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There is a lot to like at Viacom (NASDAQ:VIA): Tremendous global reach, brands with definitive staying power, shareholder-friendly management, strong long-term prospects for EPS growth, efficient capital structure, and 9% trailing FCF yield. Viacom does face softer ad spending and Internet-based competition, but those factors only explain the current stock price—they do not justify it.

BUSINESS OVERVIEW

Viacom is a leading global entertainment content company. It operates through two reporting segments: Media Networks, which includes MTV Networks and BET Networks; and Filmed Entertainment. Viacom engages audiences on TV, motion picture and digital platforms through well-known brands, including MTV, VH1, CMT, Nickelodeon, Comedy Central, Spike TV, BET, Paramount Pictures, and DreamWorks Pictures. Viacom’s reach includes 160 channels and 340 online properties in 160 countries. MTV Networks reaches 520 million households worldwide, while BET reaches 88 million U.S. households. Paramount dates back to 1912, has a library of 3,500 motion pictures, and ranked #1 in domestic box office revenue in 2007. Viacom became a standalone company via a separation from the former Viacom (now known as CBS Corp.) at yearend 2005.

SELECTED OPERATING DATA

FYE December 31

2005
2006
2007
YTD
9/30/08
% of revenue by segment:

Media Networks

70%
63%
60%
60%

Filmed Entertainment

30%
37%
40%
40%
EBIT margin by segment:

Media Networks

39%
40%
38%
35%

Filmed Entertainment

2%
3%
2%
0%
% of revenue by component:
Advertising
42%
38%
34%
32%

Feature film

30%
36%
39%
39%

Affiliate fees

19%
18%
17%
19%
Ancillary
8%
9%
10%
11%
% of revenue by geography:
U.S.
78%
76%
73%
n/a
Europe
13%
15%
17%
n/a
Other
9%
9%
10%
n/a
INVESTMENT HIGHLIGHTS
  • Business continues to perform. Viacom’s new franchise, the top-selling Rock Band music video game, has had 18 million songs downloaded since launch. Rock Band 2 should aid EPS growth in 2009. Paramount generated $1 billion in box office receipts in record time in 2008, driven by Indiana Jones, Kung Fu Panda, and Iron Man.
  • Low double-digit EPS growth from 2008-10. Management expects to deliver low double-digit annual growth in diluted EPS from continuing operations (2007 base year EPS was $2.36).
  • Seasoned management. Founder Sumner Redstone (84) remains executive chairman, with CEO Philippe Dauman (54) at the helm since 2006. Dauman has been with Viacom for two decades.
  • Debt-financed buybacks optimize cap structure. Viacom has $8.4 billion of net debt and has repurchased $1.1 billion of stock so far this year.
  • D&A exceeds capex. Viacom recorded D&A of $1 billion from 2005-07, with capex of $639 million.
  • Stock price implies 9% trailing FCF yield, 7x trailing P/E and 7x forward P/E.
INVESTMENT RISKS & CONCERNS
  • Challenging ad revenue environment. While Viacom has diverse revenue streams including affiliate, ancillary and motion picture revenue, advertising accounts for one-third of revenue. This stream has weakened due to economic conditions.
  • TV may face newspaper-like risks in long term. Video content is becoming increasingly popular online due to the proliferation of broadband and sites such as YouTube that allow anyone to share content. Consumers increasingly spend time online, threatening TV’s still-strong market share position.
  • Hit-dependent motion picture business. While Paramount is a leading franchise, results fluctuate based on the timing of “hit” movie releases.
  • Filmed Entertainment contributes little EBIT despite meaningful revenue. While this implies margin upside, it also raises the question whether continued investment in the segment is justified or whether alternatives should be explored.
COMPARABLE PUBLIC COMPANY ANALYSIS
($mn)
MV
EV
EV/Rev
P/TB
08 P/E
09 P/E
DIS
38,427
50,065
1.3x
16.4x
10x
9x
DISCA
3,915
7,777
2.9x
n/m
14x
13x
NWS.A
19,419
27,408
.8x
n/m
7x
6x
TWX
32,825
66,762
1.4x
n/m
8x
8x
VIA.B
10,295
18,722
1.3x
n/m
7x
7x
MAJOR HOLDERS

Viacom has 57 million Class A common shares (one vote per share) and 556 million Class B shares (non-voting) outstanding. Both classes of stock trade publicly, with the Class A shares controlled by Sumner Redstone.

Economic ownership: Sumner Redstone 12%│ Insiders other than Redstone <1% │ Franklin 7% │ Morgan Stanley 6% │ Wellington 6% │ NWQ 5% │ Barclays 5%

RATINGS

VALUE

Intrinsic value materially higher than market value?

****
MANAGEMENT

Capable and properly incentivized?

****
FINANCIAL STRENGTH

Solid balance sheet?

***
MOAT

Able to sustain high returns on invested capital?

****
EARNINGS MOMENTUM

Fundamentals improving?

***
MACRO

Poised to benefit from economic and secular trends?

***
EXPLOSIVENESS

5%+ probability of 5x upside in one year?

*

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Source: Viacom: Poised for Long-Term Growth, Despite Near-Term Challenges