While many investors are skeptical about investing in media due to consumer unpredictability, the upside can often be very attractive. In this article, I will run you through my DCF model on Time Warner (TWX) and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared to Comcast (CMCSA) and Viacom (VIA). I find the strongest bull cases for Viacom and Time Warner.
First, let's begin with an assumption about the top-line. Time Warner finished FY2011 with $29B in revenue, which represented a 7.8% gain off of the preceding year: Acceleration. I model growth trending from 8% to 10% and then back down to 5% over the next half decade or so. This estimate, I believe, errs on the conservative side.
Moving onto the cost-side of the equation, there are several items to consider: Operating expenses, capital expenditures and taxes. I model cost of goods sold as 56% of revenue versus 23% for SG&A, 0% for R&D, and 2.4% for capex. Taxes are estimated at 35% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model).
We then need to subtract out net increases in working capital. I expect this to hover around 1.2% of revenue over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $42.14, implying 15.1% upside.
From a multiples perspective, Time Warner is equally attractive. It trades at a respective 13.5x and 10.1x past and forward earnings versus 19.6x and 13.7x for Comcast and 13x and 9.5x for Viacom. Assuming a multiple of 14x and a conservative 2013 EPS of $3.59, Time Warner's stock would hit $50.26.
Comcast, meanwhile, has delivered impressive momentum:
"We're very pleased today to be increasing our dividend by 44% to $0.65 per share on an annual basis and that our board has approved a new $6.5 billion stock buyback program under which we plan to increase our repurchases of stock by 40% to $3 billion this year. Now the way we come to those conclusions of the optimism and good feelings we have about the company is based on the financial results.
Cable had an outstanding year, capped by a great fourth quarter of improving customer metrics combined with healthy financial results. In the fourth quarter, Video customer losses declined to 17,000, our best quarterly video performance in almost five years. And for the full year, we reduced video customer losses by nearly 40%. We also added 336,000 High-Speed Internet customers in the quarter, a 15% increase and marked the sixth year in a row of adding more than 1 million high-speed data customers."
The stock is near its 52 week high off of this solid momentum. Consensus estimates for Comcast's EPS forecast are that it will grow by 18.4% to $1.87 in 2012 and then by 16% and 16.6% in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $2.14, the stock market has reasonably factored in the projected growth.
Consensus estimates for Viacom's EPS forecast are that it will grow by 12.7% to $4.26 in 2012 and then by 17.8% and 16.1% in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $4.96, the stock would hit $69.44 for 48.9% upside. Accordingly, I highly recommend an investment in the company.