Crown Media (CRWN) Is An Attractive Stock Right Now

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Feb 23, 2015
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Crown Media (CRWN, Financial) owns two pay TV channels: the Hallmark Channel, and Hallmark Movies and Mysteries (formerly Hallmark Movie Channel). The company has delivered solid operating results recently, culminating in a better-than-expected Q4 just reported Friday, and encouraging guidance for Q1. Furthermore, the firm still has some runway to improve its operations and balance sheet, giving new investors in the stock more potential for gains. MagicDiligence believes the stock looks attractive at current valuations, but let's look a little closer...

Your Mother's (and Grandmother's) Favorite Channel

Hallmark Channel reaches 82% of all U.S. paid TV subscribers. The primary audience is women ages 25-54, with programming such as reruns of Golden Girls, Little House On The Prairie, I Love Lucy, Fraiser, and Murder She Wrote - in addition to some newer original series like Cedar Cove and When Calls the Heart.

Hallmark Movies and Mysteries was recently rebranded from Hallmark Movie Channel last fall. As the name implies, it is emphasizing programming around the mystery genre, as well as continuing to air movies from the Hallmark Hall of Fame collection. This channel reaches just 53% of all U.S. paid TV subscribers, with 5.5% subscriber growth in 2014. Extending distribution of Hallmark Movies and Mysteries is a key growth opportunity for Crown.

I've always liked pay TV channels because of their dual revenue sources of over-the-air advertising and subscriber fees. In Crown Media's case, the revenue breakdown is roughly 80/20 in favor of advertising, with ads driving pretty much all of the 11% growth in revenues in 2014.

The Christmas season is where the Hallmark channels really shine. Indeed, Crown Media generates over a third of its ad revenues in Q4. The channel is well known for its slate of popular Christmas movies - the Hallmark Hall of Fame collection is heavily weighted towards holiday fare. Just this year, Hallmark Channel�s Countdown to Christmas 2014 was #1 on cable, and The 12 New Movies of Christmas averaged a 2.6 rating, making it #1 in weekend prime time.

Plenty Of Room To Grow And Improve

Crown has performed well over the last several years, but there is still room for improvement.

We already mentioned increased distribution as one possibility, particularly for Hallmark Movies and Mysteries. To this end, Crown is trying to get its channels into more popular cable/satellite pricing tiers, and to secure more distributors. Longer-term, we could see Crown try to expand internationally, as right now this is a U.S.-only operation. Ironically, in the short-term, being U.S. only might actually be a good thing, as the strong dollar is hurting revenue results from firms that do a lot of business offshore.

Improved digital distribution is another path to increased revenue. The company redesigned its network websites last quarter, and during the holiday season grew unique visitors 29% from 2013. In time, I see no reason its networks could not follow other media companies into apps or other Internet distribution such as Netflix or Amazon.

Distribution improvements should also help ratings, which drive advertising dollars. The Hallmark channels did a solid job of maintaining and even slightly improving their ratings in 2014, no small feat considering the poor results from some big competitors. Management mentioned that the Hallmark Channel debuted five new movies geared towards Valentine's Day in January, including the network's highest rated January show in six years. Early results from Q1 indicate ad volumes pacing 20% ahead of last year and rates up as much as 30%! Shooting to be the go-to holiday channel is a strategy that seems to be working for the company.

Finally, there is simply a lot of financial improvement white space here. Crown carries a lot of debt, almost $390 million, vs. just $61 million in cash. Much of this debt is at high interest rates... the company's interest coverage ratio is not ideal at 4.25 times, under the minimum 5 times I like to see.

However, the trends are good. The debt figure has been whittled down from $507 million 3 years ago, and interest coverage has improved from a 2.8 figure in 2012. Like most media firms, Crown Media generates reliable free cash flows, and as debt continues to be paid down, interest payments will decline in turn, bringing earnings per share up.

The Risks to Consider

The biggest near-term risks in Crown are the same as for all media companies. Viacom and other cable networks have reported weak domestic ad rates, and Crown Media is fully exposed to the U.S. market. Cable and satellite networks continue to slowly bleed subscribers to Internet-provided entertainment, where Crown does not have much of a presence. Declining ad revenues would certainly hurt the stock, and the firm's high leverage would be likely to magnify its losses more so than for established competitors.

Renewal discussions have also proven to be difficult for media companies, as distributors look to push back on pricing. For example, we've seen DISH have spats with several media firms, including FOX, AMC, and even CBS! Two of Crown's distributors account for 45% of their subscribers. That kind of leverage could lead to unfavorable contract renewals in the future, hurting Crown's subscriber fee revenues. The firm's nearest renewal is up at the end of this year.

Specific to Crown Media is the "Hallmark effect". Hallmark owns about 90% of the company, and licenses the Hallmark brand for use on the networks. The risk here is that Hallmark looks to unload a portion of its stake on the market, or that it decides to consolidate the company at a price unfavorable to shareholders. Also, Hallmark's ownership makes it almost impossible for the company to buy back shares - the share count has remained steady for 3 consecutive years. While no action from Hallmark seems imminent, should it happen it could be a big downer for shareholders.

So What's It Worth?

I like Crown Media's business and trends, and the stock looks like a reasonable buy at present. Currently at an 11% earnings yield, it trades below its 5-year average of 10% and the industry average of about 9.5%. However, Crown has more room to grow and improve its operations than most of its competitors. Assuming about 9% earnings growth over the next 5 years (at an 11% discount rate), coupled with a 10% target earnings yield, I get atarget price of about $4.10 per share on the stock.

At the current price of $3.45, that represents roughly 19% upside, a reasonable margin-of-safety. Magic Formula investors could do a lot worse than this one.