Description

Investment Thesis

AMC Networks (AMCX) is a long. AMCX owns a number of extremely attractive media properties such as AMC Network, IFC Channel, Sundance Channel, We TV and various other domestic and international assets. The stock is trading at a very attractive valuation and I think the investment IRR over the next couple of years should be ~12-18%.

The AMC Network is the company’s most valuable asset and has transformed over the last couple of years into a “must-have” channel for cable systems. This is due to popular programs such as The Walking Dead, Mad Men, and, until recently, Breaking Bad. This “must-have” status is resulting in increased pricing power for the network when cable contracts come up for re-negotiation. Realized affiliate fees (the amount charged to the cable company per subscriber) for the AMC Network are currently at least 50% lower than similar channels. The contracts for affiliate fees have pricing escalator provisions that are currently running between 5% and 10% per year. Therefore, I see realized affiliate fees for AMC Network growing between 10-20% per annum for the next few years as new contracts bring fees more in-line with peers.

Advertising is the other large source of revenue for AMCX. Advertising rates are dependent on ratings which have been very strong for AMC’s networks. The company is currently investing in numerous new programs in order to make sure this continues. However, this investment in programming is detrimental to near-term profit and, as seen in the company’s Q1 report. This investment will keep a lid on current profits until revenue from the new shows starts to show up. The company has at least 5 new shows that they are currently spending money on that are not currently providing revenue (most of these will start up in the next 12-18 months). Short-term investors have punished the stock due to this lower near-term profitability and not giving credit to the investment payoff that will be seen over the next few years.

The company took an important step in the past year when it purchased Chellomedia from Liberty Global for ~$1bn or 10x EBITDA. Chellomedia’s focus is in the international media space and its networks are currently distributed in approximately 400mm households in almost 140 countries. One knock against AMCX before this acquisition was small exposure to international distribution. This acquisition will allow AMCX to distribute its original programming overseas to a much broader audience. Some investors were not happy with the acquisition as they were hoping for large share buybacks to commence. However, I feel that this acquisition will be massively accretive going forward and provides a new growth avenue for the company. The acquisition did bring leverage up to ~4.3x but the company should be able to de-lever relatively quickly and buybacks could be possible in a year or so.

I believe AMCX’s media assets are extremely attractive and I think that it is highly likely that it could be an acquisition target over the next couple of years. This is especially likely in response to recent M&A transactions in the cable space (ie Comcast’s acquisition of Time Warner Cable). These transactions are essentially consolidating and increasing the power of the buyers of content. Content providers have also started to merge and acquire assets in order to fight back. Assets, like those of AMCX’s, are extremely valuable as the larger media conglomerates tend to achieve much higher affiliate fees on a per station basis because of bundling. For example, Disney is able to achieve much higher affiliate fees for ABC Family network than it would if it was not able to bully the cable companies with ESPN (a “must-have.” I think that an acquirer could pay a hefty multiple (12-15x EBITDA) for AMCX and still have it make economic sense.

Miscellaneous

Here is a comparison of AMC Network’s affiliate fees compared to some similar networks:

Source: SNL Kagan

As can be seen above, AMC is currently under-priced due to legacy contracts that will come up for renewal. As these contracts are renewed, AMCX should start to see fees more in-line with peers. This, in addition to normal contract annual escalators, should drive significant revenue growth over the next few years.

Valuation

AMCX is currently the cheapest major media company in US at less than 9.5x 2015 EBTIDA and I think it begins to look very cheap on an absolute basis in 2016. In a base case I think AMCX can generate ~$5 in EPS in 2015, placing it at less than 13x 2015 earnings. This multiple is too cheap for a media company with substantial growth opportunities both internationally and in the US. With a more appropriate 17x multiple on 2015 earnings AMCX could trade to over $84, or ~30% upside. However, I think AMCX could have substantially higher upside as an M&A candidate in a media industry that is rapidly consolidating. At a $4-5bn market cap AMCX would be a relatively small acquisition for its larger peers and there would be significant synergies as larger peers could leverage a broad channel portfolio to substantially raise AMC’s affiliate fee revenue. In this scenario I would not be surprised to see AMCX trade above $95/share or ~50% upside.

Major Risks

A la carte cable: AMC’s is reliant on affiliate fees paid by cable, telco, and satellite distributors. If the cable is unbundled due to rising prices and over the top options, AMC’s channel fee stream would be significantly hurt. I don’t think this is likely as it is in all parties’ best interests to keep the cable bundle intact and TV viewership continues to increase in American households, indicating consumer willingness to continue to pay rising costs for cable TV.

Distributor consolidation: The merger of Comcast and Time Warner Cable (and potentially DirecTV and AT&T) creates larger cable distributors with increased leverage in affiliate fee negotiations. I don’t think this will have a material effect on AMC as it is paid a low rate compared to its peers.

A Cyclical downturn in advertising would affect AMC’s revenue growth. However, advertising industry statistics point to moderate growth in the TV advertising market and AMC advertising revenues have yet to catch up to its outsized viewership growth.

Catalyst

Affiliate fee increases

Realization of programming investments