June 11, 2012
Over the past five weeks, the share price of AMC Networks (AMCX) has drifted down by about 15% and dropped its market capitalization below $3 billion, which brings it into my investment consideration universe for the first time since January. Spun out of Cablevision (CVC) one year ago at around $36 per share, until recently AMCX shares had performed well, reaching $46 in March. And for good reason: AMCX has been a high-margin, cash-flow generating growth machine and AMC, in particular, has developed into a top tier network thanks to several highly acclaimed original series that have driven viewership and solid cash flow gains.
AMCX’s recent stock price weakness is principally attributable to a carriage dispute with Dish Network (DISH), the fourth-largest distributor of its family of programming networks that include AMC, IFC, We TV, Sundance Channel and IFC Films. DISH dropped Sundance Channel from its programming lineup on May 20 and has announced that it does not intend to renew affiliation agreements for AMCX’s other channels upon contract expiration on June 30.
These developments and the pending litigation with DISH (discussed below) make AMCX a very difficult company to analyze, which may present an interesting investment opportunity as the AMCX-DISH hostilities play out over the next several months. But, by my estimates, with 13% of AMCX’s revenue imperiled by the threatened DISH drop and a considerably higher percentage of its operating cash flow set to disappear (the DISH revenue has virtually no direct expense associated with it) at least temporarily, it is surprising that AMCX shares are down only 15% from recent highs. The stock seems to be trading as if an outcome to this crisis highly favorable to AMCX is likely in the near term. I happen to think that while a global settlement that resolves the litigation and restores the ACMX channels to DISH subscribers is indeed probable , it’s not likely to be until immediately pre-trial and not without considerable summertime pain for AMCX. DISH has a history of maintaining its resolve in disputes with programmers and this one is more bitter than most. Do not expect a quick resolution.
First, a bit more on the fractured AMCX-DISH relationship. In an especially combative counterpunch, around midnight on June 3 DISH abruptly moved AMC from channel 130 to channel 9069 (and inflicted similar pain on IFC and We TV) two hours after AMC ran a spot in its popular program “Mad Men” informing DISH viewers that AMC could disappear at the end of the month and asking viewers to complain to DISH management. In justifying its plan to drop the ACMX channels, DISH claims that the networks are lightly viewed and therefore not worth increased affiliate fees. AMCX claims that ratings for its networks, especially AMC, are healthy and that the carriage dispute is an attempt by DISH to gain negotiating leverage in the four-year old litigation between the two companies that only peripherally relates to the five AMC programming networks. AMCX’s position is more plausible, though industry observers can’t help but admire DISH’s aggressive tactics aimed at mitigating the worrisome trend of rising programming costs by hitting networks with the full force of losing 14 million subscribers, or about 15% of U.S. homes that subscribe to multichannel video.
The 2008 litigation referenced above is related to Voom, a now-defunct direct-to-home satellite provider and suite of high-definition channels launched in 2003 by Rainbow Media, like AMCX at the time a subsidiary of Cablevision Systems. The majority of Rainbow’s assets, including the legacy Voom litigation, were spun off in 2011 into AMCX. Suffice it to say that the history of Voom, its relationship with Echostar, DISH’s former parent company, the sale of Voom’s orbital slots to DISH in 2005 and, mostly, the details of the legal case itself are complex but AMCX, as plaintiff, is seeking $2.5 billion in compensatory damages from lost Voom profits. A recent pre-trial ruling in the case asserted that DISH had “acted in bad faith in destroying electronically stored evidence” and the judge scolded DISH for its litigation tactics, denying further appeals. A September 18 trial date has been set, news that roughly coincided with the announcement from DISH that the AMCX networks would go dark on July 1.
It’s difficult to handicap the outcome of the legal proceedings but there is industry precedent to consider. DISH is an experienced, fearless and formidable litigant, but it’s not always victorious. In May 2011, DISH and former parent SATS agreed to a $500 million pre-trial settlement with TiVo that resolved years of acrimonious litigation and granted DISH a license to deploy TiVo’s DVR technologies (TiVo reached a similar, 11th hour pre-trial settlement with AT&T for $215 million in January 2012). Given the risks of a trial, this would be a constructive path for any AMCX-DISH resolution to take but it seems unlikely that any substantive discussions will take place until after AMCX feels the impact of the planned network drops on July 1. Another meaningful precedent of which DISH is surely aware is that distributors are often less exposed to operating and financial shortfalls in carriage disputes than are programmers. The recent Time Warner Cable-MSG Network rift generated some adverse publicity for TWC but had no discernible impact on its operating results, while MSG lost six weeks of affiliate fees from its largest distributor and advertising contracts surely had to be adjusted downward to reflect the temporary subscriber losses and ratings shortfalls. In other words, if the AMCX-DISH dispute was entirely about network value and the pricing of programming, DISH would have the upper hand. It may lose, say, 10,000 subscribers when the AMCX networks go dark, but that’s a mere fraction of 1% of its customer base and its action sends a powerful message to other programmers that it intends to aggressively battle the rising cost of programming.
But this dispute is not just about the cost of programming. DISH must feel some discomfort with its current legal position and with the judge’s recent actions denying further appeals and setting a September court date. Like in the TiVo case, it seems unlikely that DISH will allow the case to come to trial. But why initiate settlement discussions with AMCX before the howls of financial pain can be heard from AMCX management and shareholders (and bondholders)? Using a blended rough estimate of 8.5 million DISH subscribers (60% of DISH’s base) and 70 cents per subscriber per month in aggregate affiliate fees across the five networks, I estimate that AMCX generates about $6 million per month in affiliate fees from DISH. Adding $8 million per month in losses from renegotiated advertising agreements attributable to the lack of DISH carriage and the damage looks to be in the $14 million per month range (I am assuming that a very small percentage of AMC fans switch providers to cable, telco IPTV or DirecTV, offsetting a portion of losses to AMCX and delivering a bit of pain to DISH). The $14 million per month estimate puts about 13% of total AMCX revenue at risk and a considerably higher percentage of AMCX’s operating cash flow.
Following the path of the DISH-TiVo settlement of 2011, let’s say AMCX and DISH come to terms immediately pre-trial in September 2012 with a multi-hundred million dollar settlement in favor of AMCX. For illustrative purposes, let’s use $250 million and assume that any settlement includes full reinstatement of the AMCX suite of networks across the DISH distribution platform with a very modest increase in affiliate fees. AMCX investors would probably applaud such an outcome but since AMCX is obligated to equally share DISH litigation/settlement proceeds with former parent Cablevision, only $125 million would be realized in this hypothetical example. Offsetting the gain would be the $14 million in monthly revenue and cash flow losses for July, August and part of September as well as accumulating legal expenses. While the above outcome would be a net positive for AMCX shareholders and probably justifies the current share price, it is by no means an assured, or even a likely, outcome. It is perhaps a base case outcome, with an equal likelihood of a more favorable one and a less favorable one for AMCX.Thus the difficulty in making informed investment decisions at the current stock price for AMCX. Given the uncertainty of the litigation and the likelihood that AMCX will be without its fourth-largest distributor on July 1, I could see the stock price retreating to the low $30s over the summer. That would represent a much more attractive risk-adjusted entry point, in my view.
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