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May 03, 2006

Central European Media Enterprises: Earnings and Guidance Due Tomorrow

Central European Media Enterprises (CETV) reports before the open tomorrow. The company should also provide full year 2006 guidance and possibly comments on 2007. I am confident in the 2006 and 2007 outlook, however, I think the first quarter holds the potential to disappoint some investors and create skepticism that the full year guidance will be achieved.

The stock has acted poorly over the next month and several analysts have commented on the possibility of weakness in the quarter so maybe the bar has been lowered. I think the numbers and commentary will tell the story and would not take a position, long or short, to play the quarter. I remain long CETV in Northlake client and my personal accounts and expect the shares to be much higher over the balance of 2006 and 2007 unless tomorrow's news is a worst case scenario.

1Q06 faces an issue because of weakness in advertising revenue at TV Nova, the company's station in the Czech Republic, which will produce about 40% of total CETV revenue in 2006. Nova faces a tough comparison against the final quarter of ownership under previous management. The problem is made worse because Nova lost advertising market share in 1Q when it tried to implement aggressive price increases. Despite strong economic growth and good ratings, ad prices in the Czech Republic are unchanged since 1999. Advertisers balked at Nova's asking price of a 20-30% increase and the primary competitor, TV Prima, decided to take the money rather than support the price increase. Analyst estimates range from a decline of 10-20% at Nova in 1Q. Included in the decline is a 4% currency hit, so local currency declines are in the 6-16% range. I think local currency will witness a 10% decline....

Several items mitigate my concern about Nova's weak 1Q performance. First, Nova settled with advertisers on a price increase of about 15% beginning in April. Second, 1Q is seasonally slow and I think it may account for 20% or less of Nova's full year results. Third, at current exchange rates, currency provides a mid-to-upper single digit tailwind the rest of the year. Fourth, ratings at Nova have been stable. Fifth, beginning next year, state-owned TV stations must eliminate advertising. Finally, management has indicated deep cost cutting is underway at Nova which should support margins in 1Q and provide leverage later this year and in 2007.

Despite the weak 1Q, I think Nova can still produce top line growth of 4% this year with stable operating margins. I also expect continued growth of 25-35% in Romania and Ukraine and rebounding performance in Slovenia and Slovakia, so I believe the company will guide to double digit revenue growth with expanding margins in 2006. For 2007, I think the company will forecast similarly considering that Nova could have a full year at the new higher price points.

I think CETV shares can reach the mid to upper $70s this year if the outlook for 2006 and 2007 is consistent with my expectations. Focusing solely on 2007, I think the shares can work well into the $80s.

Posted by Steve Birenberg at May 3, 2006 01:27 PM in CETV