Spin-off situations tend to be good investment opportunities, as smaller divisions of larger companies tend to be misunderstood and incorrectly valued initially. In addition, the divested company can better focus on its specific business, increasing returns for shareholders in the process. Initially, the spun-off stock may underperform, as investors who received the shares might not want to hold it; once this selling pressure is gone, however, the stock tends to outperform.
During the fourth quarter of 2013, many ‘hedgies’ increased their holdings in the Class A shares of Starz (NASDAQ:STRZA), including Murray Stahl of Horizon Asset Management (who owns 8.1 million shares and is the fourth largest shareholder), Jeffrey Gates of Gates Capital Management (3.8 million shares) and Steven Cohen of SAC Capital Advisors (1.6 million shares). Other investors bullish on the stock include Warren Buffett of Berkshire Hathaway (with 4.5 million shares, the fifth largest shareholder), David Shaw of D E Shaw (890,000 shares) and Mario Gabelli of GAMCO Investors (763,000 shares).
Starz (NASDAQ:STRZA) is a $3.6 billion market cap integrated global media and entertainment company with operating units that provide premium subscription video programming on domestic U.S. pay television channels (Starz Networks), global content distribution (Starz Distribution) and animated television and movie production (Starz Animation). Liberty Media Corp (NASDAQ:LMCA) spun-off Starz in January 2013 at $14 per share to better focus on its investments in other companies, including Barnes&Noble Inc. (NYSE:BKS), Live Nation Entertainment (NYSE:LYV) and Sirius XM Radio Inc. (NASDAQ:SIRI).
Since then, the stock has been a strong performer, more than doubling following its divestiture. Despite rising costs for television content amid intense competition from both traditional cable networks like HBO, owned by Time Warner Inc. (NYSE:TWX), and alternative competitors such as Netflix Inc. (NASDAQ:NFLX), Starz (NASDAQ:STRZA) has generated strong earnings, aided by prudent expense management and growth in subscribers, who are increasingly interested in its original programming. In addition, following its spin-off, there had been heightened speculation that Starz was looking to sell itself to a larger buyer with multiple cable networks that could better leverage Starz’s growing original content, although that chatter seems to have died down recently.
Relative to its peer group of cable and satellite companies, Starz (NASDAQ:STRZA) looks favorable on most metrics, including above-average profit margins, high return on invested capital, strong free cash flow generation and manageable debt levels. The only negative comparison is the company’s EBITDA margin of 25%, which is below the peer group median of 30%. Valuation-wise, the stock trades at a discount to its peer group on a forward P/E basis (15.4X vs. 18.9X for peers) but a modest premium on a forward EV/EBITDA basis (10.0X vs. 8.3X for peers).
With a pipeline of original series, growing distribution in international markets and strong cash flows (approximately $475 million of which will be used to repurchase shares, equal to 13% of its market cap), Starz (NASDAQ:STRZA) is well-positioned to continue investing in its own content and grow its subscriber base while generating attractive returns for shareholders. At the same time, continued success as a stand-alone entity would make the stock a more attractive acquisition candidate by larger players.