CBS: Industry Leader With 20%-Plus Upside In 2014 On Content, CBS Outdoor And More

| About: CBS Corporation (CBS)

Summary

CBS has significant upside this year as the company's original content continues to outperform its competition.

The IPO of CBS Outdoor will provide significant upside for CBS as the company's investment structure provides solid returns, especially as CBS) will become a REIT.

Our pricing model shows a 2014 price tag of $81 in the mid-case scenario with the potential for even higher prices.

The court case between CBS and other companies versus Aereo is another potential catalyst for the company this summer that would provide upside.

Risks for the company include the above mentioned case as well as risks surrounding the CBS Outdoor IPO.

Last time we took a look at CBS Broadcasting (NYSE:CBS) we set a price target of $67 with a Hold rating. In this update, we want to examine previous catalysts in original content, retransmissions, CBS Outdoor and more. Additionally, we want to examine the potential Supreme Court ruling on CBS (and other networks) v. Aereo in June. Today, we are upping our price target to $81 and placing a Buy rating on the stock.

During the company's Q4 earnings call, CBS continued to put emphasis on diversifying its revenue stream. The company has consistent revenue coming in from its network leading shows, but the company recognizes the change in the TV industry and have set themselves up to thrive in new growth areas. The company reemphasized its plan to raise capital and grow the CBS Outdoor segment through an IPO in the back half of this quarter. Along with this it is also aiming to generate more non-advertising revenue through retransmissions, reverse comp and deals with Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX) and Hulu Plus. Going forward, the company must continue to push out strong original content while expanding non ad-based revenue through licensing and its CBS Outdoorsdivision.

In this article we will take a look at how the TV industry is changing and the effect that web-based programming has on the current market make-up. We will also look more specifically at how CBS can stay relevant in this new TV market and some of the potential risks that CBS may face.

Oxen Thesis

Business Overview

CBS is part of an industry that is rapidly changing. CBS, though, has done a good job in growing revenues in local broadcasting through new and original content as well as continuing to diversify its revenue stream to adapt to the new industry trends. The company continues to have success with its current programming bringing in 58% of its revenue through ads.

CBS has also focused on growing its revenue streams outside of ad-based revenue. The company has stated that it wants its revenue stream to be split 50/50 between ad-based and non ad-based revenue. CBS Outdoor's IPO and continued licensing of CBS's content to companies like Netflix and Amazon are areas of growth that can bring it closer to its goal. We feel that CBS is taking the right steps in capitalizing on the content it has now and setting itself up for new industry trends.

Industry Overview

As previously noted, the TV broadcasting industry is changing. With internet access becoming easier and cheaper to obtain for consumers, companies such as Netflix and Amazon are capitalizing on constantly growing streaming media. Large cable companies will no longer have the power to dictate TV programming. With companies like NFLX and AMZN, consumers can decide what, when and where they will watch its content. Aereo is also causing concern for the industry's current business model. Aereo is a company that is essentially intercepting broadcasting companies' airwaves and distributing its content to its own subscribers without the broadcasting companies' permission.

Here are a couple statistics showing the direction of the industry:

· While US TV ad revenue is declining, global TV ad revenue is expected to grow to $209B by 2017 with a CAGR of 5.3%.

· New digital video customer growth rates declined in the past five years. Total number of customers grew only 26% from 2007-2012 compared to a growth rate of 92% from 2002-2007.

· Total cable customers have been declining. From 2001 to 2012 total cable customers has declined 16% from 66.9M to 56.4M subscribers.

Many of the major TV networks (including CBS) have seen this shift coming and have been adapting to fit into the new TV programming business model. Companies are continuing to look for non-traditional revenue sources and many started producing their own content.

Main Catalyst

The main catalyst for CBS continues to be its ability to produce wholly owned original content. The company's success is tied into its content and much of the company's growth revolves around that. Another catalyst we will cover is growth of CBS Outdoor (CBSO) with its IPO and plans to convert to a REIT, which will benefit CBS, as it will be a holder of CBS Outdoor stock.

Since the beginning of the year, CBS shows have dominated TV ratings rankings. The chart below shows all the CBS programs that have made multiple appearances on the weekly top 25 in 2014.

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*Data recorded for 7 weeks from week ending January 5 to week ending February 16 (all charts by Oxen Group).

It's a great sign to see that two of its shows, The Big Bang Theory and The Millers, have been in the top 25 every week. Taking a deeper look at this chart shows that the company is continuing to find success in developing its own content. The Big Bang Theory is consistently rated as TV's #1 comedy and even in its 7th season is a huge success. The Millers is in its first season and has ranked in the top 25 all year. This is a great sign for CBS as the company is continuing to produce top-notch content. This top notch content directly drives revenue.

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The chart above shows that the network's biggest hit, The Big Bang Theory, generates over $300,000 per 30-second ad. That means that every week the show is bringing in $4,567,640 in revenue. The network takes in an average of $52,297,532 a week from its prime time lineup ads. With industry TV ad revenue expected to grow at 5.4% through 2017, CBS expects TV ad revenue to equal $3,356,193,419 by the end of 2017. Original content has also drastically boosted its margins. Since CBS dropped the Paramount name and began focusing on wholly owned content in 2009, CBS's gross margin has grown from 33.2% to 43.5%. Even more impressive is that in that same time its operating margin has nearly tripled from 7.8% to 21.3%.

The chart below also shows that CBS is making the most ad revenue on its prime-time lineups, making just over $52M per week.

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However, while CBS is earning the most ad revenue from prime time airings, it is slightly behind its competitors for revenue from self-produced shows. The chart below shows the ad revenue that each network is earning on CBS's shows regardless of what network it airs on.

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CBS is currently behind FOX and ABC in revenues from the shows it owns, but this isn't due to a lack of successful content as much as a lack of quantity of content. CBS currently produces 9 shows and co-produces 3, FOX produces 14 programs, and ABC produces 12 and co-produces 3 more. So while CBS's total revenue from its content trails that of FOX and ABC, its average revenue per in-house produced program is right on par with its competitors. Fox currently earns $2.78M per show, ABS earns $2.59M per show, and CBS earns $2.47M per show.

We see this more as opportunity rather than weakness because the company is pushing in this direction.

Currently the company wholly owns the following shows: 60 Minutes, Blue Bloods, Elementary, Hawaii 5-0, NCIS, NCIS: LA, Survivor, The Good Wife, and The Millers. CBS also co-produces Criminal Minds, CSI and The Amazing Race with ABC.

Original content also means that the company can continue to license its content to streaming services like Netflix, Amazon and Hulu, retransmit the programs, and license the shows to other cable networks. Netflix currently spends around $2B on licensing shows and movies, and the good news for CBS is that Netflix CEO Reed Hastings announced that his company is shifting focus from quantity of shows to quality. As Hastings noted:

"As we've gained experience, we've realized that the 20th documentary about the financial crisis will mostly just take away viewing from the other 19 such docs, and instead of trying to have everything, we should strive to have the best in each category. As such, we are actively curating our service rather than carrying as many titles as we can."

With CBS's top lineup of shows it is in a prime position to strike future deals with Netflix for its top shows.

The company is also excited to introduce its new series Extant and season 2 of Under the Dome (which generated over $45M in its first season) exclusively to Amazon. With this model, the company is essentially able to generate multiple streams of revenue through one show. The company will continue to earn revenues through ads during original airs of the show and revenue will also come in from deals licensing these shows out. With TV ad revenues expected to grow at a rate of 5.4% over the next four years CBS can continue to grow through original airing of its content.

The company has also increased its outlook on retransmissions and reverse comps. Originally CBS sought to grow revenues in this area to $1B by 2017. The company now believes that its can generate $2B in revenues by 2020. This goal increase displays the company's optimism in its content going forward. The company has already shown signs of increased revenues from retrans and reverse comp through its licensing of Blue Bloods to WGN and ION and Elementary to WGN and Hulu Plus. The licensing of Elementary has been especially encouraging considering it resulted in the largest syndication revenue per episode ever.

Another growth area for the company is through non-traditional revenues and its main focus for this is through the CBS Outdoor division. The company announced last year that it planned to take CBS Outdoor public, and the IPO is expected toward the back-end of Q1. The company plans to only take its North and South American divisions public while selling off its international parts. The company already sold its European and Asian outdoor ad business to Platinum Equity LLC in October for $225M.

To finance this CBS Outdoor is prepared to take on $1.6M in debt split between bonds and loans. A majority of this debt will be taken on by the parent company. The company expects this debt to be put to good use since it sees CBS as a huge growth potential especially with its plans to convert the business to a REIT. A REIT would significantly increase operating income for the company because REITs do not pay federal taxes. REITs pay out at least 90% of its taxable income to shareholders. This benefits CBS because the company can then write off CBS Outdoor's income from its corporate taxable income. The company is currently waiting for the IRS's response in its application to turn CBS Outdoor into a REIT. The company has said that the IPO will happen according to schedule even if CBS's request is denied, but the company believes that is unlikely.

Risks

There are a few threats to CBS's success that may impact our price target depending on how it plays out. One of the risks is one we previously touched on - the threat of Aereo stealing business from CBS. The battle between Aereo and CBS (among other networks) has reached the Supreme Court. Aereo is currently intercepting CBS, and other broadcasting stations, signals and redistributing its content without the consent of the parent networks. The Supreme Court is expected to make a ruling on this by the end of June. Our price target currently assumes that the ruling is favorable to CBS, as many signs have indicated it will be.

We believe that this ruling may be favorable for CBS based on some formidable opponents stacking up against the company. For one, the White House believes that what the company is doing is illegal. From The Verge:

Aereo has some formidable new opposition in the courts. According to Deadline, the White House has recommended that the Supreme Court rule against Aereo when broadcasters bring its service to trial this April. The administration made the recommendation in an amicus brief filed today, which argues that Aereo's use of discrete antennas to record broadcast television for its customers does not change the fact that it is later retransmitting those recordings to the public. "Like its competitors, (Aereo) therefore must obtain licenses to perform the copyrighted content on which its business relies," reads the brief.

Additionally, the US Department of Justice also unveiled its support for CBS and networks:

Aereo "transmits copyrighted broadcast programs to the public, without the authorization of the copyright holders, and is therefore liable for infringement," the Justice Department said in its 34-page brief. The U.S. show of support for the broadcasters, which was authored by the Solicitor General, amounts to a significant setback for Aereo, which is trying to convince the Supreme Court that its streams constitute legally protected "private performances," not copyright protected "public performances."

With two major influences that both understand the legal system well and can be precursors for a Supreme Court decision both siding with the networks, Aereo looks to be in a tough spot.

Read more: U.S. Backs TV Networks Against Aereo in Supreme Court Battle | TIME.com.

Along with this, there is the slight risk that the IRS does not approve CBS's application to form CBS Outdoor into a REIT. While this is highly unlikely because CBS Outdoor has all the characteristics of a REIT and has already operated like one for the past few years, if its application is denied our price target may not hold true.

Pricing/Valuation

Step 1

Project operating income, taxes, depreciation, capex and working capital for five years. Calculate cash flow available by taking operating income - taxes + depreciation - capital expenditures - working capital.

2014

2015

2016

2017

2018

Operating Income

3,450

3,700

4,050

4,450

5,000

Taxes

1,208

1,295

1,418

1,558

1,750

Depreciation

490

510

530

550

570

CapEx

-270

-275

-285

-295

-306

W/C

146

146

146

146

146

Available Cash Flow

2,317

2,494

2,732

3,002

3,368

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Step 2:

Calculate present value of available cash flow (PV factor of WACC * available cash flow). You can calculate WACC, but we have given this number to you. The PV factor of WACC is calculated by taking 1 / [(1 + WACC)^# of FY years away from current]. For example, 2016 would be 1 / [(1 + WACC)^4 (2016-2012). WACC for CBS: 10.00%

Step 3:

For the fifth year, we calculate a residual calculation. Taking the fifth year available cash flow and dividing by the cap rate, which is calculated by WACC subtracting out residual growth rate, calculate this number. Companies with high levels of growth have higher residual growth, while companies with lower growth levels have lower residual growth. Cap rate for CBS: 5.0%

Step 4:

Calculate Equity Value - add PV of residual value, available cash flow PVs, current cash, and subtract debt:

Sum of Available Cash Flows

$8,269.35

PV of Residual Value

$46008

Cash/Cash Equivalents

$397.00

Interest Bearing Debt

$6,436.00

Equity Value

$48,238

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Step 5:

Divide equity value by shares outstanding:

Equity Value

$48238

Shares Outstanding

593.66

Price Target

$81

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Conclusion

CBS is making all the right moves to grow and adapt with the ever-changing TV industry. It has set itself up to be successful in the long run. The company needs to continue to produce wholly owned content and diversify its revenue stream in order to sustain its growth. At this time, we like buying shares at $65 or lower, so we are slightly above where we would add. Yet, the upside potential looks so strong and the company is the best of its industry that we still think adding on the way up is a good move.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: I have no business relationship with any company whose stock is mentioned in this article. The Oxen Group is a team of analysts. This article was written by David Ristau, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.