In 1994, the season finale of NBC’s popular sitcom, “Friends,” garnered an estimated 52.5 million viewers. Today, “The Office,” one of NBC’s most popular comedies, is lucky to have about 2.5 million viewers each week.

The steady demise of network television has been a boon for cable television. In recent years, major subscription-based channels such as HBO, TNT and Showtime have developed such high-quality content that consumers are willing to pay a  monthly cable or satellite bill of $100 or more just to be able to have access to these channels. Steady demand throughout the latest economic downturn only served to prove that the vast majority of cable subscribers were unwilling to cut the cord to save a few bucks. The same has been true of watching shows through the Internet, though the same amount of content just isn’t there yet.

One of the most successful cable programmers has become AMC Networks (Nasdaq: AMCX), which burst onto the scene in 2007 with the release of an original program called “Mad Men.” The series is about Madison Avenue ad agencies in the 1960s and has been critically acclaimed, winning more than a dozen Emmy and Golden Globe Awards. The first show of the fifth  season, which premiered on March 25, garnered 3.5 million viewers, proving that network television now takes a back seat to cable.

In 2008, AMC Networks released another critically-acclaimed drama, “Breaking Bad,” which attracts a couple of million viewers per episode. It more recently rolled out the zombie horror drama “The Walking Dead,” which boasted 9 million viewers during a recent season finale and now holds title to the highest-rated drama among younger viewers. Other popular shows include “The Killing,” “Hell on Wheels,” and “Portlandia,” which show on AMC and its other paid channels: IFC, IFC Films, WE tv and the Sundance Channel.

Unsurprisingly, advertisers are flocking to AMC Networks and its highly-coveted demographic of 18- to 49-year-olds. Another steady source of revenue is affiliation agreements, which are paid from cable service providers such as Comcast (Nasdaq: CMSCA) and Time Warner (NYSE: TWC) for the right to carry AMC’s channels.

It’s now possible to see the results of the network’s growing popularity among advertisers. Last year, AMC Networks brought in $1.2 billion in revenue, up 57% from 2007. Profits were up even more sharply and have jumped more than eight-fold from $0.22 to $1.79 per diluted share. Analysts project steady revenue growth of about 8% in each of the next two years, and earnings per share (EPS) of $2.24, a growth of more than 25%. They project another 25% bump in 2013 to $2.79 per share.

It’s important to note that reported earnings generally understate the true profit-generating potential for media firms. It’s crucial for AMC to create new programs consistently, and they require heavy upfront costs. They also represent a competitive advantage that smaller content providers on the Internet are unable to match. For AMC Networks, these development expenses come through as costs each year on the income statement, but the cash has already been spent. Because there’s no real cash outflow, the actual free cash flow generated is actually quite a bit higher.

So in 2011, for instance, AMC Networks reported $126.4 million in earnings, but free cash flow was just a hair below $240 million, or about $3.40 per diluted share. Overall then, the reported price-to-earnings (P/E) ratio appears quite high at 24, but the price-to-free cash flow multiple — which I think is the more accurate metric for viewing this company — is more reasonable at just shy of 13. This is still above the market average multiple of 9, but AMC Networks deserves a premium because it is growing quickly.    

Risks to Consider: The viewing of TV shows is still predicted to migrate to the Internet and related mobile devices, a trend that’s expected to further impede on TV networks and eventually eat into cable viewership. But it has already been almost 10 years since this prediction was made, and it has yet to come true. Cable TV networks have done a stellar job of maintaining their viewership and will probably find profitable ways to migrate with its customers to the Internet.

Action to Take –> Right now, AMC Networks is expected to grow cash flow by 9% annually. I actually think it has the potential to grow closer to 15% based on my discounted cash flow analysis. This is based off the continued success of its popular series and steady growth of new, high-quality content. Management’s track record of hits has certainly been impressive so far, so it has a good chance of continuing the streak.

Based off of my projected growth estimates, I find that the share price of AMC Networks is undervalued by about 45%. Based on recent prices, that means the stock could surge to $62, which I think is achievable within a couple of years.