll see the impact in fiscal '27 -- our fiscal '27.

What do you forgo in the home video window by accelerating that delivery to Starz?

Yes, there's a little bit there. We obviously looked at that very carefully. It's just a few weeks. And so we think net-net, it's clearly a win-win, and we're very confident about being able to strike the deal. And it's just a good example as windows will continue to evolve, right, and they have been. And every time you have content and you can slice the window or do something more creative, again, you're just squeezing more juice out of the same orange.

Makes sense. I think another piece of the motion picture puzzle is the way that you finance films through international presales. Just wanted to get a gut check in terms of how you see the health of that market as a financing vehicle for your movies. Are you seeing the demand for first-run film content increase in spite of the broader industry focus on cracking down a little bit on content spending?

Yes. No, we're seeing -- we're actually seeing a very robust market. Helen Lee Kim and her team have been seeing more and more buyers of English-speaking content in the international markets. And just recently, we actually got John Wick Chapter 4 accepted for release in China. And so that will be the first John Wick ever released theatrically in China. That bodes well perhaps for Ballerina. We'll wait and see. But we're just seeing more and more market opportunities. The Michael Jackson project was another great example as was Flight Risk, where you cover a substantial portion of your production cost in those presales. And then that just minimizes the amount, what we call our U.S. GAAP, the amount that we need to recover predominantly in the U.S. market, but also we self-distribute in the U.K. that you need to recover to be kind of in the clear and then it's gravy and upside from there.

Got it. Makes sense. Switching to the television side. I do feel like in the last few quarters, there's been some comments from you about just a spending environment where there have been a little bit more lower series orders in general. Do you expect that rationalization efforts across the industry to continue to be a source of pressure for you?

We're seeing some bounce back and some green shoots. I have to tell you, but it has been very difficult with the strikes and then everything that's transpired has definitely had its effect across the entire industry, not just Lionsgate. So we've seen it across the industry. We've seen some disruption in the industry with mergers and people reevaluating their spending patterns, driving the streamers to profitability as opposed to just chasing subs is something that, that Jeff Hirsch at Starz has been doing for a long time and now other people are starting to follow suit. It's amazing, but profitability is important. But they're achieving that, and we're seeing people open their pocket book up again. We have -- since the strike, we had -- we've put 60 series orders into development. And we have another 60 that we have across more than 2 dozen platforms that are in production. So we've got a significant breadth across our television business, both scripted and unscripted. And I mean, just last month, we announced CBS. We've got the #1 or #2 comedy on all of broadcast, which is Ghost. I hope you watch it. CBS after premiering Season 4, put in a 2-season order for Season 5 and 6. That was just this last month, okay? And in January, we premiered Rookie Season 7. And those procedurals, and that was actually a pickup from eOne. And those procedurals can go on and on and on. So there's a lot more runway well beyond Season 7 for that, that Season 7, like I said, premiered in January on ABC. And then on the unscripted side, Ultimate Fighter in production for its 33rd season, okay, and [ Arizona ] ESPN+. So those go on and on. And in that context, another eOne asset that we picked up done by Renegade on the unscripted side was Naked & Afraid, and it's going into production for its 12th season. So you can just see how much runway there is there. So we're seeing, again, more orders, people bouncing back, and we really feel good. We had a very good quarter in our TV business this third quarter, which was our third quarter, so the December quarter. And we're also projecting a very good end of fiscal year fourth quarter for ourselves ending March. So a lot of these episodes are delivering as we speak.

Great. So the demand trends, it sounds like that on a both scripted and unscripted basis, you're kind of seeing a little bit more...

A little bit of bounce back. I mean, good, it's off of an easier comp, right? But I think the strength is there. At the end of the day, content is what drives viewership. And whether you're a streaming platform or broadcast, you've got to have content and you've got to drive viewership or else it's a downward spiral, right?

Starz, I think, has been historically a big buyer of Lionsgate TV series. How does that relationship evolve over time as Starz, I think Jeff has mentioned looking to de-age his lineup and move towards newer shows with better economics to them. How should we think about the offset to that on the studio side?

No, I think it's great. Look, the studio owns the IP and the Power franchise and BMF, all of those shows that we produce, the studio owns the content. And we have always had an intercompany agreement with Starz, and that will continue on in strength. So in separation, we're kind of keeping the best of the best. We're breaking -- letting the 2 companies trade and pursue separate paths, but at the same time, keeping the synergies and the best of the best in the context of content sharing. And if you look at Power franchise, I mean, the Power franchise, when we merged with Starz, it was just Power, okay? We've had 3 spin-offs since then, Canon, Ghost, Force, and more to come. And so Jeff is working on that with Kevin and our team, our TV team as we speak. So there's a lot more to come out of all of those. And in terms of the de-aging, what Jeff is looking at there and other buyers, too, you're always looking creatively how you create adjacencies and characters that can be spun off and carry their own -- just like Force, just like Canon, just like Ghost, okay? They can carry their own weight in terms of a new series, okay, or adjacent storylines. We had a spin-off of BMF. So that allows you to kind of start with a fresh cast and therefore, lower your overall cost and reset the budget. And so that's just a natural phenomenon. And it's very creative and something that there's always a focus on where do we go from here? When does the story end? When should it end? A lot of times it ends a little before the consumer wants. But then again, we're in this business to make money. And that's another good way to do that and you drive shows that are driving 10 million viewers. So these are some of the shows that are the biggest in television. We're just not necessarily demographic and so you got to check it out on Starz.

Yes. Sounds good. You talked about the sub-$2 billion of cash needs for the studio side. On the Starz side, how should we think about the investment needs in the path there as we think through this kind of lineup mix shift? Over time, do we see that coming down in terms of how much the cash spend might deploy?

Well, I think of the $2 billion, Jeff, was plus or minus $700 million in that business. So I think that's a nice steady state. That could be managed back, I think, in the context of this de-aging and where you can bring your overall cost of production down and therefore, bring down your overall cost of licensing fees. Those 2 go together, right? Then you can get a better breadth and more throw rate. So I don't think the goal is necessarily just to drive down production costs as much as be efficient with the production spend and programming spend and then get better breadth and drive and super serve those consumers. And keep in mind, he's focused on 2 major demographics, right? So women in African-American, not trying to be all things to all people, no sports, no news. It's pretty much edgy programming are rated. It's not -- again, it's premium content.

Got it. Okay. Before I dig deeper into the Starz piece of it, I did want to ask about an eOne update. At acquisition, I think even with synergies, it appeared like it was a lower-margin business than your legacy TV segment. What's the road map for driving margin improvement from eOne? And now that it's fully operationalized into the broader content library, how should we think about its ability to drive the TV segment's profit overall?

Sure. This has been a great acquisition, actually. I mean it was a year of integration. So that took some time and clearly affected the time line to the ultimate separation. But now that we're there and now that we've transitioned and integrated eOne, it's just a great asset. So first of all, slightly lower margin just given the makeup of the library. But again, 6,500 titles, we ingested that relatively quick. That wasn't the lengthy transition. That comes pretty natural to Jim Packer and his team, which can -- without adding any incremental G&A effectively and in fact, can reduce G&A pretty substantially in that category can create so much more value by linking that library to our existing library. So that's been a major plus. The TV side was a longer integration, but it's come over. I've mentioned a few of the projects already. The Rookie, I mentioned, the Recruit, the Naked & Afraid, so it had scripted and unscripted business. The scripted business, we've matched up with Pilgrim Media or the unscripted business, we've matched up with Pilgrim Media. It's now Lionsgate Alternative. So we've got what was 3 or 4 different brands under eOne. And then our Pilgrim brand now under Lionsgate Alternative realizing some significant savings and overhead there. And again, integrating those assets fully into the TV business. On the film side of the business, keep in mind, Den of Thieves 2, we were actually distributing already for eOne, and that was an eOne film. So we just definitely upped our economics there, which was great. But otherwise, the film integration went fairly quickly because we're not picking up a lot of projects other than I would suggest that there definitely should be a Den of Thieves 3 in the future, but nothing to announce. But again, we're just very happy with that asset across the board.

Okay. Great. So with the time we have left, I do want to touch on Starz a little bit and then maybe also just the ancillary revenue opportunity that you saw -- that you see going ahead, given the fact that I think there's maybe a little bit of increased focus on monetizing some of that. But just on Starz first, despite its largely a la carte subscriber base, I think that we've seen linear headwinds remain a pretty significant source of pressure on the overall subscriber number and that as of late, at least has been outweighing the OTT games. So what do you see as the growth opportunity from here more broadly for Starz domestically as we kind of think about this asset on a stand-alone basis?

Yes. Every year, you grow your OTT subs and you have a little bit of reductions on the linear side, you're getting closer and closer to effectively kind of having lapped that. And so as Jeff would say and as we've said on our earnings calls, at the end of this year, we'll be 70% digital. And really, Starz was digital first. So they had been focused on this really since the date of acquisition when we merged the company. So this has been, again, a consistent path for them. And if you look back, their revenues and subscribers have been very domestic, have been very steady and very strong. And so I think here going forward, there's bundling opportunities. You saw the announcement bundling with Max. We have other bundles as well. So bundles is kind of becoming the new way, if you will. And Starz is perfect to bundle a bundling partner because, first of all, it's not ad-based. It's edgy. It's catering to 2 very important demographics, okay? And that creates what that does, it reduces churn. It gives you better economics. And likewise, you can serve up advertising or serve up rather programming that can be timed with programming in the other parts of your bundle. So particularly for African-American and women audience and what Starz brings to the table, it can really provide a continuing serving that audience in the bundle. And that's helpful to your -- not only to Starz, but also to your bundling partner.

Got it. So lastly, on the ancillary revenue opportunity, which you spoke about on the quarter call. Can you maybe just help us dimensionalize how you think about it in terms of an earnings contribution perspective just from the various opportunities that you might see, there's a musical, video game, Broadway.

Yes, we've got Dirty Dancing, La land, Musical, the John Wick Experience opening in Las Vegas. We've had the SAW experiences. We've got the AAA John Wick game in development. So the great thing about this is it's effectively 100% margin, okay? Not quite, but almost. We're basically getting publishing rights and fees, minimal, if any, investment in that space, minimal in the way of overhead required to drive that. And it keeps your franchises live and just keeps them relevant. And at the same time, you're clipping coupons, bringing in incremental revenues usually in the form of minimum guarantees.

So the model that makes sense for you is a licensing one where you're licensing...

Yes. Look, we always look for the right opportunities. But yes, that's the premise of that. And you're always open to opportunities where you can expand your upside. But generally speaking, that's just incremental licensing fees without any significant investment.

Understood. Well, I think we're out of time. So thank you so much for being here. Thank you.

Thank you. Appreciate it.