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Starz – A Shining Opportunity

Starz is an interesting investment at current levels. Starz is a premium cable channel which is available for an extra cost per month by most cable providers such as Comcast, Time Warner Cable and Verizon Fios. Starz has long-term contracts with built in price increases with these cable providers providing a consistent stream of revenues. The cable providers have an incentive to promote Starz to their subscribers thereby charging higher fees and making more money.  So as long as Starz can provide compelling content, it will have a consistent source of revenues from cable providers.

Starz obtains its content from two methods. The first method is by securing first run movies and older movies from film companies. Currently, Starz has a long-term agreement with Sony Pictures that runs through 2021 and through 2015 with Disney for first run exclusive rights to new movies.  Additionally, Starz licenses older movies from a variety of film studios in order to offer a curated selection of movies to its viewers.

The second method that Starz uses is by producing its own original content. Historically, most of its original shows have been co-produced with other studios, such as the BBC, in order to share production cost risks. These shows have had moderate success with shows such as Spartacus and The White Queen. But these shows have not had the same success as shows from HBO, Showtime and AMC networks, for example Game of Thrones, Homeland and Breaking Bad. Original shows can be enormously lucrative because they can differentiate a network thereby making it more appealing to cable providers and can be sold as DVDs and to Netflix to generate more revenue.

Starz is making a bigger bet on original programming going forward. In fact, Starz chose not to renew its contract for exclusive rights to first run movies from Disney, expiring in 2015. However, Starz still retains the rights to the first run  Disney movies  through 2017 as per the contract. So, they still have 4 more years of exclusive first run Disney films. With the money saved from not renewing the deal with Disney, Starz is investing in self-produced original programming. In 2014, Starz will premier “Black Sails” produced by Michael Bay, “Power” produced by  Curtis “50 cent” Jackson, and “Outlander” based on a popular novel. The Starz CEO Chris Albrecht,  previously CEO of HBO, oversaw the development of some of the most successful cable shows ever including “The Sopranos”, “The Wire”, and “Sex and the City” with HBO.  Albrecht’s track record of success at HBO bodes well for Starz’s new original programming.  These new shows are promising and if successful could be a big boost to Starz’ bottom line.

Another differentiating factor for Starz is that it owns Anchor Bay Entertainment, its own distribution arm. This enables Starz to give preference to its own content over other produced content as far as distribution is concerned. It also enables Starz to control the whole process from film production all the way through distribution, unique among content creators. If Starz new programming is successful, Anchor Bay will help Starz generate profits.

Currently, Starz has a consistent revenue source from cable providers and low debt which results in enormous free cash flow. Starz management has been committed to a large stock buyback, which has amounted to over 7% of the outstanding shares over the first 3 quarters of 2013. This is indicative of a financially strong company.

Starz currently trades at $27.65 and has a PE ratio of 14.04. Taking into account the huge stock buyback and the recurring nature of its revenue, Starz is a pretty secure investment with limited downside. If the new original programming is successful, there is possible upside of between 20%-40%.  This makes it an attractive risk/reward in our view.

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