TEXT-S&P revises Lions Gate Entertainment outlook to positive
Overview -- British Columbia-domiciled and Santa Monica, Calif.-headquartered movie and TV studio Lions Gate Entertainment Corp.'s film slate has been successful, and continued success of The Twilight Saga: Breaking Dawn Part 2 could result in EBITDA growth beyond our current expectations. -- We have affirmed our 'B' rating on the company. -- We revised our rating outlook on Lions Gate Entertainment Corp. to positive from stable. Rating Action On Oct. 26, 2012, Standard & Poor's Ratings Services revised its outlook on British Columbia-domiciled and Santa Monica, Calif.-headquartered movie and TV studio Lions Gate Entertainment Corp. to positive from stable. The outlook revision reflects the recent successes of the company's film slate, particularly The Hunger Games, and the potential for continued success with the last Twilight film (The Twilight Saga: Breaking Dawn Part 2, to be released on November 16) and our expectation that, as a result, the company could increase EBITDA beyond our $150 million expectation. We affirmed our 'B' corporate credit rating and all issue-level ratings. We revised the recovery rating on the second-lien notes to '3', reflecting expectations of a meaningful (50% to 70%) recovery in the event of a default, from '4'. This does not result in a change to the issue level ratings on those notes. Subject to signs of progress broadening its success to other film franchises and additional TV series, which could establish more sustainable credit measures, we could raise our rating to 'B+'. Rationale The rating on Lions Gate reflects the consolidated company's "weak" business risk profile and its "highly leveraged" financial risk profile (based on our criteria). Our assessment of the business as "weak" is based on Lions Gate's ongoing exposure to the unpredictable nature of the audience reception of films, track record of negative or weak EBITDA margins, and modest base of stable cash flows, despite its recent success with the Twilight and Hunger Games films. We believe the continued success of the Hunger Games franchise (three more films are expected over the next three years) could improve Lions Gate's profitability and credit profile, especially if accompanied by continued TV success and the success of other feature films that builds the company's base of continuing cash flow. Our assessment of the financial profile as "highly leveraged" is based on Lions Gate's historical negative cash flows, high debt to EBITDA, and the formidable upfront business cash requirements. The company recently fully repaid the senior secured term loan ($299 million outstanding) that was issued earlier this year to finance its acquisition of Summit Entertainment. Year-to-date as of Oct. 21, 2012, Lions Gate, pro forma for its January 2012 acquisition of Summit Entertainment, ranked fifth in domestic box office, with a 10.8% share, according to boxofficemojo.com. Its box office success is in part attributable to the March 2012 release of Hunger Games, together with carryover revenues from Twilight Breaking Dawn Part 1 (November 2011 release). Domestic box office position is a loose proxy for total film revenue success. Lions Gate will need to continue to source creative material for films that will appeal to a global audience, a contrast to its traditional smaller-audience, genre film. Aside from its feature film business, Lions Gate is a small supplier and distributor of cable TV programming, most notably "Mad Men", "Weeds", and "Anger Management" although it has scored some success with several popular series on cable TV and network TV, most notably "Nashville". We view the TV production business as complementary to feature film production, with the potential for recurring profitability if it produces hit shows that move into syndication. Lions Gate and the industry benefit from growing international box office revenues that help cushion what we regard as a long term secular decline tendency in the US domestic theatrical business. Home entertainment sales of library titles, recent releases, and other content comprise about one-quarter of its revenue (for the June 30, 2012, quarter). DVD sales have been declining industrywide. We regard this as a secular trend, as studios have saturated retail channels with catalog DVDs. We also expect consumption of home entertainment to continue its shift to digital formats, the profitability of which has not yet been securely established. Our base-case scenario for the fiscal year ending March 31, 2013, assumes that the box office success of both the final Twilight film, Breaking Dawn 2, and the first Hunger Games film, The Hunger Games, will result in a significant boost to EBITDA in mid- to late-fiscal 2013, with a corresponding decline in leverage. The EBITDA turnaround, which we estimate could produce total EBITDA surpassing $200 million, also should cause discretionary cash flow to turn substantially positive. Pro forma for the Summit acquisition, we estimate that EBITDA for the 12 months ended June 30, 2012, was negative. Thus, pro forma debt to last-12-months' EBITDA was not meaningful. As a result of recent film success, the company could end fiscal 2013 with leverage in the low-4x area. In fiscal 2014, we expect the company to keep benefitting from Breaking Dawn 2 and the second Hunger Games film, The Hunger Games: Catching Fire, with EBITDA that we believe could exceed $300 million, resulting in leverage in the mid 2x area. Depending on the success of the Hunger Games franchise and progress developing additional film and TV franchises, Lions Gate could have substantially greater cash flow visibility over the next few years. EBITDA and discretionary cash flow generation will depend on these factors, together with the future magnitude of production spending. Liquidity Lions Gate's liquidity is "adequate" over the next 12 to 18 months. Our assessment incorporates the following expectations, assumptions, and factors: -- We expect sources of liquidity (including cash and unused revolving credit facility capacity) over the next 12 to 18 months to exceed uses by 1.2x or more. -- We expect net sources to be positive, even if EBITDA does not achieve our $200 million expectation in the next 12 months. -- We expect Lions Gate to remain in compliance with the covenants under its new credit agreement. Liquidity to finance film production is provided under separate facilities. -- The company has good relationships with its banks. Lions Gate has a new $800 million credit facility of which $650 million is accessible due to restricting covenants. Over the next 12 to 18 months, it has potential debt maturities of about $220 million of production loans, about $36 million outstanding under its Mandate film financing facility (maturing April 2013), and a $65 million Pennsylvania Regional Center secured loan due April 2013. We expect the production loans and the Mandate facility to be repaid with the revenues of the films financed under these facilities. We also expect discretionary cash flow (modestly negative for the 12 months ended June 30, 2012) to turn significantly positive (more than $150 million) in fiscal 2013. Lions Gate has minimal annual fixed capital investment spending needs of about $4 million (assuming no additional advances to affiliates), and we assume it will not initiate a shareholder dividend. Recovery analysis For the complete recovery analysis, see Standard & Poor's recovery report on Lions Gate, to be published shortly, on RatingsDirect. Outlook The positive rating outlook reflects our view that Lions Gate's financial performance, including its profitability, will improve over the next several years due to the success of the Twilight franchise and the potential success of the entire Hunger Games franchise. We expect quarterly earnings and cash flow to still fluctuate widely, depending on the timing and success of new releases. We could raise the rating if the soon-to-be-released Twilight film were to perform at least in line with the previous Twilight films, giving us greater confidence in our $200 million EBITDA estimate for fiscal year 2013, and if we see indications of progress broadening the ongoing base of cash flow. This includes developing new film franchises that ensure healthy ongoing EBITDA and positive discretionary cash flow after the conclusion of its important current franchises, and growing the TV production segment which could reduce earnings volatility and improve margins. We could revise the outlook back to stable if the film slate, particularly the November 2012 Twilight film, underperforms at the box office, causing EBITDA and discretionary cash flow to miss our $200 million target for fiscal 2013. Related Criteria And Research -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Methodology: Short-Term/Long-Term Ratings Linkage Criteria For Corporate And Sovereign Issuers, May 15, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Use Of CreditWatch And Outlooks, Sept. 14, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Affirmed; Outlook Action To From Lions Gate Entertainment Corp. Lions Gate Entertainment Inc. Summit Entertainment LLC Corporate Credit Rating B/Positive/-- B/Stable/-- Ratings Affirmed Summit Entertainment LLC Senior Secured Local Currency B+ Recovery Rating 2 Rating Affirmed, Recovery Revised Lions Gate Entertainment Inc. Senior Secured Local Currency B B Recovery Rating 3 4 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. 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