Despite Uninspiring Year, Viacom Looks Undervalued In 2013

| About: Viacom Inc. (VIA)

While Viacom (VIA,VIA.B) struggled with the ratings of its key networks in 2012, it also benefited from the improvement in the general advertising market. The company’s stock remained more or less flat.

Given the strong brand, high dependence on the cable networks business, international market potential and growing digital licensing fees, one would have imagined the stock to perform better. However, the weak performances by Nickelodeon and MTV dragged profits down and kept investors a little wary. As we head into 2013, Viacom will continue to focus on improving the programming of its key networks and expand more internationally. The pay-TV market in developing countries is growing fast, and there is a tremendous opportunity to syndicate more successful shows and launch fully-owned networks in these geographies.

Nickelodeon & MTV Experienced Weak Ratings, Slight Recovery At The End

Viacom’s flagship networks, Nickelodeon and MTV, saw a sharp decline in their ratings. These two channels together account for more than 20% of Viacom’s value from their U.S. operations alone. If we account for international markets, the contribution is much higher.

While the programming dispute with DirecTV (DTV) worsened the situation, the primary culprit was a lack of new and appealing shows. For instance, one of Nickelodeon’s famous series, SpongeBob SquarePants, saw a significant ratings decline of 29% in Q1 of 2012 compared to the same period in 2011. Similarly, the ratings for MTV’s new season of Jersey Shore were down substantially (~40%) compared to the year before. While SpongeBob and Jersey Shore have done very well in the past, it’s time for Nickelodeon to invest in some new programming with innovative ideas. The ratings directly impact advertising revenues, which we estimate to be slightly higher for Nickelodeon and MTV compared to their subscription revenues.

In this direction, the company made some programming investments towards the latter half of 2012 which resulted in a ratings improvement. While Teenage Mutant Ninja Turtles has helped Nickelodeon, Catfish seems to be doing well for MTV. ((Viacom CEO Touts Recent Nickelodeon, MTV Ratings Gains, The Hollywood Reporter)) Going forward, we expect the company to introduce more original programming and the ratings weakness that we saw in 2012 may just become a temporary anomaly of the past.

Dispute with DirecTV Leading To Channel Blackout

Viacom and and DirecTV were involved in a dispute in mid-2012 over the issue of carriage fees hike. This resulted in channels such as Nickelodeon, MTV and others becoming unavailable to DirecTV subscribers. This issue further worsened Viacom’s ratings which were already suffering due to the relatively weaker programming. However, an agreement was finally reached with Viacom reportedly compromising on its initial demand for carriage fees. Finding a middle path was something that we expected and it appeared that Viacom took the initiative. Perhaps the reason was that although the situation was bad for both companies, Viacom was facing the brunt of the face-off as it was losing ad dollars due to fewer viewers. In fact, in the first week of the dispute, the ratings for Viacom’s channels declined by 27%. Although the movie entertainment business constitutes close to 40% of Viacom’s revenues, margins are extremely low, and therefore Viacom’s value is heavily dependent on its TV channels (close to 80%).

Paramount Slipped

After its stellar performance that granted it top position in worldwide Box Office in 2011, Viacom’s Paramount movie studio slipped to 6th position in 2012. Viacom’s box office revenues declined dramatically with no substantial box office hits that could match the performance of Transformers: Dark of the Moon, Thor, Captain America: The First Avenger and Kung Fu Panda 2 in 2011. Only Madagascar 3: Europe’s Most Wanted has done well for Viacom in 2012. Some of the successful movies that we talked about include Marvel characters and it is no guarantee that Disney (NYSE:DIS) will let Paramount be the distributor for future sequels. We feel that it might be difficult for Viacom to repeat last year’s performance anytime soon.

Expansion In Emerging Markets Wasn’t Very Notable

In the calendar year 2009, about 10% of Viacom’s revenues came from international markets, excluding Europe and the U.S. This figure rose to 12% in fiscal year 2011. However, for fiscal year 2012, the figure stood stagnant at 12% and there wasn’t any notable year-over-year change.

However, Viacom did launch its Comedy Central channel in Southeast Asia, which marks a step towards tapping the emerging market potential. There is a growing appetite for pay-TV services in the emerging markets of Asia and Latin America, and Viacom will look to leverage this growth. The company already operates its biggest channels, Nickelodeon and MTV, in these markets and has had quite a success with them. While MTV reaches close to 600 million subscribers globally across 150 countries, Nickelodeon is present across 330 million households in 110 countries. In comparison, Comedy Central is present only in 200 million households across 70 countries

Our price estimate for Viacom stands at $68, implying a premium of more than 25% to the market price.


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