AMC Networks Inc (NASDAQ:AMCX) is a favorite stock of Horizon Kinetics, the parent company of Horizon Asset Management which upped its stake in the entertainment company by 20% during the second quarter. In its Q3 investor letter (you can download a copy here), Horizon Kinetics discussed its investment thesis on AMC Networks and Howard Hughes. We covered Howard Hughes in this article.
Here is what Horizon Kinetics said about AMC in its letter to investors:
Cord-Cutting Explodes: 22 Million U.S. Adults Will Have Canceled Cable, Satellite TV by End of 2017
Variety (September 13, 2017)
Cord-Cutters Sap AT&T’s TV Business
Wall Street Journal (October 12, 2017)
‘The ravages of cord-cutting’: AT&T’s race against time to save its TV business
Washington Post (October 13, 2017)
The Messy, Confusing Future of TV? It’s Here.
New York Times (August 13, 2017)
“Cord-Cutting,” “Skinny Bundles” and “OTT Offerings” are disrupting the traditional television landscape, as the NY Times title above expresses succinctly. There are substantial implications for operators in the media sector, but as is often the case, perception often obfuscates reality, which can be very helpful for research-based value investors.
For those not conversant in media industry jargon, cord cutting refers to a cable subscriber foregoing a traditional subscription (‘cutting’ the cable cord, although cable signals are now provided via the same fiber as internet). The consumer is left with a variety of options to access video media (both free and pay models), one of which is a skinny bundle. This refers to a cable package, offered either over the top (OTT) or via the traditional linear system, in which fewer channels are offered in the bundle compared to traditional packages. OTT refers to the ability to bypass the traditional time-linear cable subscription (that is, if you don’t get home before the show starts, you’ve missed it) and instead consume video via a streaming internet feed at a time of your choosing. These offerings now exist directly from content companies, cable companies and third party providers.
Got that? Neither do a lot of other consumers, hence, the NY Times headline. But that is a contributing reason why traditional media companies, which used to trade at material valuation premiums to the broader market, now trade at a median 13x earnings, or about 40% cheaper than the S&P 500. To be sure, some companies are better positioned than others, as exemplified by AMC Networks (“AMC”) and Lions Gate Entertainment, both of which are held in Core Value as of quarter end.
AMC’s primary business is providing television programming via five national networks, including its flagship AMC channel, IFC and SundanceTV. It earns revenue relatively equally from advertisers and the affiliate fees that cable companies pay to carry the company’s networks. These revenues are driven by viewership rates and the number of subscriptions. The headlines above imply that as more consumers forgo traditional cable subscriptions, companies like AMC will lose subscribers, impacting affiliate fees, hence, viewership and advertising fees. Partly as a result, the shares trade at approximately 8.5x earnings, which is about 35% cheaper than other media companies, and 60% cheaper than the S&P 500. More importantly, AMC trades at less than 12x free cash flow. Which is why we purchased AMC in 2016 and added to it this past June.
If someone knew those valuation figures only in isolation, they might wonder what manner of business risk is reflected in such a deep discount, that perhaps that pricing suggests a dire future. Yet, at the company’s National Network division, which accounts for over 80% of sales, revenues increased by 5.6% in the June quarter, and operating income rose by 12%. That operating strength, though, is indiscernible to an index buyer or quantitative investor, since the international segment records negative earnings on a GAAP basis, distorting consolidated results, although that division breaks even on a cash flow basis. AMC was able to achieve these overall results despite the “ravages of cord cutting” because of the value of its primary asset: content.
AMC has amongst the highest rated and viewed primetime television shows on cable television, which enables it to negotiate higher distribution fees and advertising revenue. That it only has five channels is a further advantage; carriage of these channels is far less burdensome to cable companies than is carriage of many larger, competing networks that try to include over a dozen channels. AMC’s sought-after content is actually resulting in stronger results despite a weaker industry backdrop.
Content is the key variable with all media companies (other than distributors), and if consumers demand specific content it will be valuable. The economics of original content in a world in which more consumers access content via OTT offerings and/or skinny bundles is yet to be determined, but AMC appears well positioned. It has control of long-term contracts covering much of their valuable original content library and production. As a result, the company should be able to continue to monetize these assets for many years to come, across various media platforms.
Back to the valuation, the shares trade at 12x free cash flow despite no contribution from AMC’s international division, which accounts for about 17% of revenues. The international cable division was largely acquired recently, with the strategic notion that AMC could extend the commercial reach – mostly into Europe – of content it already produces. That could be very profitable. This requires a certain amount of time to market and to attain a certain degree of scale. If this venture is successful, then AMC’s earnings will be that much higher. If ultimately unsuccessful, one presumes that AMC will sell or disband the effort, in which case the earnings drag from this effort will cease.
Lest we forget about behavioral finance, the discounted valuation should not be ascribed to the presumption that rational analysts and investors are making informed decisions about the AMC business prospects.
– First, AMC has a stock market value of only about $3.5 billion, which is well below the size needed for most major index ETFs. In a single week, Disney shares trade $3.5 billion of volume, equivalent to the entire market cap of AMC. Disney has a $150 billion market cap.
– Moreover, the Dolan family, which operates AMC, owns nearly 20% of the company’s shares, so the tradeable market capitalization, or float, is that much lower. As well, they have majority voting control, so the company can’t be acquired without their say-so.
None of these factors are conducive to inclusion in indexes and ETFs. Accordingly, the current valuation appears to have little to do with practical financial or economic factors; as a result, the company is dedicating a large portion of free cash flow to share repurchases, and has bought back 12% of its shares since year-end 2015.
AMC Networks Inc (NASDAQ:AMCX) manages its business through two operating segments: National Networks (which includes AMC, WE tv, BBC AMERICA, IFC and SundanceTV, AMC Studios) and International and Other (which includes AMC Networks International, its international programming business and its independent film distribution business IFC Films).
AMCX is also the popular stock among the hedge funds tracked by Insider Monkey. There were 29 funds in our database with bullish positions in AMC Networks Inc (NASDAQ:AMCX) including Omega Advisors and Tourbillon Capital Partners.
For the second quarter of 2017, AMC reported a year-over-year increase of 3.8% in revenues to $711 million. Its operating income arrived at $176 million, a 1.3% decrease compared to the prior year’s same quarter. The company made a quarterly profit of $103 million, or $1.54 per share, up from $77 million, or $1.05 per share, in the same quarter of 2016.
Meanwhile, shares of AMC Networks Inc (NASDAQ:AMCX) are up only 0.4% so far this year. During the last six months, the stock has lost nearly 12% of its value. However, AMCX has surged more than 7% during the last 12 months.
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