CBS: A Buy for Cyclical Upturn as Balance Sheet Concerns Ease

I purchased CBS for most Northlake clients on July 7th. The stock has pulled back by 33% off its recovery high, leaving it at a point where I think the risk-reward tradeoff is favorable. I can easily construct a scenario where the stock moves from $6 to $9 assuming that advertising trends begin to improve and turn positive late this year or early in 2010. If I am wrong and advertising trends remain negative, I think downside is contained at $4.50, setting up $3 of upside against $1.50 of downside.

CBS is highly leveraged to the economy due to the fact that 70% of its revenue comes from advertising. TV is the largest business segment along with significant exposure to Radio and Outdoor Advertising. The purchase of CBS is consistent with my view that the economy has bottomed and will show sustained improvement later this year.

Obviously, the cyclical exposure adds risk to CBS. Other media conglomerates such as Time Warner (TWX), which I recently sold, receive 20-30% of their revenue from advertising. The reason why I am willing to take the added risk in CBS is that the company has effectively used the easing of credit conditions to refinance the balance sheet and eliminate near-term maturities. This should prevent the stock from revisiting its lows even if the economy and advertising fail to recover.

The upside in CBS comes from the fact that a recovery in revenues and operating margins creates substantial earnings power. Even if margins recover to a level well below the 2007/2008 peak, the stock will be trading at one of the lowest P/E multiples among major media stocks.

A final point in favor of CBS is that the CBS TV Network is coming off a very good season. CBS was the only broadcast network to maintain ratings. This leaves the company in good position for the late-breaking upfront ad sales market. I suspect that CBS may be able to limit its upfront price decline to low single digits, far better than ABC, NBC, or FOX. If ratings hold early next TV season, overall ad sales could end up flat or even up slightly once the balance of inventory is sold in the scatter market. This outlook is contingent on decent ratings and a better economy and advertising environment but that is the reason to own CBS.

Beyond the cyclical risks, CBS faces two other unique challenges. First, Sumner Redstone's control of the company creates corporate governance issues which are exacerbated by pressure on his personal finances. Second, the company has made a few expensive acquisitions to expand its online presence. I think CBS overpaid for CNET and LastFM but the problem is more investor perception than financial. CBS CEO Leslie Moonves is widely respected as perhaps the top executive in Hollywood, providing comfort that the acquisitions are either going to work out better than expected or are just a misstep that will not be repeated.

Disclosure: Long CBS

Comments

[Larry House:]

I sure hope CBS works out for you, but I just don't see how macro economic conditions are going to be good for the company. You mention its leverage to the economy--you must be very positive about the econmy. I don't see it.

Jul 07 04:54 PM

[Steve Biren...:]

Hi Larry,

I guess I should have emphasized that by cyclical exposure I mean that CBS works in the "less bad" trade. As revenue declines abate, marigns will expand form cost cutting. I will admit that I am more bullish than you on the global economy. But the key at CBS is that they fixed the balance sheet risk which means at a price it is worth owning for the cyclical upturn when ever it occurs since the operating leverage is very high. What i need to aovid is another step down in the economy.

Steve

Jul 08 08:03 AM

[exportman:]

Here's the thing. The polarization of politics in this country has reached its apex. Too many millions think that CBS is off the deep left. Not to offer a position here but that's the way it is. Until balanced journalism returns to CBS (or any network) difficult times lie ahead for all of the news networks (even Fox the right's favorite.) I say stay away and find somewhere else to invest.

Jul 15 09:49 PM

[Steve Biren...:]

CBS is an entertianment company. news is just a small part of the business. For example, Showtime brings in $1.2 billion in revenue and about 25% of profits, dwarfing the News division. I seriously doubt people do not watch Showtime or Survivor or CSI because they think CBS is a liberal network. For those that do, the number is immaterial. Don't forget you also have radio, billboards, and some internet businesses here.

Jul 18 07:49 AM