As many Fools have mentioned in articles past, spinoffs can be phenomenal opportunities for the diligent and prudent investor. Though not a guaranteed win (nothing is), spinoffs are typically neglected by the market but many times hold more value than their parent company. Though this particular spinoff is technically the parent of another widely known public company, it's a smaller, faster-growing organization. Here are a few reasons why you should be looking at Starz today.
Another Malone spin-off
Liberty Media Chairman John Malone knows a thing or two about picking up and spinning off companies. Between buying and selling majority stakes in a wide array of businesses -- from Sirius XM to the Atlanta Braves -- Liberty has established itself as an adept media conglomerate capable of generating shareholder value time and time again. Before the Starz spinoff, my favorite Liberty property-cum-independent public company was DIRECTV. I still love it as a long-term investment, but this new opportunity presents an immediately tempting special situation.
Starz, which was technically the parent of Liberty Media, though now a much smaller company, is a media company that provides subscription video services to cable and satellite operators. For those unfamiliar, it's just like HBO or Showtime. What's great about a company like Starz is that it is an asset-light business with strong cash-generating practices (i.e., subscriptions). Being a premium entertainment product but without owning and operating the costly infrastructure, Starz is able to produce strong margins -- both top and bottom line. To top it all off, the company has an industry veteran at the helm who knows what ultimately drives the success of this type of company: top-notch original content.
Most of the hype surrounding the Starz spinoff has been centered on the idea of an acquisition. While this, in my opinion, is highly probable, Starz is a great business to own either way.
So what makes Starz any better than other content providers? For one thing, it sells a product that, despite being in a generally disliked industry (who likes paying the cable bill?), people still pony up the extra dollars for. The best example of this is HBO, owned by Time Warner . I can point to countless friends who often struggle to make ends meet, but who always opt for the premium service from their cable or satellite provider. It's not because they are poor money managers -- it's that HBO's content is, in their eyes, worth the money. It's simply superior to 95% of what is on regular television.
Starz has the same thing going for it: better offerings at a higher price. For some added sugar, the chief of Starz is Chris Albrecht. Albrecht was the original programming boss for HBO just a few years ago, when the channel was pumping out its greatest hits: "The Sopranos," "Entourage," "Sex and the City," "The Wire," "Six Feet Under," the list goes on. His content-curating abilities are second to none, and it made HBO the destination for premium programming. Albrecht is in his element leading Starz, which boasts more than 55 million subscribers, into a new era of best-in-class programming.
This wonderful business model translates to some very attractive numbers. Though full year 2012 numbers are not yet available, in the nine months ended in September, the company brought in over $1 billion in revenue, with an operating income of nearly $320 million -- in other words, an approximately 32% operating margin. Bottom-line margins aren't too much lower at a little more than 20%. This compares very favorably to other media companies, such as Time Warner and its 10% net margin.
Starz has grown its subscriber base through boom and bust over the last several years, generating more and more free cash flow along the way.
So what can investors expect looking forward?
Let's address the first option we mentioned earlier: an acquisition. As it is today, Starz is the only stand-alone pay TV channel. Time Warner has HBO and CBS owns Showtime. It makes sense for these businesses to have owners because of the synergies arising from content creation and distribution. This makes Starz an immediate takeover target for a wide net of media juggernauts from Sony to Disney to Time Warner to Comcast. It's anybody's guess as to who will bite first. If this happens, I am expecting a strong premium to today's price of $16.20. At nine times its one-year forward earnings, the company is cheaper yet growing faster and more profitable than many comps. Time Warner and Disney both trade at 14 times forward earnings. Comcast is even richer at nearly 18 times forward earnings.
Without even looking at Starz's strong growth prospects, a multiple correction implies a stock price of at least $23-$24 per share (using 13.5-14 as a forward multiple). Fifty percent immediate upside potential? I'll take it.
To me, an acquisition is most likely here, but even if it doesn't happen, I expect the company to mature in price based on both multiple correction and growth. Starz has a strong programming pipeline that comes at a great time for the pay TV business. It has already had major successes with shows such as "Spartacus" and "Boss."
Risks and closure
What could hold Starz back? Well, investors were upset when the company did not renew its agreement with Netflix . It had been making around $30 million per year from the streaming entertainment provider before they were unable to reach a new agreement at the end of the contract. To add insult to injury, Netflix then signed a major agreement with Disney, which is currently providing content to Starz. After 2017 or so, Disney content will not be available to Starz subscribers.
I believe this risk is rather immaterial at the moment. Starz has plenty of opportunities between now and then to sign new deals with any other large media company, and it's also several years away. My investment horizon of one to three years (barring an acquisition) does not place much weight on the lost Disney content.
All in all, Starz has a great business model with a sound management team, and it's selling at a fantastic price. I strongly encourage readers to take a look at the stock and consider it for a risk-averse, value-oriented portfolio.
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The article Starz Is a Great Buy Today, Acquisition or Not originally appeared on Fool.com.
Fool contributor Michael B. Lewis has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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