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May 23, 2005

Central European Media Enterprises Clarifies 2005 Guidance

Central European Media Enterprises (CETV) shares have rallied sharply since the company announced it would be holding a follow-up a conference call to expand and better explain the 2005 guidance it gave on its 1Q05 conference call. CETV shares fell sharply after 1Q earnings and guidance were issued. The 1Q numbers were a bit light and the company gave 2005 guidance in broad terms that could have led one to believe that they were trying to mask troubling trends in 1Q05. The drubbing in the shares was compounded by the fact the company sold 5.4 million shares in secondary offering at $44.91 in late April. The shares suffered as new investors headed for the exits when the company disappointed investors. As summarized below, the follow-up call was very comforting and closley followed my feelings as outlined in my original discussion of the reaction to the first quarter.....

Recap Of The First Quarter Issues

As an investor in CETV for many years, I know that CETV's results on a country-by-country and quarter-by-quarter basis are lumpy. TV markets in Central and Eastern Europe are still developing and hit shows or new programming investments can lead to large variations in results at any one station. On top of this, CETV's business is quite seasonal with the first and third quarters being weak (typically accounted for 37-40% of yearly revenue). There have been numerous occasions over the last few years when 1Q/3Q results were "negative surprises" only to be followed by "positive surprises" when operating leverage kicked in during the high revenue 2Q/4Q periods.

CETV's 1Q05 results were also complicated by the inclusion of losses at a newly acquired station in Croatia. Losses were higher than expected in the quarter and the company hinted at sizable losses in 2005 continuing into 2006. On the 1Q call, management refused to specify the forecasted loss in 2005, which made interpretation of its guidance for 25% revenue growth and 15% EBITDA growth for the whole company in 2005 difficult to understand. Add in a shortfall in margins in Slovenia and Ukraine that went largely unexplained and investors responded by assuming a worst-case scenario.

Follow-Up Call Details

Fortunately, CETV management listened to analysts and large investors and hosted a follow-up call to clarify the guidance and offer expanded comments on 1Q. Management explained that Ukraine faced a timing issue as a popular Russian mini-series that ran in 1Q04 won't run until 3Q05. In Slovenia, a new employment law will pressure costs in 2005 but the overall market remains healthy. CETV also said organic revenue growth in the Czech Republic (50% of pro forma revenues) would be 8% in 2005, much better than expected.

Putting all the pieces together, the latest conference call made it clear that the company's guidance for 25% revenue growth and 15% EBITDA excluding the Czech Republic was in fact very healthy. Management also indicated that this guidance could be conservative. Plugging the new data into my spreadsheet, I still feel CETV can trade into the $60s on my 2006 estimates. My new pro forma 2005 and 2006 EPS estimates are $1.72 and $2.25. John Tinker of ThinkEquity has a 2006 estimate of $2.50. On an EBITDA basis, $62 works out to 12 times 2006 estimates, a level I find quite reasonable given the growth rate.

Certainly, the poorly handled 1Q05 call and the volatility revealed in the quarterly numbers will limit the multiple investors will place on CETV until a few more quarters put the 1Q05 questions to rest. I now think the shares will trade around the mid-$40s until results later this year give confidence to 2006 estimates at which point a move toward my price target should kick in.

Posted by Steve Birenberg at May 23, 2005 04:11 PM in CETV