Lion's shares buyers' mane concern
Kerkorian unlikely to get desired price for equity
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The results may not be music to billionaire owner Kirk Kerkorian's ears.
A new report from Lehman Brothers values MGM equity at just under $4 billion, with over 90% of the value attributed to the 4,000-title library and zero value attached to the loss-making film and TV production units.
Lehman reckons library license revenue is growing at around 9% annually and should be generating around $326 million in cash by the end of next year thanks to huge DVD gains. Lehman derived a 12-month price target of $15 per share, far short of what Kerkorian hopes to get from a potential strategic buyer.
While recently playing coy about possible partnerships, Kerkorian's Tracinda Corp., which already owns 77% of MGM's outstanding shares, this summer filed to acquire 842,000 shares at $9.42 to $11.98 per share in an effort to boost the stock. The buyback has become part of the company's new plan to acquire some 10 million in shares on the open market to exploit the low price. Analysts say the recent volatility of MGM's shares is due in part to its thin float (only 55 million shares are traded in the market), which exaggerates the effects of good or bad news on the stock price.
But based on analysts' estimates, MGM may be trading not too far off its fair market value in the short term, which either means Kerkorian will have to face the music and accept a lower bid -- if indeed one were even in the offing -- than he had once hoped for the business, or else continue buying back stock.
Last January, MGM hired advisers to rev up merger talks, but Kerkorian's reported minimum price of $20-$25 per share was, and remains, too rich for many would-be buyers. Even taking into account the 25% discount to its asset value that Lehman believes the stock is now trading at wouldn't bring a premium high enough to satisfy MGM's owner.
A roll-up of MGM, DreamWorks and EMI has been touted as an ideal combo for some time, but negotiations apparently have faltered recently over how the company would be valued as a combined public entity. In the meantime, MGM stands by its conviction that the company is committed to going forward on its own at a more modest expenditure level. Some analysts speculate Kerkorian could take the company private if he truly believes it to be undervalued.
JP Morgan is even less sanguine about MGM's prospects than Lehman. The bank recently put out a year-end 2002 price target valuation of $12 per share (compared to $11.02 on Tuesday) and estimates it should be worth around $14 per share by the end of 2003. The bank has downgraded its revenue targets for the third quarter to $367 million and its full-year estimates to $1.54 billion, with a higher than anticipated EBITDA loss of $137 million. The better-than-expected performance of "Barbershop" will likely be offset by the delayed release of "A Guy Thing" and lower-than-expected homevideo revenue from "Windtalkers."
Even the "Bond effect" -- the share price rise that usually precedes the release of a Bond film up to six months prior to release -- has yet to work its magic on MGM's upcoming "Die Another Day" in the current dismal market. The James Bond franchise is considered the company's second most valuable asset after MGM's library, which is comprised of post-1977 releases. MGM is nevertheless expected to get a small market boost next month with the Bond release on Nov. 22 and the concurrent retail debut of the first of a three-part James Bond homevideo boxed set.
While Lehman analyst Stuart Linde expects the Lion's film library to generate some $300 million in cash flow in 2002, he believes far more value could be unlocked if MGM were to team up with a larger entity and tie itself to a better distribution platform. "We believe that Kirk Kerkorian ... would be willing to sell at the right price," Linde concludes.
The right price?
But just what the right price is remains a mystery to Wall Street, and the number of potential buyers willing to pay a significant premium for the pure-play content company are scarce in the current climate. Disney was the obvious buyer, but its $5.2 billion acquisition of ABC Family last year drained its dealmaking pocketbook.
The lack of distribution clout continues to be a major stumbling block for the studio.
Some 85% of its cable and broadcast licensing deals are currently up for renewal, and the continued health of the library revenue stream will depend on securing higher prices for its contents.
As long as MGM remains at the mercy of the grim economics of filmmaking, even its lucrative library won't boost the company's value in the medium term.
In its recent report, JP Morgan noted that film production "is difficult to predict and capital intensive." Those characteristics, combined with only modest annual increases in aggregate box office revenues, make it tough to earn meaningful returns on invested capital from theatrical production, even after factoring in contribution from ancillary markets, such as homevideo.
Lehman praised MGM's policy of pre-selling foreign rights, instituting a more rigorous film approval process and lowering its overhead. But the bank remains unconvinced about the economics of filmmaking outside of a vertically integrated group. Total box office theatrical rentals are forecast to generate $270 million in 2002, 80% of which will come from the latter half of the year.
