Two years ago, in August 2015, Disney (DIS) set off the angst that has troubled traditional media stocks since by admitting to larger than expected subscriber losses at ESPN. We refer to August 2015 as the Media Meltdown. This May, another round of media companies created a smaller, mirror image decline in media stocks, this time triggered by greater than expected subscriber losses for cable and satellite companies that deliver subscribers to the companies that own TV networks. This time the subscriber losses were occurring as ratings for most TV networks were in sharp decline.
During this period of cord cutting, cord shaving, and cord nevering, CBS Corporation (CBS) has navigated the landscape particularly well. Its latest quarterly earnings exceeded expectations across the board even as its peers mostly stumbled. CBS has the advantage of owning only one major TV network. This advantage is further pressed because it is a broadcast network. After decades of losing ground to cable networks (ESPN, CNN, TNT, Food Network, MTV, HGTV, etc.), broadcast networks are now in a relatively stronger competitive position, none more so than CBS.
CBS was early to see the importance of direct to consumer over the top offerings and established CBS All Access and Showtime as OTT services a few years ago. Perhaps the most important takeaway from CBS’s latest earnings report was that both services are well ahead of 2020 subscriber goals of 4 million each. Suddenly, CBS is positioned with a must have broadcast network on every major cable, satellite, and OTT service with a well-established direct to consumer flanker strategy. Disney’s recent announcement of OTT services for its ESPN, Disney, and Pixar branded content supports the importance of a direct to consumer strategy. CBS is well ahead of the curve.
CBS has also done a good job of reducing its reliance on advertising revenue. Led by CEO Les Moonves, the latest earnings report showed advertising is down to 40% of revenue from over 70% a few years ago. Smart divestitures of the company’s billboard and radio businesses have helped but more importantly for the future, CBS has shifted heavily toward subscription revenue via retransmission fees it receives from cable, satellite, and OTT distributors and its own network affiliates. This revenue source, which barely existed ten years ago should be over $2.5 billion per year by 2020 while growing at 15-20% for the next several years. CBS also has a thriving subscription at Showtime, which has emerged as a strong premium network, second only to HBO and the aforementioned All Access OTT service. All Access will soon supplement its network and local TV content and massive library of older TV shows with new series like an updated Star Trek and spin-offs from popular series like The Good Wife.
With a long history of analyzing and investing in the media industry, Northlake understands well the challenges the industry is facing from the shift in viewing habits of American households. We have acknowledged these secular challenges by diversifying our individual stock portfolio into other industries such as video games and internet media and even looked abroad. Even as we revaluate holdings in Disney and Liberty Global and other media-linked investments, we remain fully committed to CBS. With earnings looking to be over $5 in 2018 and the divestiture of the radio assets (and accompanying share buyback) scheduled for yearend, we think the shares are cheap at 13X earnings, a large discount to the average stock at 18X. Just reaching 14X would get the shares to $70 and a more realistic target is 15X, which equates to our year ahead target of $75.
CBS is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov. CBS is a net long position in the Entermedia Funds. Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.