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Lionsgate (LGF) Ratings Affirmed by Moody's Amid Malone Stock-Swap Deal (STRZA)

February 12, 2015 11:47 AM EST

Moody's Investors Service said that Lions Gate Entertainment Corp.'s (NYSE: LGF) announcement that it has entered into a stock exchange agreement with affiliates of Dr. John C. Malone, will not impact its Ba3 Corporate Family rating (CFR), SGL-2 Speculative Grade Liquidity rating or the stable outlook. Lionsgate today announced that it has entered into a stock exchange agreement to exchange shares representing 3.4% of its common stock for a portion of Series A and Series B of Starz's common stock held by Dr. Malone and his affiliates, representing roughly a 4.5% stake in Starz and 14.5% of its voting stock. Further, as part of the exchange agreement, Lionsgate will appoint Dr. John C. Malone to its Board of Directors, upon completion of the exchange. In our view, Dr. Malone's appointment to the company's Board brings to Lionsgate his significant industry prowess and ingenuity, but also creates some event risks, given his financial risk tolerance, financial engineering and history of aggressively using debt to boost equity returns. However, Lionsgate's rating is at similar rating levels as other companies in which Dr. Malone has significant influence or control. Our concerns are also tempered by Starz's modest ownership stake following the exchange and Lionsgate's positive operating momentum, which has allowed the company to strengthen its credit metrics and improve financial flexibility over the last two years. Nevertheless, Dr Malone's presence on Lionsgate's Board does create minor constraints for material future upward rating movement, though the outlook is presently stable.

Moody's considers the transaction to be strategically beneficial as it creates the potential for collaboration between the two companies. "The deal will enable Lionsgate to boost its revenues and cash flows as it continues to leverage its production capabilities to benefit from the increasing demand for content - specifically original programming, which is what is most important to Starz," stated Neil Begley, a Moody's Senior Vice President. "The transaction also bodes well for Starz, which like other television networks, is increasingly competing with SVOD players such as Netflix and Amazon, and has been focusing on an original-content strategy to strengthen its competitive position and the deal could potentially and informally give Starz early looks at new original television content projects at Lionsgate," added Begley. Of note, Lionsgate has a significant motion picture production and television programming business and the deal could allow the film studio to feed its vast library catalogue of titles into Starz's lineup of programming. Lionsgate's new titles are contractually locked up in the US with its partially owned (31%) EPIX premium channel, and its Summit subsidiary production house is obligated under output contracts with HBO, at least for the next few years. Lionsgate has deep and numerous international relationships which could be a further source of collaboration between the two companies as well.

The partnership between the two companies takes place at a time when the media landscape continues to evolve, with television networks and streaming players increasingly being needful of premium original content to attract consumer interest and drive up subscription dollars. Lionsgate also owns its stake in EPIX, with the balance being owned by Viacom Inc. (49%) (Baa2, Stable) and Metro-Goldwyn-Mayer Inc.(20%) (Ba2, Stable). EPIX, which is a premium cable network, directly competes with Starz and licenses library titles and new products from Viacom's Paramount Studio, Lionsgate and MGM. Notably, the exchange agreement allows the companies to consider future initiatives, including in our view, a possible eventual merger of the two premium cable networks to leverage Starz's broad distribution across the U.S., EPIX's content catalog consisting of film franchises produced by three important film studios and Lionsgate's international platform. In Moody's opinion, such a merger could have good strategic rationale for all parties as revenue and cost synergies from the deal could be significant, given the potential for access to exclusive content and a vast customer base. However, we believe that such a combination could be accomplished more through a stand-alone joint venture of EPIX and Starz rather than a stock swap arrangement as we consider the likelihood to be remote for Viacom and possibly MGM to swap their stocks and appoint Dr. Malone on their Board of Directors.



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