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May 17, 2005

Central European Media Enterprises To Clarify 2005 Guidance

CETV announced last night that they will hold a follow-up conference call tomorrow morning to clarify 2005 guidance provided on the first quarter results conference call held on May 10. The guidance caused confusion, particularly among new shareholders who bought shares on the secondary offering, and led to a sharp drop in the shares. I think tomorrow's call will provide specifics in line with my own analysis which I wrote back on May 11th but have yet to post. I also think the call is a smart move and will stabilize the shares and lead to a rebound. Today's gains are a good sign. Here are my thoughts from May 11th....

....I had a chance to talk to one of my better analyst contacts on Central European Media Enterprises (CETV) yesterday afternoon after I posted my initial comments on the quarter. The analyst had heard from a lot of shareholders. The big issue appears to be the guidance given on the call for 25% revenue growth and 15% earnings before interest, taxes, depreciation and amortization growth for 2005 on the stations in Romania, Slovakia, Slovenia, Ukraine and Croatia (excluding the acquisition of TV Nova in the Czech Republic which closed just a week ago). This guidance is inconsistent with a more bullish message sent on the recent road show for the equity offering.

Lack of Specifics Causes Confusion, Concern
I think that part of the problem is that the company offered vague guidance with no details on a country-by-country basis. Complicating matters was a statement by management that losses in Croatia (a new station purchased for just $20 million in 2H004) would be larger than expected in 2005 and possibly continue into 2006. However, management would not answer repeated requests for the size of the loss in Croatia, so investors are unable to determine whether margin issues are developing in the other countries or the weaker-than-expected guidance is solely related to Croatia. Since Slovenia and Ukraine reported margin declines in the just-reported first quarter, without knowing the losses in Croatia, investors are rightly concerned and confused about the guidance that implies a decline in margins from 30% in 2005 to 28% in 2005. With revenue growth as expected at 25%, there would be little reason to expect a margin decline given the operating leverage in the television station business.

The Picture Is Brighter Than It Seems
In the last three quarters, Croatia reported a cumulative EBITDA loss of $7 million. Investments in new programming have already improved ratings to a 14% share but the company plans more investments with the goal of getting to a 20% share. Consequently, I am assuming losses in Croatia of $9 million in 2005. Plugging this figure into my spreadsheet and working backwards suggests that the other four countries will have EBITDA growth of closer to 21% on stable margins. Romania and Ukraine will grow above 30%, Slovakia in the low double digits and Slovenia will bring up the rear in the upper single digits. I'd like a better understanding of the slowdown in Slovenia but if my assumptions about Croatia are correct, the picture is better than someone who listened to the conference call would have taken away.

Seasonality Is a Large Factor
Investors newer to the story may also not realize that quarterly results for CETV, particularly on a country-by-country basis, have been volatile over the last five years. Seasonality has played a major role in the volatility. The seasonally weak first and third quarters have accounted for just 37%-40% of revenue over the last over the last five years. This has often led to negative EBITDA surprises in individual countries in these quarters due to operating leverage inherent in television stations. Since CETV is investing heavily in programming to establish dominant ratings, negative leverage is enhanced in the first and third quarters. Positive surprises have occurred often in the second and fourth quarters when revenues receive a seasonal boost. Individual hit shows and elections can also lead to large variations in quarterly results. Management did a poor job explaining these things on the conference call.

Long-Term Story Is Intact
I still think my initial conclusion that the long-term story is intact but the shares will be sloppy and unrewarding in the short-term is correct. Valuation is hardly demanding at 11 times 2005 EBITDA and 20 times pro forma 2005 EPS even if growth is only 15%. I hate to sound like an apologist and defend an idea. However, sometimes taking a little longer term view is necessary in small-cap growth situations. I had not thought that would be the case for CETV in 2005, but I do think that is the right approach to take now.

Posted by Steve Birenberg at May 17, 2005 11:43 AM in CETV