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October 14, 2005

E.W. Scripps: No Sign of Weakness Yet at Cable Networks

E.W. Scripps (SSP) reported earnings in line with consensus but stronger than I had been anticipating. I came quite close to buying October or November at the money puts yesterday but in the end I decided against. As noted in my preview comment, I have a growing concern that fundamentals of the cable network business are deteriorating more than the Street is willing to admit. If this theory proves correct, the ramifications for the stocks of SSP and other major cable network owners (Viacom, Time Warner, Disney, News Corp) could be significant as most analysts are assuming a 13-14 times EBITDA multiple in their valuation models for cable network assets. I still believe my theory could play out in 1H06 but as far as SSP is concerned 3Q05 was another quarter of excellent results for the company's cable networks with no signs of weakness....

....SSP reported 38 cents in 3Q05 after adjusting for special items. One item will recur but is non-cash as the Denver Joint Operating Agreement which operates the Rocky Mountain News and Denver Post is upgrading its printing plant. Analysts asked a lot of questions about this on the conference call as it will cost the company about 7 cents in 2005 and another 4 cents in 2006. Since this is a non-cash charge and cost savings will begin to accrue the company in 2008, I don’t think analysts are worried about it but 2006 estimates will fall a bit.

The most important data in the quarter was that advertising revenue at the cable networks (HGTV, Food, DIY, Fine Living, Great American Country) rose 25%, above estimates of 20%. Guidance for 4Q05 cable network ad revenue is a healthy 25%. This puts to bed near-term concerns that weaker ratings and flattening subscriber growth (penetration levels of HGTV and Food have reached their maximum) might lead to slower ad growth. I still think that could occur and I don’t think analysts include it in their forward estimates.

The other big news out of the quarter is that the Shopzilla acquisition looks like a real winner. Shopzilla reported revenue growth of 121% and EBITDA of $7.3. Analyst estimates for EBITDA were closer to $4 million. Furthermore, 4Q05 EBITDA guidance for Shopzilla of $13-15 million is way ahead of current estimates. SSP paid a lot for Shopzilla but it appears it may have been worth it. The division could quickly grow to represent 5-10% of SSP's EBITDA and given the high EBITDA multiples applied to internet businesses, the division provides a nice boost to SSP's overall EBITDA multiple and mitigates some of the risk related to multiple contraction at cable networks.

Trends in SSP's newspaper and broadcast TV businesses in 3Q05 were poor but no different than industry trends. Cable nets now were over 60% of EBITDA in the quarter so these two traditional media businesses are becoming less important to financial results and valuation. 2006 does set up as a better year in TV as political advertising will return.

SSP shares aren’t moving higher despite an in line quarter that contains a lot of positive news in the company's key growth drivers. SSP has evolved into an entertainment conglomerate more akin to DIS, NWS, or VIA. Presently, SSP trades at a premium multiple to those stocks which is appropriate but limits upside unless there is a positive surprise. Exiting the quarter, I am moderating my evolving bearish view of SSP to a neutral one as current fundamentals are better than I expected and Shopzilla success supports the premium valuation.

Posted by Steve Birenberg at October 14, 2005 11:07 AM in SSP