I came across an interesting headline as I watched Bloomberg News yesterday. The Redstone family is supposedly asking CBS Corporation (NYSE:CBS) and Viacom (NYSE:VIA) (NASDAQ:VIAB) to research a potential merger. I was amused but not surprised.
It coincided with my previous article on Viacom. I stated that Viacom's primary business is marketing and it should not be confused as a content provider. How is this relevant to a potential CBS / Viacom merger?
Viacom's competitive advantage is its multi-media marketing capability. It can reach target markets using subtle messaging across a diverse array of dissemination platforms. This is Viacom's critical capability.
As I stated in my last article, the Redstone family disallowed the sale of Paramount Pictures because it would have weakened Viacom's critical capability. The strategy is to increase dissemination platforms over time, not sell them off.
Surprise! Now the Redstones (supposedly) want to reunite CBS and Viacom. This is another act that strengthens multi-media marketing with both parties. They believe the merger would create a more powerful company. I think this is true.
Why Did They Split?
As most long term shareholders know, the present day Viacom is not the original. The old Viacom (pre-2005) was renamed to CBS Corporation and the new Viacom was a spinoff of MTV, Nickelodeon, Paramount, etc. So CBS is the actual Viacom of old, minus the new Viacom's assets.
There are lots of speculations as to why the split occurred. I don't want to get into the politics or the fact that the spinoff created new board seats for people like Sumner Redstone. This conversation isn't useful here.
I think that management wanted to unlock share value. At the time, the new Viacom's assets were faster growing than what remained with CBS. The theory is that the new Viacom would appreciate faster if it was a separate company.
I believe that the spinoff did increase share prices, but it was temporary and it also weakened Viacom's marketing capability.
Acknowledging The Mistake?
It's no secret that Viacom was more powerful as a marketer with the full capability of CBS / Viacom assets under one roof. The split degraded the multi-media marketing capability, just as surely as the sale of Paramount Pictures would have done.
I believe Sumner Redstone is now aware of this mistake. This is why he stopped the sale of Paramount. It's also why he would want to merge Viacom back with CBS.
Degrading the old Viacom's multi-media marketing capability in exchange for quick stock market gains was the key error in 2005.
A Timely Switch Of Strategy?
When did Sumner Redstone begin to catch his mistake? I don't know. But I doubt it was last year. Viacom's troubles didn't begin in 2014-2015. It also hit low share prices in 2008 and they didn't recover until mid-2012, well behind the broad market indexes. It's had difficult times intermittently since 2005.
I think the current talks are the result of opportunistic share prices. CBS shares trade near a P/E ratio of 16 while VIAB trades near a P/E of 7 (B shares account for a majority of the equity). A merger followed by a CBS share issuance is likely to benefit CBS, even if CBS gives an additional 50% in shares to compensate for the undervaluation of VIAB.
If the problems with Viacom have been festering prior to 2014, why didn't they talk about mergers between 2008-2011 when Viacom shares were even cheaper than today?
Here's my cynical point of view. The timing wasn't opportune for a merger in 2008-2011. CBS and Viacom shares were distressed at the same time, so a merger would have been a wash. Today, CBS is fairly valued or even expensive but Viacom is still distressed. Now it is timely to merge. My guess is that CBS will try to merge with Viacom by trading expensive shares for cheap ones.
Viacom Is Undervalued
Long-term Viacom shareholders who've held since $85 will likely be disappointed with any potential mergers. For instance, they'll lose money if they have to exchange $37 VIAB shares for $50-$60 worth of CBS shares. They'll be denied the opportunity for share price recovery. I think Viacom has great assets and they'll recover over time if the merger didn't happen.
Regardless, new shareholders have a good deal. Any merger, and even merger speculation, should drive the shares higher. Quick capital gains are possible. And even if a merger never materializes, you're still sitting on some cheap shares in a great company.
But make no mistake. CBS would be wise to merge with Viacom. The CBS managers might not want the hassle, but it's the Redstone family's decision and they know what's best for their own businesses.
The merger talks make Viacom a stronger buy than when I wrote my previous article on September 21st.
Thanks for reading.
Disclosure: I am/we are long VIAB.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.