Lionsgate: A Bond Arbitrage Opportunity
Lionsgate's ongoing separation may offer a compelling arbitrage opportunity for bondholders
Lionsgate's ongoing split into two companies, Lionsgate Studios and STARZ, may offer bond investors an attractive arbitrage opportunity. In May, Lionsgate listed its studio division as a separate company, with STARZ retaining an 87% ownership stake.
Following the split, the $715 million 5.5% bonds due 2029 were divided between the two companies. This has resulted in a significant spread in their trading prices, creating a potential arbitrage situation for relative value investors.
According to Bloomberg, the $389m 5.5% senior unsecured notes issued by Lions Gate Capital Holdings 1 (Lionsgate Studios) are currently trading at 90.6, yielding 7.9%. Meanwhile, the USD 332m 5.5% notes held by Lionsgate Entertainment (STARZ) are trading at 66.6, yielding 16.0%.
This discrepancy in yields suggests that there may be an opportunity to profit by buying the bonds held by STARZ and simultaneously selling the bonds issued by Lionsgate Studios.
The bonds remaining in the direct-to-consumer streaming business STARZ offer compelling value. Here's why:
Debt Reduction: A substantial portion of the STARZ debt will be transferred to the studio business, where the primary collateral resides.
Profitability: Lionsgate Entertainment (STARZ) retains 87% ownership of Lionsgate Studios. With a proven track record of profitability and cash generation, the spread between the two bonds seems unjustified.
Deleveraging Strategy: Management has indicated a commitment to reducing debt levels at STARZ, which would improve credit quality and lower borrowing costs.
These factors collectively suggest that the current yield spread may narrow to a more moderate level once the separation is complete and the capital structure becomes more transparent to other investors.
Additional Considerations:
Market Liquidity: The market for these bonds may be illiquid, making it difficult to buy and sell them at the desired prices.
Transaction Costs: Transaction costs, such as brokerage fees and taxes, can erode the potential profits from an arbitrage trade.
Covenants: The STARZ business is vulnerable to priming risk due to its covenant-light bonds. This means that new debt that takes priority over existing debt could be issued.
To conclude, Lionsgate Entertainment's (STARZ) 2029 bonds appear undervalued. Despite a lower leverage ratio of 3.0x and significant opportunities for risk reduction, these bonds are trading at a substantial 870 basis point spread compared to similar debt. I anticipate a significant price appreciation once the separation is complete and the market has a clearer understanding of the capital structure post-split.
Disclaimer:
The information and opinions expressed on this blog are for informational and educational purposes only and should not be construed as financial advice, investment recommendations, or solicitations to buy or sell any securities.
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