Description

Company Background:  

CBS and Viacom merger was completed in December.  Post the acquisition, the Company generates 37% of its Revenue from CBS (primarily CBS and CW Broadcast stations), 34% from Cable Networks (Nickelodeon, Comedy Central, MTV), 11% from Paramount (movie and TV studio), 8% from Showtime, and 7% from Local Media (Owned and Operated affiliates).  The Company generates 40% of sales from advertising, 31% from Affiliate fees (subscription fees), and 23% from licensing its content (to 3rd party providers).

Investment Thesis:

• Cord Cutting

• Cord cutting is accelerating.  Cord cutting impacts all their business lines.  Fewer subscribers means less in affiliate fees.  Fewer subscribers means fewer potential viewers which means pressure on advertising revenue.  Fewer subscribers means less ability to create a new hit show which will ultimately hit licensing revenue.  

• Decline of Linear TV in General Entertainment

• OTT competition from Netflix, Amazon, HBO, Hulu, Disney, You Tube, etc. is resulting in significantly falling viewership for linear programming outside of sports and news (that is best watched Live).  Viacom’s cable Networks (Nickelodeon, Comedy Central, MTV) are general entertainment.  Worse, these channels are geared towards a younger audience that is abandoning linear TV at a faster rate.  As a result, rating for the cable networks are declining 15%-20%. 

• Ratings for CBS Broadcast are much more volatile around sports (for example, whether they have the rights to SuperBowl or Final Four).  Absent sports, however, CBS ratings are similarly declining double digits.

• Historically, online has primarily taken dollars from Newspapers and Magazines.  There is now significantly less $s available to take from these mediums.  Increasingly, advertising dollars will be forced out of TV consistent with the shift of eyeballs.  With ratings falling double digits, it is unsustainable for TV to continue to raise CPMs by double digits to largely offset.  That historical equation leads to falling Return on Advertising spend.  

• CBS’ Business Model is Increasingly Reliant on Sports Content that it Licenses.  Sports Inflation Will Result in Falling Margins for the Broadcast Network

• As general entertainment ratings fall faster than live content, the linear TV ecosystem becomes increasingly reliant on sports content.  This creates increased leverage for the sports leagues that own the content.  Nothing is more important to the linear TV ecosystem than the NFL.  Rights to the NFL end after the 2021-2022 season for the Broadcast Networks.  The current contract was negotiated ahead of the 2014-2015 season.  Since that time, affiliate revenues for the Broadcast Networks have substantially increased and the NFL has even more leverage.  The NFL will likely get a material lift in its annual payment.  We are seeing this across sports leagues that are in less demand than the NFL.  A 65% increase in the cost of the NFL would cost CBS $750mm of incremental expense annually.      

• CBS is already scheduled to lose CBS Football to ESPN in 2024.  That CBS contract at $55mm annually was purchased for over $300mm per year.  That legacy CBS contract was likely one of the most lucrative in sports.  For example, CBS was a paying a fraction of what it pays for PGA Golf.  While CBS will no longer have this expense, it will result in ratings pressure and less leverage in affiliate negotiations.  It also results in the NFL having even more leverage against CBS in the NFL negotiations.  

• As media networks lock in higher sports costs, it forces price hikes on distributors in the form of affiliate fees.  Distributors are then forced to raise prices on consumers accelerating cord cutting.  As the cost goes up, increasingly subscribers will only be die hard sports and news fans, resulting in fewer subscribers overall and resulting in less leverage for CBS’ general entertainment cable networks.

• COVID is a Material Risk to Viacom

• Increased COVID cases could result in the suspension of the NFL and college football this fall.  Sports are ~10% of total viewership on TV in the fall.  It is even more impactful in terms of ad spending because the NFL’s broadcast window generates the most expensive commercial unit rates in the business.  Sports advertisers are attracted to the ability to efficiently reach a large portion of US consumers.  What is most negative, however, is that if sports were not to occur in the fall, it would likely lead to significant acceleration in cord cutting with many of these customers never coming back.

• COVID negatively impacts Paramount’s ability to release movies and create content for both CBS/Viacom and third parties.

• Showtime is Overearning

• Premium pay channels such as Showtime are most directly competing with OTT options such as Netflix.  Historically, Showtime was essentially a free-rider on the MVPD big bundle.  Increasingly, Showtime is being forced to aggressively invest in more original content, direct-to-consumer marketing, and infrastructure.  The shift to OTT not only brings more competition but is margin dilutive.

• Paramount Business Will Have Challenged Return on Capital

• Movie theatres are in structural decline.  The Home Box Office is becoming more competitive with increasing SVOD/AVOD options, including an aggressive push into movies.  There is likely long-term damage done from the closures of theatres as a result of COVID.

• Paramount makes content for third parties.  In the process, it is essentially just an arms distributor.  The returns on creating that content are poor and working capital intensive.

• Higher Corporate Taxes Should Biden Win

• Tax rate of 25% would potentially go higher if corporate tax reform was passed.

Risk/Reward:  Legacy media is trading at a substantial discount to historical multiples but they are irrelevant given the accelerated structural decline that is occurring.  Each year that passes, the legacy bundle is becoming more and more irrelevant, which will result in increased pressure on the exit year multiple as EBITDA declines accelerate. I am modeling 2022 EPS of ~$4.00 versus the Street of $4.85. Applying 5x PE (~3x leverage), results in price target of $20 or down ~25%.

Key Risks: 

• Valuation:  Asset is cheap at 5x PE on 2019 financials.  

• Cyclical Rebound:  Current numbers negatively impacted by COVID.  I assume a rebound in 2021 on a post-COVID basis, but rebound could be more substantial than expected.

• Less Bad is Good For the Stock:  Should cord cutting or viewership show sequential improvement, it could be viewed favorably (i.e., less bad is good news).

• Focus on Cash Flow:  Historically, the Company has invested (primarily in content) to try to more effectively compete.  That investment in content however is a poor return on capital because the terminal value is negligible.  Company could aggressively try to milk the business for cash which could result in higher FCF than expected.

• Monetization of Assets:  There is opportunity to create value through selling pieces of the business.  In particular, there would likely be significant interest in Paramount and Showtime.  There is also speculation that there could be a merger with another legacy media player such as Discovery.

Catalyst

Any datapoints regarding the acceleration of the decline of the legacy TV ecoystem, sports rate renegotiated at higher contract values, earnings missing Street expectations.