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October 24, 2005

Central European Media Enterprises: Recent Weakness Should Be Temporary

Central European Media Enterprises (CETV) shares have pulled back 10% since early October and about 15% since peaking in September. I think the current pullback will prove temporary with the company's early November earnings report providing a positive catalyst. 3Q results won't be exciting due to seasonally weak TV viewing in the summer but I expect the company to issue strong guidance for 4Q....

CETV's recent weakness can be tied mostly to faltering stock markets in Central and Eastern Europe and Russia. For example, since peaking on October 4, the main index in Prague (CETV's home market) has fallen 11%. Declines in other Central European markets have been as bad or worse. I believe most of the decline is due to increased risk aversion on the part of investors. The sharp decline in energy stocks has also contributed as many of the largest stocks in these markets are energy related.

Other potential reasons for the decline in CETV shares include Euro weakness and a new competitor in the Czech Republic. The Euro has been volatile but not that much changed since its decline from the $1.30s to the $1.20 range. As a U.S. company, CETV is exposed to Euro exchange rate fluctuations as the currencies of its operating countries closely track the Euro (CETV itself does very little Euro business). Dollar-based estimates may have to be adjusted for currency but the company goes out of its way to discuss results in local currencies so I don’t think downward adjustments to estimates that are solely currency related will be a problem.

In the Czech Republic, Modern Times Group bought the other private broadcaster, TV Prima. Some investors may fear the increased competition but I think the market offers enough growth for the next few years to accommodate Prima and CETV's Nova. As I have posted before, besides core growth, the Czech TV ad market will get a boost as advertising on still heavily watched state-owned TV is phased out through 2008 according to a new law.

Finally, I also think that some investors who piled into CETV in September were anticipating the possibility that CETV could be a seller in the frenzy of M&A in European media. CETV shares spiked up on the back of the buyout of SBS Broadcasting (SBTV). In a suddenly risk averse world, this takeover premium has quickly receded.

CETV is now trading at 11 times 2006 EBITDA estimates and about 22 times 2006 estimated EPS. I find these multiples quite reasonable given a mid-teens corporate growth rate and the one-of-a-kind asset base. SBTV was purchased for 16 times current year EBITDA, which would equate to $73 for CETV on 2006 estimates. Assuming 2007 shapes as another good growth year, I think CETV could move into the $60s solely on the basis of its own fundamentals over the next twelve months given its status as the only pure play on the emerging consumer economies of Central and Eastern Europe.

Posted by Steve Birenberg at October 24, 2005 09:01 AM in CETV