The Rise of an Underdog Cable Network

GuruFocus.com

In order to survive in the television entertainment industry, a company must be large and diversified. While this supposition is true to some extent, it doesn't apply to all success stories in the media industry. AMC Networks Inc. (AMCX), post its spin-off from Cablevision Systems Corporation (CVC) in 2006, was shy of major profits at the start, but in a little over five years has managed to become one of the most tantalizing investment options in the TV market. In fact, investment gurus Steven Cohen (Trades, Portfolio) and Joel Greenblatt (Trades, Portfolio) have been buying large amounts of the company's shares this past quarter, hoping to gain decent profits in the long term.


Slowly, but Steadily Gaining Terrain

It's nothing new that AMC is much smaller and offers less diversified programming than its steep pocketed competitors Time Warner Inc. (TWX)'s TNT and TBS or Twenty-First Century Fox Inc. (FOX)'s FX, but the firm's cable networks have been consistently gaining viewership in the past years. Today, the flagship channel AMC is vastly distributed, reaching 95 million pay TV households, while the secondary We TV network targets mainly the female audience, reaching 77 million households. The company also owns the smaller networks IFC (independent films) and Sundance (premium movie channel), but more than half of total revenue stems from AMC, due to its popularity. Up until now, management's aggressive strategy was to attract viewers mainly by shifting AMC's programming from movie reruns to investing in quality original programming.

The hit show "Mad Men", which resulted from a production deal with Lions Gate Entertainment Corp. (USA) (LGF) in 2007, was the company's breakthrough moment. Although the main industry rivals are part of media conglomerates with higher programming budgets, AMC's handful of TV shows have attracted a very large audience, which should allow the company to increase affiliate fees amongst distributors looking forward. Also, growth should be further boosted in years to come as the new $1 billion acquisition of international cable channel business Chellomedia, from Liberty Global Plc (LBTYA), is fully integrated into the company. This transaction will bring AMC to the next level on an international basis, establishing it as a broad cable network firm.

Valuation

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When looking at AMC's balance sheet, one thing immediately becomes clear: there's no lack of growth, and 2013 has been a good year. While revenue grew consistently over the past few years, fiscal 2013 was a particularly solid year, reeling in $1.6 billion, compared to the $1.35 billion of the prior year. Moreover, this average annual revenue growth rate of 7.5% is expected to continue over the next five years, consequence of higher advertising dollars and affiliate fees. Earnings growth has also been impressive over the past few years, catapulting an EPS of $1.79 in the fourth quarter of 2011 to a current $4.0, with an upward trend. Furthermore, AMC's returns on invested capital have grown increasingly attractive and with a current 11% metric are more than healthy for the TV industry.

I believe the company's operating and net margins are also quite convincing, averaging at 36.6% and 18.3% respectively. Investors should expect this expansion to continue looking forward, as some operating leverage results from boosts in ad dollars, though somewhat offset by an increase in the cost of content. But all in all, I feel very bullish about AMC's future and believe it has tremendous growth potential. Also, I think this may be a good time to buy the firm's stock, because the trading price may be sporting a 20% price premium relative to the industry average of 16.8x, but this price is bound to trend upwards in the near term future.

Disclosure: Patricio Kehoe hold no position in any stocks mentioned.

This article first appeared on GuruFocus.

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