Lions Gate Reaches out to Starz to Expand Global Reach

The $4.4 billion cash-and-stock deal to create media powerhouse

L1 Film studio Lions Gate Entertainment Corp. (NYSE: LGF), the maker of the Hunger Games movie series, has agreed to buy billionaire John Malone’s television network Starz Inc. (NASDAQ: STRZA) for $4.4 billion in cash and stock, as reported by Reuters on July 1st, 2016. The potential deal with Starz, which operates premium television channels in the U.S. and global markets, would give Lions Gate a broader global footprint. Starz, which competes with HBO and Showtime, also develops original programs such as the Outlander series.

Apart from diversifying Lions Gate’s business, the possible deal would make the Company less dependent on the movies business. The potential deal comes at a time when the media-entertainment world is hit by the growing onslaught of online services from Netflix Inc. (NASDAQ: NFLX) and Inc. (NASDAQ: AMZN), which have dominated the market for on-demand television and are now moving into feature films.

Valuations and share split

If the deal comes through, most Starz shareholders will get $18 a share in cash and newly issued non-voting stock in Lions Gate for a total value of $32.73 a share; and that represents an 18% premium to Starz’s closing price on Wednesday, June 29th, 2016. The pricing includes $1.1 billion in assumed debt.

L2Lions Gate currently has one class of stock; one of the terms of the deal is to split the Company’s shares into voting and non-voting stock. If the deal goes through, Starz Series A stockholders will receive $18 in cash and 0.6784 a share of Lions Gate non-voting stock. Starz Series B holders will get $7.26 in cash and 0.6321 of a share of Lions Gate voting stock and 0.6321 of a share of Lions Gate non-voting stock. Lions Gate will fund the cash portion of the deal with bank loans and bonds.

Since February 2015, Lions Gate and Starz have been mulling a merger when they exchanged minority stakes and Malone joined the board of Lions Gate. Two other Malone companies, Liberty Global PLC (NASDAQ: LBTYA) and Discovery Communications Inc. (NASDAQ: DISCA), later acquired a stake in Lions Gate.

Merged entity to create media powerhouse

Lions Gate expects the possible deal to contribute significantly to its earnings and close by the end of 2016. The combined entity, if the deal comes through, would have MHR Fund Management LCC, run by Lions Gate Chairman Mark Rachesky, as the biggest shareholder both in voting and equity interest, with a 14% stake. Liberty Media’s entities, owned by Malone, would be the second largest shareholder.

The combination of Lions Gate and Starz would create a more diverse media company, with annual revenue exceeding $4 billion. Its interests would span film and TV production, and would include the Starz and Encore cable networks, serving about 56 million subscribers. The potential deal would also create a global content powerhouse that invests nearly $2 billion a year in new content. Starz reported sales of $1.7 billion, while Lions Gate reported sales of $2.36 billion in FY15.

In addition to movies and original programing, Lions Gate would gain access to Starz’s new online-only subscription video service to use as a channel for its own content. Lions Gate is looking to consolidate infrastructure and expand a portfolio of services together with Starz. Starz was spun off from Liberty Media Corp. (NASDAQ: LMCA) in 2013. In recent weeks, CBS Corp. (NYSE: CBS) and AT&T Inc. (NYSE: T) had expressed interest in Starz.

Advisors to the deal

PJT Partners was the lead adviser to Lions Gate, along with J.P. Morgan, Bank of America Merrill Lynch, Deutsche Bank and Credit Suisse. LionTree and the Raine Group were advisors to Starz. The legal advisers on the deal were Wachtell, Lipton, Rosen & Katz and Dentons for Lions Gate and Baker Botts and Weil, Gotshal & Manges for Starz.

Lions Gate in premium TV push

Lions Gate has struggled at the box office as one of its biggest franchises, The Hunger Games, concluded with no blockbuster releases coming up soon. To add to its woes, the Company witnessed a series of box-office failures such as “Gods of Egypt” and the last installment of its series “The Divergent Series,” due to which its shares have tumbled 35% so far in FY16. Hence, the company has been growing its TV business with shows like the popular Netflix series “Orange Is the New Black,” to counter the volatile film business. Hence, the potential deal with Starz would bring in free cash flow and a steady subscription-based business that can offset the volatility of its films business.

Break-up fee

If Lions Gate’s shareholders do not approve of the deal, the Company would have to pay Starz $150 million. Moreover, Lions Gate would have to cough up $175 million if it changes its mind, and $250 million if it cannot raise the debt financing. On the flip side, Starz would have to pay Lions Gate $150 million if it backs out of the deal. That being said, either of the parties can scrap the deal if it is not completed by December 31st, 2016. However, the terms permit either of the parties to extend the deadline to March 31st, 2017, if regulatory approvals are pending.

Stock Performance

L3Lions Gate’s stock stood at $19.85, down 1.88%, at the close on Friday, July 1st, 2016, having vacillated between an intraday high of $20.18 and a low of $18.52 during the session. The stock’s trading volume was at 11,180,170 for the day. The Company’s market cap was at $2.98 billion as of Friday’s close.

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