Analysis: Hallmark channels on a roll but not all shareholders celebrate

The Hallmark Channel and its sister network Hallmark Movie Channel are doing so well they should get congratulation cards from their namesake.

Ratings for both networks are up, ad revenue and cash flow is growing too, and the stock price of parent company Crown Media Holdings Inc. has almost doubled in the last 18 months.

But a Hallmark moment this isn’t.

While independent shareholders are pleased with the performance of the two channels, that happiness doesn’t translate to Crown management or Hallmark Cards Inc., which owns the majority of Crown stock.

Investors would like to see Crown shop itself to a bigger media company, believing that continuing as an independent will limit the company’s growth potential. The bulk of cable and broadcast networks are controlled by a handful of companies including Walt Disney Co., 21st Century Fox, Time Warner, and Viacom. Their size gives them advantages over competitors when negotiating distribution deals with pay-TV providers and acquiring content.

“They don’t belong as a stand-alone company,” said Sal Muoio, whose S. Muoio & Co. is a Crown stockholder. “I think they should want to sell it.” Muoio added that if Crown ended up in the hands of a bigger programmer, there probably would be $50 million in overhead savings.

In a letter to Crown co-Chairman Herb Granath earlier this month, Spencer Grimes, a principal of shareholder Twinleaf Management, urged the company to look for a buyer.

Crown, Grimes wrote, needs a “strategic buyer capable of bringing scale, operating efficiencies and elevating the two Hallmark channels to full potential while rewarding shareholders in the process.”

Grimes and Muoio are not the only shareholders pushing for a sale. Lawrence Stern of Stern Family Partners wrote the board in December advocating exploration of a sale.

Neither Crown nor Hallmark responded to Grimes’ or Stern’s letters. The companies also declined comment for this story. Crown’s annual meeting is scheduled for June 25.

Hallmark owns 79% of Crown stock, and an additional 11% is held by Blue Holding Co., a Hallmark subsidiary.

One of the concerns of the minority shareholders is that Hallmark will decide that instead of a sale it will buy the 9.3% of the shares it doesn’t already own and take the company private in a short form merger available under Delaware law. Such a move, minority shareholders argue, probably would dramatically undervalue the company based on its potential growth.

Crown executives have declined to answer questions about Hallmark’s plans for the company during recent calls with investors.

On a Feb. 21 call, Stern asked if management was interested in having Crown remain in the public marketplace. Crown Chief Financial Officer Andrew Rooke replied, “I cannot comment on the intent of our parent in that regard.”

“You have a private company that owns 90% of a public company with minority shareholders that they never want to communicate with” Stern said in an interview, adding that he has tried unsuccessfully several times to talk with the owners and independent board members about their plans.

Grimes expressed the same frustrations in his letter to Granath.

Minority shareholders are also concerned that despite the Hallmark chokehold on the company’s stock, Crown’s top executives and the board of directors own very little of the company and thus aren’t as vested in its future as they should be given their positions.

Although the stock has grown 70% in 12 months, it is still trading at less than $5 a share, closing Friday at $3.52 a share. That price, investors complain, is hardly fitting for a company with an enterprise value of $1.6 billion.

“We have quite a differential between fair market value and what the stock trades at today,” Stern said.

Unhappy shareholders is nothing new for Crown. Muoio got into an ultimately unsuccessful legal battle with Crown and Hallmark over a 2010 recapitalization of the company that he felt diluted shareholder value.

Never the sexiest of channels in the pay-TV universe, Hallmark and the Hallmark Movie Channel (which is being rebranded this fall as “Hallmark Movies & Mysteries”) aim for middle America with more wholesome fare than what is found on most broadcast and cable networks these days. Hallmark Channel still shows reruns of “The Waltons” in prime time.

Thanks to original dramas “When Calls the Heart,” “Cedar Cove” and “Signed, Sealed, Delivered,” Hallmark Channel’s numbers have improved. In the last 12 months, Hallmark Channel averaged 868,000 viewers, a 20% increase from the previous 12 months, according to Nielsen. It is also up in its key demographic of adults ages 25 to 54. It is currently averaging 220,000 viewers in that group, a 4% increase.

Original movies are solid as well for Hallmark, averaging 1.5 million viewers this year.

The growth at the Hallmark Movie Channel is even more impressive. While its prime-time audience for the last 12 months is only 275,000 people, that is a 22% improvement from a year ago and a 160% jump from five years ago. It has also more than doubled its audience in adults ages 25 to 54 during that time. There is lots of room for growth too because the network is currently available in only 53.5 million homes.

The bottom line is also improving for Crown. In 2013, the company had pretax profit of $109.4 million, a 30% jump from 2012. Revenue also grew, rising 8% to $377.8 million. Cash flow for 2013 was $160 million, a gain of about 16%.

“You have to give them credit, the value is there and it is growing,” said Muoio. “The movie channel has been a grand slam for them,” he added.

Not all of Crown’s moves have been on the money. The Hallmark Channel’s track record on acquired programming is mixed. “Frasier” reruns have done well but a deal to acquire repeats of “The Good Wife” didn’t pan out. Repeats of the ABC sitcom “The Middle” are also under-delivering.

Being independent probably has hurt Crown in terms of distribution and subscriber fees from pay-TV distributors. According to SNL Kagan, Hallmark Channel gets only 7 cents per subscriber a month and Hallmark Movie Channel is carried by many distributors for free. Those that do pay cough up an average of just 2 cents per subscriber, SNL Kagan said. Those fees are very low given the ratings growth those channels have experienced. An owner with more networks probably would be able to negotiate for stronger fees.

Still, Crown’s situation is much improved from 10 years ago, when it did put itself on the block. In those days, it was losing money and having to pay cable and satellite operators to carry it. Crown was looking for an offer north of $1 billion, but there were no takers.

While Crown’s two channels are on much more solid ground than they were a decade ago, there is no obvious suitor for them.

Viacom and CBS are often mentioned as potential candidates but neither has expressed interest. Although Discovery and Scripps focus primarily on unscripted programming, the Hallmark channels could give them a platform for scripted fare. But Discovery is focused on its international strategy at the moment and Scripps is seen as a target more than a buyer.

One of the challenges for Hallmark is that its channels skew old in an industry obsessed with youth. The median age for both channels is over 60 and advertisers pay a premium for youth.

That thinking is gradually starting to change as Madison Avenue recognizes that people over the age of 50 often have more disposable income than those in the 18-34 and 18-49 demographic. If Crown can get its median age down just a little without compromising its wholesome brand, that could raise interest in the networks from potential suitors.

But that may not be what Hallmark wants.

Follow Joe Flint on Twitter @JBFlint.