This year’s presidential race will set records for crotch talk, crime accusations and apocalyptic warnings — records that hopefully won’t soon be broken. It also briefly put a spotlight on tax loss carryforwards, with reports that Donald Trump declared a loss of more than $900 million in 1995, and speculation that he used it to avoid personal taxes for many years afterward.
Stock investors can benefit from carryforwards, too, and not just the kind that involve offsetting portfolio winners with losers. Consider two pending deals on Wall Street. One will pair a movie studio and its accumulated losses with a cash-generating pay-television business. In the other, a telecom with plenty of cash flow and a massive dividend, but little growth, is buying another telecom whose gigantic tax losses will make those dividend payments more affordable.
Lions Gate Entertainment (ticker: LGF) was once known for turning quirky, low-budget films into profits — think of the 1999 “found footage” horror film The Blair Witch Project, which cost $60,000 to make and brought in nearly $250 million in worldwide ticket sales. The studio’s luck has cooled. This year’s Gods of Egypt was a pricey flop. Even Blair Witch, a summer sequel to one of the biggest financial successes of all time, has sold only about $50 million in tickets.
There’s reason for hope. A Tyler Perry movie called Boo! A Madea Halloween did well. Early reviews on the newly released Mel Gibson war picture Hacksaw Ridge are good. There’s a Power Rangers reboot next year, which, well, who knows? But the benefits of a pending buyout of Starz (STRZA) are more tangible. The deal doesn’t present much by way of the “synergies” investors look for — opportunities to slash costs or cross-sell. But Lions Gate, which already has a low 15% tax rate, is sitting on an estimated $290 million in federal tax offsets and $250 million in state offsets. It didn’t top $50 million in profit last year and isn’t expected to this year (although free cash flow will likely be higher), giving it a limited ability to put those losses to work, barring a new string of hits.
Starz, meanwhile, is expected to turn a $220 million profit in its current fiscal year. As the tax assets are put to work, the result could be sharply higher free cash flow for the combined companies, especially because Lions Gate has recently refinanced debt at favorable rates. Citing the tax savings and free cash potential, RBC Capital analyst Steven Cahall upgraded Lions Gate to Outperform from Sector Perform on Friday and raised his price target to $31 from $24, implying more than 40% upside, even after a sharp gain for shares on Friday.
The other tax-fueled deal is a pending purchase by telecom CenturyLink (CTL) of Level 3 Communications (LVLT). Here, the target has the accumulated losses, about $10 billion worth in the case of Level 3. CenturyLink isn’t growing. In fact, it is in gradual decline. But next year it is expected to generate free cash equal to 13% of its stock market value. And it carries a 9.2% dividend yield. Level 3 has only modest growth potential, but enough to stabilize revenues for the combined companies, according to UBS analyst Batya Levi. Management says it can save $850 million in yearly operating costs, 80% of it within three years. And the deal could add 10% to 20% to free cash flow right away, reckons Levi. That could help CenturyLink pay down debt and preserve its dividend. First, however, the deal will add debt, and risk. Management slashed its dividend payment back in 2013. Today’s payment looks affordable, but it ultimately depends on management’s priorities.
Historically, CenturyLink has yielded an average of two percentage points more thanAT&T (T) and Verizon (VZ). Now it pays nearly double. Levi projects a rise in the stock price to $31, for a gain of over 30%.