Starz Profits Slump as Subscriber Growth Accelerates

By Markets Fool.com

Image source: Getty Images.

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Subscription TV specialist Starz (NASDAQ: STRZA) (NASDAQ: STRZB) posted mixed third-quarter earnings results this week that paired strong sales growth with a substantial decline in profits.

Here's how the headline results stacked up against the prior-year period.

Metric

Q3 2016 Actuals

Q3 2015 Actuals

Growth (YOY)

Revenue

$408 million

$404 million

1%

Net income

$34 million

$60 million

(43%)

EPS

$0.34

$0.57

(40%)

Data source: Starz's financial filings. YOY = year over year.

What happened this quarter?

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Spending soared as the company plowed cash into acquiring and developing new programming and supporting those shows with increased advertising. In exchange, Starz enjoyed unusually strong sales growth. Here are a few operating highlights:

  • Starz Networks subscriber growth sped up as the company added 1.2 million new users compared to 700,000 in the prior quarter. That marked the best quarter of member gains in over three years.
  • Its direct-to-consumer services improved to nearly 1 million subscribers with help from the show Power, which set record viewership numbers at 7.3 million.
  • Operating income slumped 28% to $74 million thanks to increased spending on programming and advertising expenses. Starz premiered 22 new original shows this quarter, compared to 12 last year, and so expenses tied to that surge naturally spiked. The company also booked significant costs tied to the upcoming merger with Lionsgate (NYSE: LGF).
  • Starz spent $30 million more in cash payments for its programming as the company ramped up its output of original shows that require more upfront cash than is needed for licensed content.
  • Operating margin worsened to 18% of sales from 25% last year.

What management had to say

"Starz continued its solid operational performance in the third quarter," CEO Chris Albrecht said in a press release. Management was particularly pleased with the 6% revenue bounce at the Starz Networks division, which was its best performance since the second quarter of 2013. "Third-quarter performance also saw year-over-year subscriber growth of 1.2 million customers, with 300,000 added in the quarter, setting a new record high of 24.5 million subscribers," Albrecht added.

Contributing to those solid subscriber results was popular content like Power, Ash vs. Evil Dead, and Survivor's Remorse, executives explained. Starz also made good use of its new over-the-top sales channel to bring in more subscribers and add value for its distribution partners. "The strong performance of our Amazon and Starz app initiatives complements the Starz Networks business with core distributors," Albrecht said.

Looking forward

Starz is looking forward to its $4.4 billion merger with Lionsgate that will create one of the largest content and distribution companies on the market. This week's results illustrate a few good reasons why Albrecht and his team are so excited about the potential in this move. After all, more financial muscle should allow Starz to spend freely on the original shows that it needs to produce strong subscriber gains. The added distribution opportunities should also result in a faster growth pace, as we saw this quarter.

In the meantime, look for operating income to improve in the months ahead as Starz's pace of premiering new shows declines. Both programming and advertising costs should be much lower in the fourth quarter compared to the prior-year period, in fact. It will be interesting to see whether subscriber growth slows down along with these spending categories, too.

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Demitrios Kalogeropoulos has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Lions Gate Entertainment. The Motley Fool recommends Starz. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.