Viacom - Soft Operational Performance Creates Longer Term Opportunities

| About: Viacom Inc. (VIAB)

Summary

Viacom reports some disappointing numbers again.

As investors take some profits amidst the operational miss and general market sell-off.

Yet the valuation is fair, amidst a strong long term track record of value creation.

The high leverage makes current shareholder payouts unsustainable and creates limited leverage risks.

I like the shares with a slightly greater increase in the margin of safety.

Investors in Viacom (NASDAQ:VIAB) were not very pleased with the company's third quarter results which missed consensus estimates again, as topline sales continue to fall.

While these short term issues should be noted, Viacom has proven itself to long term investors amidst a solid long term operational performance and strong returns to investors. Yet these payouts to investors have increased leverage a bit recently, limiting the potential for ¨excessive¨ payouts going forwards.

As such I like the current valuation, the long term track record and parts of the franchise. Yet I would like to see a bit more appealing valuation before picking up some shares at this point in time.

Third Quarter Headlines

Viacom posted third quarter revenues of $3.42 billion, a 7.4% decline compared to the year before. Analysts were anticipating a much more modest decline in sales towards $3.56 billion.

Adjusted net earnings were down by 2.7% to $618 million. Diluted earnings per share from continuing operations were up by eight cents to $1.40 per share.

Adjusted earnings on a per share basis from continuing operations came in at $1.42 per share, missing consensus estimates by two cents.

Looking Into The Performance

Viacom's core media networks business posted a 0.9% increase in sales towards $2.59 billion. The performance of the unit was relatively flat amidst slightly higher advertising revenues. The unit remains very profitable, posting operating earnings of $1.12 billion, which is a three percent fall compared to last year due to increased programming expenses.

Sales of the filmed entertainment business dropped by 26% to $856 million. A lower number and unfortunate timing of new releases caused a 43% fall in theatrical revenues. Home entertainment and TV license fees were down significantly as well, partially offset by a 21% increase in ancillary revenues. Despite the shortfall in topline sales, operating earnings improved from just $17 million last year to about $55 million.

Valuation

The company ended the quarter with $1.6 billion in cash and equivalents, while total debt including capital lease obligations was $12.8 billion. This results in a net debt position of about $11.2 billion.

At the end of the quarter, Viacom had some 424 million shares outstanding. With shares trading at about $80 per share, equity in the business is valued at roughly $34 billion.

The company has posted trailing revenues of nearly $13.5 billion on which it has posted earnings of close to $2.5 billion. This values equity in Viacom at 2.5 times annual sales and just 13-14 times annual earnings.

A History Of Growth And SHareholder Returns

Viacom had been spun-off from CBS (NYSE:CBS) back in 2005 and it has grown the business rather rapidly. The company's extensive reach of networks reach some 700 million consumers across the globe while of course it owns Paramount as well.

Acquisitions and solid organic growth allowed the company to double revenues from just $7.2 billion in 2003 to a peak of nearly $15 billion in 2011. Ever since, revenues have been down by some 10%. The company has been very profitable, posting earnings between $1.5 and $2.5 billion in recent years. What has been even more impressive has been the aggression in terms of share repurchases, with Viacom repurchasing nearly 45% of the outstanding share base since the spin-off from CBS.

In the latest quarter, Viacom repurchased 10 million shares, retiring shares at a rate of nearly 10% per annum at the current pace. Some $7.1 billion remains being authorized to repurchase shares among the company's huge $20 billion share repurchase program.

Final Takeaway

Viacom offers quite a bit appeal despite the lack of topline growth in recent times. Of course its network business has faced quite some pressure from the emergence of the internet which has impacted notably MTV and VH1 in particular. This in combination with the relative disappointing results at Paramount, has impacted topline sales.

That being said, investors have seen greater returns on a per share basis, given the very aggressive pace of share repurchases in recent years following the spin-off. This has resulted in above average leverage, with the net debt position being equivalent tot roughly 5 times annual earnings. Yet this leverage is acceptable as cash flows are quite predictable. Furthermore the weighted average duration of more than 13 years of the debt profile is attractive, as are the relative low interest rates of 4.6%.

As such, Viacom continues to return cash to investors at a rapid pace, although this current pace is not really sustainable with the sum of share repurchases and dividends being equivalent to nearly 2 times annual earnings at the current rate.

Yet the overall valuation, the interesting assets and the increased focus on the industry, with regards of merger and acquisition activity, makes Viacom a manageable target for some larger suitors.

A recent 10% sell-off in the matter of a few weeks, with shares now being down quite a bit year to date, creates a bit of appeal in my eyes. What should be noted is that the company is relatively highly leveraged as witnessed in the share price performance during the financial crisis. As such I would like to see a slightly more appealing valuation to reflect this additional risk, being a buyer in the $75-$80 trading range depending on the general market circumstances.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.