The company will generate a significant amount of free cash flow (we believe 25% of mkt cap over 2 years) over the next several years as it is levered to a cyclical recovery in advertising and will continue to monetize its premium programming via licensing deals and through affiliate agreements as they get renegotiated.  The stock is extremely cheap trading at under 10x 2011 FCF with improving returns on capital and minimal capital requirements.  The management team is very strong and focused on returning capital to shareholders. The company is worth a minimum of $30/share based 15x 2012 EPS and/or 8x 2012 EBITDA.  So we see 50% plus upside in the stock.

History

CBS spun out of Viacom on Jan 3, 2006 at $21.64/share and hit a high of $35/share on July 23, 2007.  Summer Redstone remains a majority shareholder (6% owner) and 81% voting power and serves as its chairman.  Leslie Moonves, CEO of CBS, was previously the co-coo of Viacom and oversaw all of Viacom’s domestic and international broadcast tv operations, radio division and outdoor advertising.  He joined CBS in 1995 as president of entertainment after a successful career at Warner Bros Television where he was President and oversaw the television division that supplied the greatest number of programs over nine years (including ER, Friends, the Drew Carey Show).  Since the spin, the sold the parks business, some radio stations serving smaller markets and bought CNET for $1.8bn in June 2008.

Investment Highlights

Significant Operating Leverage should support continued margin expansion

-          CBS is high fixed cost business with a majority of costs coming from programming and thus the ability to sell that programming through other avenues (e.g. though syndication, international distribution, internet) and/or sell advertising slots at higher prices all goes to the bottomline

o        Since 2004, segment operating expenses ranged from $10.8bn to $11bn showing the fixed cost nature of the business while Revenues peaked in 2004 at $14.5bn and troughed in 2009 at $13bn; during the same time period Ebitda has gone from $3.3bn in 2004 to $1.8bn in 2009 – clearly leverage goes both ways

§         For the 1^st 9 months of 2010, Rev increased by about 650MM and 60% of that went to the bottomline demonstrating the operating leverage in the model in a recovery

§         For 2011

Advertising Recovery underway with local advertising providing the next leg up

-          CBS is levered to an ad recovery (about 64% of revenues – improved pricing goes straight to the bottomline; note that the other 35% of revenues are more recurring in nature coming from licenses, affiliate fees, and subscription fees) which is already underway.   Local advertising should be a later cycle play while national advertising continues to recover and should do well with company’s sporting great balance sheets and record profits

Upside from re-negotiation of Affiliate Agreements

-          In the last 2 years, the company has signed large long-term contracts with Time Warner (expire 2013) and Comcast; requiring re-transmission fees for the right to carry local television stations via cable systems;

o        The 10yr deal with Comcast includes escalations and analyst have projected CBS would earn $0.5/sub/month in fees so for 2012  - the company would receive $75MM/yr

o        Similar deals with are coming with other MSO, satellite operators, Verizon, etc.

o        Company has guided to $250MM by 2012 and growing beyond that which would be up from approximately $50MM in 2009

o        The opportunity could be as much as $750MM – but it will take time to achieve that level of re-transit fees

Syndication opportunities are significant

-          Given that CBS owns a majority of its programming, the ability to monetize this through syndication deals is incremental to revenues

-          International syndication has grown every year over the last five – last year the company launched three new shows (Hawaii Five-O, Blue Bloods and The Defenders) and received $2MM/episode foreign

-          Domestic syndication is still an opportunity for strong programming and CBS’s batting average has been pretty good (this makes sense given the CEO’s background in programming); they are able to sell hit shows earlier and at record prices

Strong management team and capital allocators

-          The management team, led by Les Moonves, has done a good job divesting non-core businesses (e.g. Parks business), weaker performing radio stations at 12-14x EBITDA valuations, and managing expenses while also driving content.  The management team has been particularly shareholder friendly.  Since 2007, the company has returned $5.4bn to shareholders via dividends and share repurchases and on Nov 4, 2010 – announced a $1.5bn share repurchase starting Jan1, 2011 over an 18 month period. He recently has said that he is not interested in M&A and is likely to increase the dividend this year.  At the right multiple, he would sell the outdoor business which could go for 14x forward EBITDA or close to $6bn.  (note: LMAR advertising trades at 11x 2012 EBITDA).

Momentum continuing in Showtime

-          The company increased subs by 1.5MM in the last year to 18MM subs (note: HBO is at 28MM Subs) and have grown subs over the last five years through rebuilding programming efforts

After four years of decline, the radio station business has stabilized and is turning the corner

-          Listenership in radio is exactly the same as it was ten years ago and after the company changed its format in 25 of their radio stations, the company is growing and believes it will continue

-          Margins are strong at the 30% range with local advertising turning the corner – they expect to continue to grow margins in this business; they have taken costs out and incremental dollars come at 85% margins

Outdoor coming back vigorously

-          Margin expansion should continue as past the bad transit deals that were done in the past;; company believes it can get back to $600MM in EBITDA which was the peak in 2007 from $270-$290MM in 2010

-          Currently trying to renegotiate the large, London Underground contract, with the municipalities; the Olympics in the UK in 2012 should provide upside

Valuation

-          Low capex requirements - $260-$270MM annually

-          Shares Out: 694MM fully diluted

-          Share Price: $21.5

-          Cash: $1.1bn; Debt: $6.8bn; Net debt: $5.7bn

-          Mkt Cap: $14.9Bn, EV: $19.6bn

Summary Multiples

-           

Catalyst

-          Major share repurchase expected; Next two years of $3.3-$3.4bn in FCF

-          Potential asset sale of outdoor

-          Earnings on Feb. 16^th – should be strong and analyst day on Feb 24

Risks

-          Possibility of an NFL lockout next year – the company said  it won’t greatly affect the bottomline but the stock will clearly take a hit if this happens

-          Increased Investment in the “movie” business – for now its very small – they have done 3 movies so far with the last two being breakeven (Note: last movie cost $12MM to make); expect them to do 2-4 movies/yr over the next two years with small budgets

-          With 65% of revenues tied to advertising, the company is highly correlated to GDP growth and the overall macro environment

-          The emergence of new, alternative viewing platforms could permanently impair the value of their content (if content owners are not careful to preserve the value they receive per view) – but to date CBS has been the most conservative in making its content available (they did not join Hulu, NFLX, Google TV yet)

-          Some difficult headwinds to overcome from a year over year comparison including (superbowl in 2010 and not in 2011 – however they make no margins on the superbowl, political advertising in 2010 not in 2011, CBS loses Oprah this fall – but the company has indicated that this is a low margin business and the financial impact will be minimal)