Description

Viacom, on the verge of being split up into two companies, is trading
at a very attractive valuation on a sum-of-the parts basis, approximately 60% of the component business' value. There are several reasons for this discount: 1)investors believe that the to-be-spun-off "CBS Co", which includes the CBS network, TV stations, and the Infinity radio division, does not have attractive growth characteristics due to competitive and secular challenges in TV and radio in particular; 2) Investors do not want to buy into the spin-off now, and wait post-split so they are not left with shares in the stodgy CBS Co; and 3) Investors are underestimating the impact of leverage that will increase at each entity and will be used to significantly reduce the share count.

While many will not want to receive shares in the new CBS, and are waiting for the separation of the superior-growth Cable Networks businesses (MTV, VH1, Nickelodeon, BET), the time to buy into a low-priced spinoff situation is now, about 2-4 months pre-separation; the split is expected to occur in late 4Q05/early 1Q06. Once this "catalyst" happens, the valuation of the new Viacom will likely increase substantially, and CBS-Co is likely to command a valuation more in line with public and private comparables. The Cable Networks ("New Viacom") according to my estimate, account for 75% of the value of the Viacom, rendering the CBS "stub" worth only 4.5x 2006 EBITDA. Moreover, post-split, both entities will be taking on additional debt, which will be used to repurchase shares; assuming share repurchases occur at the current pre-split market price, over 225MM of the outstanding shares will be repurchased; this would increase per share value by nearly 5%. Together, the "sum of the parts" and the capital re-allocation equity to debt via a re-leveraging of the balance sheet results in Viacom trading at a minimum of a 40% discount to its current value.

Note: For purposes of simplicity, this analysis will focus on the
valuation of the current Viacom as a whole, prior to the spinoff (with the current share count, market cap, etc).

Background: Viacom merged with CBS in 2000,in a $45BN transaction
intended to turn the company into an advertising sales media powerhouse. By combining the old Viacom's cable TV assets, with the CBS Broadcasting and Infinity radio stations, the theory was that Viacom would be able to cross-sell advertising income across all of the company's media properties to advertisers in a "one stop shop" format. Well, things didn't exactly go as planned, and large-cap media company multiples (particularly in radio and TV) have since declined substantially due to the perceived threat of Satellite radio, the lack of ad spending rebound in the radio sector once the advertising market turned in 2002 & the economy improved, the slow growth of TV broadcasting ad revenues (due to intense competition from CATV networks), and the threat of online and search-engine based advertising, which is expected to steal ad dollars from traditional media. Sumner Redstone, self-admittedly being influenced Company's investment bankers, decided to split the businesses apart, with the intent shareholders could own the high growth properties (CATV Networks) without being dragged down by the "stagnant" CBS/Infinity divisions, management incentives would be better aligned with the performance of each company, and the CATV networks could either be consolidated (by distribution companies or other content companies, such as Comcast or GE/NBC/Universal), or if the stock price of the New Viacom better reflects the better growth characteristics of the CATV businesses, the CATV networks could be consolidators (since would trade at higher multiple & do accretive acquisitions). While I usually am very skeptical of mergers and subsequent "mia culpa" split-offs, as they can sometimes signal that a company is really dumping a poor business (kind of like Viacom did with Blockbuster!), the CBS Co will still have prime assets that despite their slow growth characteristics, generate solid cash flows, are experiencing revenue growth (albeit small), and given the market position and high quality, should trade at multiples far higher than the 4.6x implied by the current valuation of the CATV networks.

Businesses:
The "new Viacom" will consist of some of the highest-quality and fastest-growing cable networks in the business: MTV, VH-1, Nickelodeon, BET, and CMT, and will also have the Paramount movie studio (including the valuable film library). The CATV network channels reach over 1.5BN cumulative Pay TV subscribers worldwide, with 877MM cumulative subscribers in the U.S. The CATV networks' revenues and cash flow have grown at double digit rates for the past 20 years. Going forward, while most of the domestic networks are now fully distributed, they continue to generate high-single digit subscriber fee increases (largely on a multi-year basis with built-in price increases) and are seeing above-average increases in advertising rates; the international and developing networks will be the primary drivers of growth, which combined with the domestic networks, are expected to drive cash flow growth in the high single or low double-digit rates.

The Paramount studio, the second component of the “new Viacom” is in the midst of a turnaround--it is ranked dead least among the majors, and its earnings have been the most volatile over the past 10 years. Paramount has been operating at a 6%-7% margin and at less than $200MM in profit; this is far less than the 12-15% margins enjoyed by Warner Bros. and Fox. The keys to performance improvement in this division, which is entirely achievable, will be better new theatrical releases and a more prolific release of the rich Paramount theatrical library to DVD format (Viacom has not released as many of its movies to DVD vs. its competitors, so there is meaningful growth potential in the home video business). Paramount actually had a very successful 2005 summer season (Longest Yard, War of the Worlds), highlighting that having a good movie studio is the result of producing desirable content. Viacom has historically under-invested in Paramount vs. its other divisions and post-split, management is an improved position to succeed given the additional focus in both management attention and capital (more can go to investing in quality films).

CBS Co will house the CBS and UPN networks (about 40% of CBS Co EBITDA) and their 40 major-market TV stations. CBS has shown some of the best ratings stability and profitability of the major networks, due in large part to its strategy of focusing on sitcoms and dramas in proven genres (e.g. CSI). CBS has attained the highest audience share shift in the past 5 seasons, growing 21.3%, vs 10.4% for Fox, and declines in NBC and ABC audience shares of 11%-12%. Once the split occurs, CBS for the first time, will likely begin to generate additional revenue by charging cable/satellite/phone networks for the re-transmission consent of the CBS channel (much like a cable channel) in addition to the advertising dollars the network generates. Historically, Viacom/CBS used re-transmission consent solely help the Viacom parent gain leverage for helping it start new cable channels, give channels numerical priorities, or charge higher fees for the channels for its desirable/popular channels. Once separated, CBS will have no such mandate to help the other cable networks of Viacom, and thus as contracts come up for renewal (about 5MM-10MM subs per year over the next several years, according to mgmt) CBS will be able to charge cable/satellite companies to re-transmit the CBS broadcast(which may become even more lucrative once CBS expands in multi-casting format--i.e. there will be several CBS channels ie CBS-1, CBS=2--and given that many consumers would want a clearer HDTV signal vs. over the air antennae).

CBS Co. will also inherit the Infinity Radio division (about 25% EBITDA) and its 180 owned radio stations; the division has been struggling with a weak local/radio ad market, and the loss of Howard Stern to satellite radio, however it is out-performing ClearChannel on a revenue growth basis (especially in smaller local markets). Notwithstanding all the calls on the “demise of radio”, Radio advertising spending is still growing (in low single digits), albeit not at the high single-digit rates of the late 1990s; as such over time I would expect revenues and EBITDA for the division to grow in the low single digits, with 2006 estimated to be a pretty strong year, due to the additional political spending associated with an election year (which will largely offset some of the revenue/EBITDA loss from Howard Stern moving to Sirius).

Other businesses to be part of the new "CBS" are the Outdoor ad segment (a segment which continues to enjoy expansion in sales/margins, about 15% of EBITDA), the Showtime subscription cable network (about 8% of EBITDA), Simon & Schuster publishing, Paramount Theme Parks (both together about 5% of EBITDA) and the CBS/Paramount TV/King World division (12% of EBITDA)--which produces and distributes most of the popular CBS content via broadcast and syndication (includes CSI, Two and a Half Men, Medium, Without A Trace, and in off-network syndication Everybody Loves Raymond, Dr. Phil, Oprah, Jeopardy, ET, and Dr. Phil). For the past three years, according to the S-4 (which properly allocates corporate overhead among the separating divisions) CBS Corp on a “standalone basis” grew both revenues and EBITDA at an approximate at a 3.3%-3.5% annual rate.

Form of the split-off:

The separation will be affected via a tax-free spinoff, where the cable networks and film/home entertainment will become a new publicly-traded entity. Each current VIA shareholder will receive 0.5 shares of each company. Currently, there are about 1,573MM VIA shares outstanding, comprised of 131.4MM shares of VIA A-class (one vote per share) and 1,440MM VIA B-class shares (no voting rights). Post the split, the “new Viacom” will have 65.7MM A-Class shares outstanding, and 720.8MM B-Class outstanding (same voting rights as currently), and CBS Co. will have the same number of A and B class shares, respectively (also same as current voting rights). Capital structure wise, CBS will have $7BN pro-forma in debt (most existing Viacom bonds), and will manage toward a debt level of 3.0-3.5x EBITDA (representing another $2.5BN in additional debt). Out of the box, the New Viacom will have about $3.2BN in bank debt, but will increase leverage to 2.75-3.0x over time (will represent another $4.7BN in debt). The additional debt levels will be used to conduct share repurchases at the new Viacom, and at CBS Co, to pay a dividend (about $450MM per year) and then repurchase shares. Sumner Redstone will be the largest shareholder of both new Viacom and CBS Co. post the split with 70% voting control and 6% economic control (he only holds the A-shares).

Management:
The management team of the new Viacom and CBS Co. will be pretty much intact, with Tom Freston and Les Moonves heading each respective company as President & CEO (they are current co-presidents and co-COOs of Viacom). They both are pretty highly regarded, having long careers at Viacom and CBS, and have done a good job of running/building their respective businesses. Tom Freston was one of the founders of MTV networks (began in 1980) and has served as CEO of the MTV division since 1987. Les Moonves joined CBS as President in 1995 (before was president of Warner Bros since 1993), and served as CEO of CBS since 1998. Sumner Redstone (who recently agreed to relinquish his CEO role at Viacom) will be the chairman of both Viacom and CBS Co.

Valuation:
The most valuable component of the current Viacom, are the CATV networks, which account for about 75% of my estimated value of Viacom. Recent public and private transactions over the past several years have occurred at multiples of 15x-30x. Given the relative maturity of the Viacom CATV networks, I would place the cash flow multiple at the low end of the range. Other comparable CATV networks over the past several years have transacted at the following multiples: Comedy Central—TWX ownership stake purchased by Viacom (30x+ EBITDA), Family Channel (Disney purchased from Fox at 22x), BET (19x), Bravo—GE/NBC purchased from Cablevision (18x), and in a recent VIC writeup on the spin-off of Discovery Holdings, the author cogently argues that DSC is worth at least 15x (it probably is closer to 20x). I’ve assigned a 10x EBITDA Multiple on the Paramount Movie studio, which is actually pretty conservative, given the turnaround potential (margins are capable of doubling in the business) and the most recent comp (NBC-Universal deal, which implied a valuation of Universal Studios at about 10x). The corporate overhead and stock option compensation expenses, I assumed at a lower 7x multiple, because in the event of an acquisition of the “new Viacom” cable channels, most of this corporate overhead could be reduced. EBITDA for the following valuation is based on estimated FY06 EBITDA.

EBITDA Mult. Value
Cable Networks $3000MM 15x $45.0 BN
Paramount Film $200MM 10x $2.0 BN
Corp OH & Comp. exp ($250MM)7x ($1.75) BN

Total New Viacom “Intrinsic” EV $45.3BN

Current pre-spin Viacom EV $60.3BN

New Viacom value as % of Current VIA EV 75%


This leaves the CBS Co “stub”, which has estimated FY06 EBITDA of $3.3BN (up 3% from FY 2005 Estimate)

EV of remaining CBS Businesses $15.0BN
CBS Co est. 2006 EBITDA $3.3BN
Implied multiple of CBS Co. 4.5x

Despite the fact that media multiples have come down over the past several years, 4.5x EBITDA is far lower than other publicly traded comps and PMV multiples in the TV Network, Radio, TV Station, Outdoor advertising and publishing businesses.

Here are some comparable multiples in both the public and PMV space for each of the segments of CBS:

CBS Network Comps: No major publicly traded pure play comps, nor recent pure-play transactions, but most industry analysts agree that at least an 8x multiple should be assigned to a major network with a good operating history. In early 2005, News Corp bought the minority interest of Fox Entertainment (which includes TV Stations, the network, the cable nets, Fox studios) for 13.5X EBITDA. In 2000, Viacom acquired CBS for 16.8x EBITDA and in 1996, Disney acquired Cap Cities/ABC for about 12x EBITDA.

TV Station Comps:
--------------------
Public:
Belo Corp (also has newspapers, which carry lower multiple): 9.4x
Hearst Argyle: 11.3x
Emmis (TV and radio): 13x
Lin TV: 12x
Sinclair: 10.5x

TV Station PMV transactions (2002-2005):

Emmis is selling 4 TV stations to Blackstone Group for 14.0x EBITDA (mkts are Portland, Honolulu, Wichita, Topeka)

Emmis is selling 9 TV stations to Lin-TV, Journal Communications, and Gray TV for 13.4x EBITDA (mkts include Ft. Myers, Omaha, Tucson, Albequerque, Mobile, Greenbay)

Granite (buyer) /AM Media (San Francisco WB, Detroit WB): $180MM, generated neg. EBITDA
Viacom/Sinclair (Sacramento, Stockton, Modesto: 15x EBITDA
Meredith/Sinclair (Kansas City) – 23x EBITDA
Tribune/Acme (St. Louis)-- $66 per POP.

Radio Comps:
---------------------
Public:
Clearchannel (includes Outdoor & SFX businesses): 11x EBITDA
Cumulus: 13.3x
Emmis (includes TV stations & magazines): 13.0x
Entercom: 11x.

PMV:
Susquehanna radio (recently announced) - will be sold to Cumulus & PE consortium for $1.2BN. 33 Radio stations in 8 large markets for about 13x-15x EBITDA.

Disney reported to be shopping its ratio stations (many of which are located in major metro areas) - price sought is reported to be at least 12x EBITDA.

Outdoor Advertising Comps (Public only):
-------------------------
ClearChannel: 11.0x
Lamar: 14.7x

Publishing Comps:
-----------------------
McGraw Hill (Public) – 10.5x EBITDA
Reed-Elsevier (incl. Harcourt, BtoB segment, and Lexis-Nexis Legal svcs)-- 9.8x EBITDA
PMV - Houghton-Mifflin, acquired by Bain. TH Lee, Blackstone in 2003 for 6.1x EBITDA

Theme Parks:
------------------------
Again, not many pure-play Comps, but Six Flaggs will likely be selling company (multiple bidders interested) over its current public multiple of 10x (likely to be transacted at around 11x-12x). Paramount parks are better assets.

Showtime:
---------------------------
No real public comps; TWX-owned HBO and Liberty Media owned Starz/Encore are estimated by industry analysts to be worth about 13x-15x cash flow. Showtime is not as attractive an asset, so I conservatively assume 10x.


New CBS Co sum-of-the parts analysis:

The blended multiple for CBS Co would be around 10.2x EBITDA (compared to 4.6x based on the implied value of the TV Networks). Note in this analysis, I assigned Corp. OH a 7x multiple and I also assigned a value of $500MM to the Paramount Network, despite the fact that it currently is around cash-flow breakeven (rationale: it would take a pretty large sum to start up a new network—likely more than $500MM, but just assumed this to be conservative).

Business EBITDA Multiple Value
CBS Network $670MM 8x $5.4BN
UPN Network nil. N/A $500MM
CBS TV Stations $630MM 10x $6.3BN
Showtime $260MM 10x $2.6BN
Theme Parks $70MM 8x $560MM
Simon-Schuster $50MM 8x $400MM
Paramount TV/ $400MM 11x $4.4BN
King World
Infinity Radio $850MM 10x $8.5BN
Outdoor $490MM 11x $5.4BN
Music Pub. $40MM 8x $280MM
Corp OH $(160)MM 7x ($1.1BN)

Total CBS Value $3.3BN 10.2x $33.2BN


This would put the total value of Viacom at $78.5BN = 45.3BN (New Viacom) + $33.2BN (CBS Co). vs. the current EV of Viacom at $60.4 BN

Now to look at the impact of capital structure leveraging, which will mostly be used for share repurchases. The company has stated that CBS will be operating at a 3.0x to 3.5x debt/EBITDA level vs. about 2.5x now (proforma for the spin-off), while new Viacom will increase leverage to 2.75x from about 1.1x currently. This implies that an additional $7.1BN in debt will be raised, primarily for share repurchases. Let’s assume, for the sake of simplicity that this entire $7.1BN will be used to repurchase shares at the current market price (this will illustrate the significance of the accretion that can occur when modest leverage is used to conduct share repurchases at levels below intrinsic value).

Current VIA market Cap = $50BN
Current Fully Diluted Shares O/S 1,578MM
Price/Fully Dil. Share $31.68
Intrinsic EV Value of VIA $78.5BN
Less current Net debt ($10.4BN)
Intrinsic Mkt Cap of VIA $68.1BN
Intrinsic Value/Share $43.2/share
Discount from current share price 36%

Assume $7.1BN in additional repurchases at $31.68 = 224MM shares to be repurchased.

New Fully Diluted Shares O/S post $4.6BN in repurchases = 1,354MM shares

“Intrinsic” EV of Viacom $78.5BN
Less new net debt $17.5BN
Intrinsic Mkt Cap of Viacom $61.0BN
Divided by 1,354MM F.D. shares O/S $45/share
Discount from current share price 42%

Thus assuming all debt is used to repurchase shares, the value per share can increase by about $2.00. In reality, all debt won’t be used for share repurchases (although management stated that most of it will), and all share repurchases won’t occur at the current market price; however this illustrates that additional value to shareholders will be created though re-levering the balance sheet to a modest degree, and that the discount per share that VIA is trading at least 40% of its “sum of the parts” valuation, including the impact of some share repurchases. Assuming also slightly higher multiples for the CATV businesses at 17x or 20x, the discount per current share of Viacom would be far greater.

Catalyst

Split-off of Viacom and CBS Co will likely result in re-valuation of both companies based on comparable public multiples and PMV transactions. The split will effectively remove any impediment to shareholders who would like to invest in one company, but not the other.

Continued aggressive share repurchases via modest re-everaging of the balance sheet of both entities will result in additional value accreted to shareholders.

Further down the road, the “new Viacom” with its venerable CATV properties would be a prime acquisition candidate for companies wanting to expand content portfolio (Comcast and GE/NBC/Universal).

Improving economy will result in higher ad spending; FY06 will be a strong year for TV and Radio due to political ad spend increases.

Potential acquisitions of certain CBS business lines (Outdoor, Theme Parks, TV Stations, Radio Stations).