AMC Networks: Media Business At The Crossroads (NASDAQ:AMCX)

Investment Thesis

AMC Networks (NASDAQ:AMCX) is at a crossroads in its business. Its legacy operations are declining as the company makes a late entry into the streaming business. But the company has shown strong early growth in its new streaming operations. I think it is well positioned to increase subscriber loyalty and reduce churn.

The business’s free cash flow has been reduced as a result of heavy investments in streaming. I think there is significant potential upside as the streaming business grows.

A Business At The Crossroads

For many years, AMC avoided the streaming business for its core content. It wasn’t until late 2020 that the company finally launched their AMC+ streaming service. Before then, the business had monetized its content by licensing it to other streamers.

The company’s entry into streaming has shown strong momentum. The business added 1.3 million subscribers in its last quarter. This brings its total to 10.8 million subscribers. The company’s streaming revenues grew by a normalized 36% year over year. AMC+ had a strong launch in Spain during the quarter. Management has plans to expand to the rest of Europe as well as South America over the next year.

This comes at a time when the company’s legacy businesses are deteriorating. Its bread and butter cable business is in secular decline. Additionally, the company is bringing in less revenue from content licensing. This is partially based on the choice to retain more original content as streaming exclusives. Even the company’s advertising segment has declined over the past five years.

The company’s growth prospects rest on its streaming services. Management has set a target of 20 to 25 million subscribers by 2025. The company’s future success depends on whether it can pull off this pivot successfully.

AMC’s New Streaming Strategy

The company’s new strategy is focused on niche content networks. In recent years, the company has acquired and created multiple specialty streaming services. Acorn TV offers British television content. Shudder offers horror and thriller movies. The newest is HIDIVE, an anime streaming service the company acquired last year.

The company sees strong brand loyalty as its competitive advantage. By targeting more niche markets, the company can focus on a highly engaged group of fans. These subscribers are more likely to keep watching compared to generic streaming services. I really like this strategy. It’s a compelling competitive advantage against services with deeper content libraries.

This retention-focused strategy is showing signs of paying off. The company has reported greater resilience to industry headwinds. On their last earnings call, management gave some examples.

When we raise[d] the price by $1 for Acorn and ALLBLK, we had minimal churn. It was almost like a nonevent and almost made me wonder if we should raise it $2, but we don’t want to do that to consumers. So the value proposition there is real.

And the other thing we’re seeing is that when you super serve fans and it’s a targeted base, obviously, it’s a smaller subscriber base, but there’s much more stickiness because you’re super serving the fan… the targeted services specificity helps with some price resilience there.

There’s still a long way to go. The company’s profitability has suffered due to high spending on content and ads. Free cash flow was negative last year. Management only guided for $100 million in FCF this year. It may take years to get back to the levels of just five years ago.

On their fourth quarter earnings call, management said that it would take years to realize the full benefits of streaming. Streaming is only expected to be the third-largest source of revenue next year. It isn’t expected to become the primary revenue driver until 2025.

Shares are Expensive But Have High Potential Returns

At first glance, shares of AMC Networks are trading at an extremely cheap valuation. The company is trading at a forward P/E of only 3.5 times. However, the company is not as cheap as it looks.

First, the business has a significant amount of debt on its balance sheet. The $3 billion of debt is much larger than the company’s current market cap of $1.1 billion. Second, the company is investing heavily in new content, meaning that free cash flow has taken a hit.

Adjusting for net debt, the company is trading at a forward EV/FCF of 36 times. This is on top of the company’s negative FCF over the past twelve months.

Management believes the company’s free cash flow levels will start normalizing soon. They don’t expect to meaningfully increase content investment above 2022 levels. This should reduce the pressure on cash generation. Earlier in the last decade, the business generated fantastic free cash flow, sometimes over half a billion dollars. If AMC can return to normalized FCF levels, there is the potential for a huge upside.

Final Verdict

AMC Networks is undergoing a late transition to the streaming world. Heavy spending on content and streaming will be a major headwind for the next couple of years. It’ll take some time before the company’s streaming services become sustainable. That segment will need to grow significantly to become the primary driver of the company.

I think the risk to reward is favorable for investors who are bullish on content and streaming. I see strong potential upside if the company can normalize its free cash flow numbers. Its retention-focused model should create better margins than its competitors. I’m bullish on shares at the current valuation.