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October 11, 2007

An Overview of Central European Media Enterpises

Since I'll be spending most of next week in Bucharest, Romania at the annual analyst meeting for Central European Media Enterprises (CETV), I thought an overview of this long-time favorite was in order. CETV is currently the largest position in Northlake client accounts and my personal accounts.

CETV is the largest broadcaster in Central and Eastern Europe. The company owns leading TV stations in the Czech Republic, Romania, Slovenia, Slovakia, Ukraine, and Croatia. In 2007, I expect the Czech Republic to produce 36% of revenue, followed by Romania at 26%, Slovakia at 14%, Ukraine at 13%, Slovenia at 8%, and Croatia at 3%.

The investment case is simple: CETV is a pure play on the emerging consumer economies of Central and Eastern Europe. CETV is a US company using US GAAP accounting. Revenue, cash flow, and earnings are growing rapidly. Most importantly, management has consistently delivered on its promises to investors whether they are producing upside earnings surprises or meeting strategic goals for developing and enhancing the value of the company.

CETV is one of the fastest growing media companies in the world capitalizing on booming economies and advertising growth throughout Central and Eastern Europe. GDP in its markets is growing from mid-to-upper single digits, double or triple the rate of growth in Western Europe or the US. TV advertising growth in the region has been 20-30%, driven by high levels of foreign direct investment and rapidly emerging consumer economies. Management has recently been noting how advertising categories like consumer staples are still growth categories whereas in Western Europe these are considered mature. Further boosting the company's growth profile is that the countries it operates in have per capita advertising spending at just 1/3rd the level of the entire Central European region and 1/6th the level of Eastern Europe. This gap is already narrowing.

CETV set a new all-time high on Thursday. The shares are up 45% this year and have tripled since early 2005. The market cap is $4.5 billion. Net debt at June 30th was $435 million. The company is free cash flow positive and produces significant earnings per share. Due to currency fluctuations, EPS are volatile and less useful as a valuation tool.

Like most media companies, total enterprise value to EBITDA is the most widely used valuation metric. The shares currently trade at 15.6 times my 2007 estimate of $284 million in broadcast EBITDA and 12.8 times my 2008 EBITDA estimate of $364 million. I ignore corporate overhead and new media investments but value Croatia at $0, a very conservative assumption.

My 2007 estimate is at the low end of management guidance. I think there is a decent chance that the company will raise the low end of its guidance range at next week's analyst meeting due to favorable currency, strength in the Czech Republic, Slovakia, and Romania, and signs of stabilization in Ukraine. Despite the huge move in the shares, I think plenty of upside remains. My current target is $127 based on 15 times my 2008 estimate. Assuming the company sustains mid-teens EBITDA growth for a few years beyond 2008, something I believe is highly likely, the shares could double again within four years....

....Historically, the company has been controlled through super voting shares held by its founder, Ronald Lauder. In August 2006, Lauder sold half of his control stake to Apax Partners, a major private equity firm with several investments in media. Lauder built the company in the 1990s mainly through ownership of TV Nova in the Czech Republic. A dispute with his former business partner led to the company losing control of Nova and almost going bankrupt in 2000 and 2001. Successful litigation against the Czech government for failing to protect CETV's license concluded in 2001 when CETV was awarded over $400 million. Since that time, investments in Romania, Slovenia, Slovakia, and Ukraine have blossomed and the story came full circle last year when CETV repurchased TV Nova.

CETV is mainly an organic growth story although a significant acquisition of another TV operation in the Central Europe region could occur at any time. For the last few years, the company has been focused on internal growth and gaining larger ownership stakes and control of all its TV licenses. This process is largely complete as CETV controls all of its licenses and has 90-100% ownership in all countries except Ukraine where ownership sits at 60%. I expect ownership to go up in Ukraine over the next year. Full ownership and control of operations and licenses dramatically reduces emerging markets risk relating to developing economies, government institutions, and legal systems.

CETV has been growing very rapidly. From 2000 through my 2007 estimates, the core four markets of Romania, Slovenia, Slovakia, and Ukraine have enjoyed a compound annual growth rate of revenue and EBITDA of 32% and 41%, respectively. I expect growth of 29% and 30% in revenue and EBITDA this year followed by gains of 19% and 28% next year. Growth in 2007 is being supported by a new strategy at Nova that purposefully pressured financial results in 2006. The financial upside of the strategic shift to modernize the Czech TV ad market and cut costs at Nova will continue in 2008. Also contributing greatly to 2007 growth is Romania and Slovakia. Romania will see revenue and EBITDA growth north of 30% in 2007 following several years of 40-100% growth. Slovakia's growth is accelerating sharply this year with revenues up over 40% and EBITDA almost doubling. Slovakia is benefiting from management changes enabled when CETV gained full control of operations, spillover from the Nova restructuring, and a booming Slovakian economy.

In 2008, steady gains in the Czech Republic, Romania, Slovakia and Slovenia will be joined by a rebound in Ukraine and a turn from losses to breakeven in Croatia. This year Ukraine has suffered due weaker than expected ratings and political turmoil. The recent elections went smoothly and CETV just gained full management control of its Ukrainian operations so optimism about 2008 is warranted. Ukraine is set to lose $5-10 million in EBITDA in 2007 following a 2006 profit of $30 million. Even a moderate rebound is material against estimated total 2007 broadcasting EBITDA of $284 million. Croatia has been in a multiyear investment mode that has gone worse than expected. However, revenue growth and ratings have accelerated sharply since mid-2006 (revenue up 38% in 2Q07) setting the stage for a $10-20 million profit swing in 2008.

With GDP growth in Central and Eastern Europe expected to remain in mid-to-upper single digits, gains of 15-25% in advertising growth throughout the region for the next few years are a reasonable estimate. Given CETV's long history of superior execution and positive earnings surprises, merely sustaining the current multiple on 2008 EBITDA is an appropriate assumption. As noted earlier, this is enough to get the shares to $127, up another 25%, even following the huge move recently. Since I am willing to take the risk of emerging market stock price volatility (which is much greater than the volatility of CETV's operations), I believe that CETV remains the premier growth investment among US media companies.

Posted by Steve Birenberg at October 11, 2007 11:21 AM in CETV