Friday, January 16, 2015

Put Viacom and CBS Back Together, The Way They Were Supposed To Be.

Why In God's Name Did I Buy Viacom? 


Recently, I bought some Viacom. Not a lot, some. 
Hmmmm. Probably an impulse buy, which means probably a mistake. I bought the stock because it is cheap at 12 times consensus estimates of $5.85 p.s. in 2015, though negative revisions would not surprise me.

And, it seems to me that it should be part of another company.  Except for Paramount Pictures, Viacom is almost exclusively in the cable network business. As such, it is vulnerable to continuing ratings and ad revenues declines.  In addition, it is strategically too small to defend itself from strategic choices that its cable operator affiliates are going to make.

It has other problems-not a few of which could sink the shares. But, the optimist in me says, hold on this is Viacom, the flagship that Sumner Redstone used to build a great media empire. It's a great cash machine and it is buying back between $2 and $3 billion of shares and cutting dividend checks for $500 million.

Cable networking was supposed to grow at double digit rates ad infinitum. It hasn’t. And Viacom’s networks skewed to teens and younger and were supposed to grow even faster.  They haven't. In fact, MTV Networks has been a ratings disaster.

Ok, so why are you buying? It is my hypothesis, (hope-fantasy?) that the Redstone family will decide, soon,  that Viacom and CBS need to be consolidated. If an all stock deal - for arguments sake - were executed at say a 50% premium to the current price, the combined company would have the scale, scope, and capitalization that it needs to compete with the other players in the media industry. 

The Way It Was Supposed To Work


The way it was supposed to work when CBS was acquired by Viacom and then was subsequently spun off (after some reshuffling of assets ) is that remaining Viacom-composed principally of cable networks and Paramount-was supposed to be the growth story and CBS was supposed to be the mature cash cow. Well that's not how it worked out. As it turned out the growth story turned out to be the cow and the cow the growth story. Over the last four years, CBS comparisons with VIA dramatically favor CBS:

CBS vs Viacom: Comparison of 4yr Compound Average Growth rates
Metric
CBS
Viacom
bp Advantage
Sales
3.22%
-1.95%
517bp
Operating Cash Flow
12.16%
2.44%
972bp
Dividend Growth
24.47%
12.03%
1244bp
Shares O/S
-2.62%
-7.23%
-463bp
P/E
22.7X
12.3X
10 turns
Source, company financial reports

None of this makes any sense. Starting from the bottom up: even a year ago Viacom  traded at a premium to the S&P and to CBS. Now it trades almost 10 full multiple turns below CBS. Not the way it should trade. Both companies have share buy backs programs but VIA has reduced share count more. Not what was expected for a growth story. CBS's operating cash flow has grown at an impressive 12.16% over the last four years  while growth at Viacom has been a modest 2.44%. Sales are up modestly at CBS-to be expected, right; after all it is supposedly the mature business but VIA sales are down? Not expected. VIA were supposed to grow at double digit rates long into the future. Cable net ratings were supposed to take additional share away from Broadcast dealing a crushing blow and affiliate fees were supposed to be a consistent stream that never went into reverse. What happened is that the cable networks relied too heavily on a continuous upward trajectory in affiliate fees. Ratings have collapsed and cable operator affiliates have begun bailing out.
As the Journal wrote recently:
  •  "Viacom is known for its aggressive bundling of two dozen channels, including little-watched spinoffs of MTV, VH1, Nickelodeon and CMT. 
  • A group of 60 cable operators representing about 900,000 subscribers dropped Viacom channels entirely this summer. In September, carriage negotiations broke off with Suddenlink, the nation’s seventh-largest operator, representing 1.4 million customers. 
Viacom’s standoff in the sticks is seen as an example of operators starting to push back at the channel bouquets that top programmers were able to develop in more advantageous times."

There seems to be a revolt breaking out all over the cable business. Cable operators are taking up arms against ever increasing network affiate fees. It is noteworthy that the worst offender/culprit is not the Viacom group of networks but rather ESPN, which charges operators almost $8 per month. Add on the Broadcast networks, whose retransmission fees have risen in the mid single digit range consistently, and smaller programming "bouquets" like Viacom will be squeezed out.  Still, as Matt Harrigan points out (Wunderlich Securities Nov 14, 2014)  over 70% of Viacom's households are covered by 3 year contracts. And, further that Viacom's affiliate fee growth is not much higher than the double digit increases that are the norm. And again as Matt points out the MTV networks are important to new and old entrants in the content world. It's just that Viacom seems to have lost it's creative energy and is being surpassed by other networks in commitment to exciting original programming.  And it is easy to drop networks like those owned by Viacom if they are perceived as losing energy.

Ok, you argue the cable network business has not performed as expected. Ratings and ad rates have been down. Across the board! Yes, some networks are down. But others are up, Here are fourth quarter numbers from MediaPost.

"Fox networks grew 5% to 858,000, with virtually all other cable network groups sinking — the worst coming with A&E down 20% to 887,000. Also in double-digit declines was Viacom, off 18% to 2.18 million; NBCU, losing 15% to 1.3 million; and AMC Networks, down 11% to 438,000".
Here below full year rankings. While Nick leads all networks in total day, and Comedy and MTV are 24th and 25th in primetime,  it is hard to find other Viacom Networks on the list.


TOP 25 AD-SUPPORTED CABLE NETWORKS

Ranked on Total Viewers

2014
Rank Primetime Total Day
Net (000) Net (000)
1 ESPN 2276 NICK 1606
2 USA 2179 DSNY 1396
3 TNT 2039 ADSM* 1238
4 DSNY 1943 USA 1150
5 TBSC 1869 TOON 1067
6 HIST 1857 FOXN 1055
7 FOXN 1732 TNT 1049
8 FX 1447 ESPN 1016
9 DISC 1414 NAN * 968
10 AMC 1355 HIST 863
11 HGTV 1343 HGTV 761
12 ADSM 1341 TBSC 712
13 NAN 1313 AEN 709
14 AEN 1269 FX 675
15 FAM 1259 ID 632
16 LIF 1132 DISC 628
17 SYFY 1131 AMC 626
18 FOOD 1087 FOOD 595
19 TLC 1079 FAM 579
20 BRAV 991 LIF 529
21 HALL 909 HALL 525
22 SPK 903 SPK 503
23 ID 811 TVLD 500
24 MTV 783 TLC 496
25 CMDY 705 DSJR 480
* Network broadcasts less than 51% of minutes in a 24-hour day.

Source: Turner Research from Nielsen data

By contrast, CBS is having a terrifiic ratings year. Last week its on-going series captured 16 of the top 25 rated shows. NCIS, Mom, Big Bang, Madam Secretary, The Good Wife, Scorpion-all shows are a mix of new and returning as well. Improvements are happening across the board. At the same time they are all owned shows whose current success on the network will translate into significant future revenues.

WEEKLY PRIMETIME AVERAGES BY NETWORK
Ranked on Households

Week Jan. 4
NetworkHouseholdsPeople 2+Adults 18-49
Rtg%(000)ShrRtg%(000)ShrRtg%(000)Shr
CBS4.6536082.5731071.113403
NBC4.4510082.5734072.025606
FOX3.1357051.8538051.823406
ABC2.8322051.6473041.214604
UNI1.3155020.9256021.012703
ION0.888010.4113010.34101
CW0.776010.4108010.34401
TEL0.673010.4128010.56902
METV0.442010.254000.1800
UMA0.332000.255000.23201
BOUNCE0.219000.128000.11000
ETV0.117000.131000.11300
MFX0.113000.121000.1700
AZA0.16000.011000.0600
*Each rating point is equivalent to 1 percent or 1.164 million homes
Note: Viewing estimates include same day (3 a.m.-3 a.m.) DVR playback.
Source: Nielsen

What Can Viacom Do? 
Viacom's fourth quarter conference call was almost exclusively devoted to why the significant declines in ratings do not reflect the real value to consumers of Viacom Networks. Yet, in my view, owners of the shares need to accept that the only ratings issues at work here are those that come from a lack of viewers and a lack of interest.

The company is currently talking to Neilsen and other ratings companies abouut ratings issues. Secondly, the company is attemptng to create an industry wide standard for capturing viewing on non cable outlets - digital, OTT- whatever. Dauman has been talking to Rentrak and others about alternatives to Neilsen. Some day soon, I believe, the ratings measurement companies will add capability although I don't have a clue how that might be done. My concern is that Viacom's numbers will be less than Dauman hopes as online takes an ever larger share of the ad market.

Recognizing the need to untether itself from ratings measurement, Viacom says that 30% of its ad revenues do not originate from Neilson rated shows. Still, there will be no real way to immunize ad sales from a lack of excitment and creativity in the product itself, which is where I believe the real problem lies.

In my view, the only way to revitalize these networks is to bring in new management and to bolt them on to a sizable company with far more market clout. Pounding away at ever higher affiliate fees in the face of lower interest on the part of viewers and subscribers is bad for everybody in the cable industry. At the moment, networks can get away with it. But there will come a day...

There is a better way. The Way It Was Supposed to Be. 

The better way is to put CBS and Viacom back together. The recombined entity will have the cash generating capacity of the two separate entities plus a lot more in my view. 

Here’s what the combined entity would have looked if merged last year with a 50% premium. It will have sales of almost $30 billion. The compound growth rate in sales is not impressive and reflects weak conditions (particularly in auto co advertising) this year and last year projected into the future.

CBS Exchange Offer For Viacom: 50% Premium
Combined Enterprise Value of
$88 billion
Combined Company
EV Mulitple of 
CAGR
Sales
$29 billion 3.03 times .060%
Operating Cash Flow $7.33 billion 12.01 7.59%
Operating Cash Flow
$8.0 billion 11.0 6.41%
Net Debt
$18.55 billion

Net Debt to OCF
2.32X

Source, company financial reports, Macdonald estimates

Still, there is good reason for optimism.  It seems likely the Broadcast and Cable network ad market will strength. A reasonable upside would be somewhere around 5% reflecting a return to modest growth for the Viacom Netowrks and an acceleration in sales at the CBS TV network. In future years, retrans fees (and reverse comp affiate fees are schduled for sharp increase in 2016. Even without any cross platform benefits, EDITDA should grow at mid to high single digits. Most of this growth will come from CBS. If Dauman is successful in piquing interest in non traditional measurement then the number would be even higher.

The above are advertising climate considerations but here below are further strategic benefits that are low hanging fruit that I see for the combination.

Here are the eight basic upsides we see for a potential combination.   
  1. Increased scale and scope for the entire CBS Entertainment complex. MTV and CBS would enhance each others offering to both advertisers and affiliates. Today Viacom Networks/Paramount (and to a much lesser degree CBS)  do not have the leverage with advertisers up that Comcast, 21st Century Fox and Disney enjoy.  Viacom/CBS would have scale that would be hard to ignore. 
  2. MTV would certainly gain from CBS success with advertisers and CBS would gain from MTV’s brand as a youth oriented programmer
  3. Internationally, MTV Networks could help CBS with local identities (MTV is local in many countries) and sales organizations. CBS could help MTV (and Paramount) with strong product offerings from its television production studio
  4. Increased scope and scale for Paramount. Instead of being an after thought, Paramount would be bolted onto to a very strong network TV production arm and be back in the syndication business. While it would not necessary have access to more capital, it would benefit from increased scale and scope and probably gain creative energy from the association with CBS Production.  
  5. CBS management has more creative energy than Viacom and its transformation from an agent and buyer of programming to a creator and owner is both impressive and likely to continue. While the creator-owner strategy is the Viacom business model, it has  seeded its creator position to younger, online competitors like Vice Media as it focused on share repurchase and returning capital to shareholders.
  6. With Paramount in the mix as well the company could create a killer digital strategy as well. Both companies are developing a portfolio of sites, though MTV managed to let Vice Media-charge ahead in a niche that should have been dominated by Viacom. 
  7. Finally, a lower risk profile in the portfolio of businesses owned by National Amusements. Without the expected benefit from shining a light on NAI’s supposedly fast growing Cable Networks, it seems inefficient to have two management teams working in two separate public silos when only one-CBS's management-is needed.

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