TEXT-S&P revises Lions Gate Entertainment outlook to positive

Fri Oct 26, 2012 4:47pm EDT
 
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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. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.