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May 11, 2006

Viacom: Better But Needs More Growth

Viacom (VIAB) reported a solid quarter, which I would characterize as slightly above expectations. Viacom's good results follow better than expected results at Disney and News Corp, possibly a sign that fundamentals are improving for the diversified entertainment companies. At a minimum, I think that analyst estimates are now achievable as they have adjusted to the deceleration in growth over the past few years. This could be a good thing for the stocks if they can produce double digit growth. DIS shares have shown that you can still make good money on a mega cap media stock if growth and a clear strategy is evident. Viacom could get on a similar track as the rest of 2006 will see pickup in growth as comparisons ease. I come away from the Viacom quarter more optimistic that the shares could provide decent upside....

EPS came in at 43 cents against consensus of 39 cents. Revenues of $2.37 billion exceeded estimates of 2.25 billion. EBITDA was a little better expected. It looks to me like about half the EPS beat came from operating income and half from interest expense or other non-operating items. My only complaint would be that it looks like the revenue and operating income beat came entirely from the Entertainment division. It is possible that most of this may have been due the addition of Dreamworks. I just don’t know if this fully captured in analyst estimates. In any event, Viacom is dominated by Cable Networks, which are also the key valuation driver, so upside from Entertainment isn’t worth as much to me.

The Cable Networks came in very close to expectations. Revenues were a little light, apparently the result of weaker international results, where revenues fell 4% due to weak advertising sales. Part of this is probably due to currency although management said it didn’t yet know how much. Despite the shortfall in revenues, very good margins kept divisional EBITDA at or slightly above expectations. Management said that margins can be a little jumpy from quarter to quarter so they wouldn’t raise margin assumptions based on the 1Q results. Margin performance seems particularly good given the press release discussed elevated programming expenses.

Commentary on Cable Networks included a lot of talk about emerging networks. These are smaller domestic channels like Logo, Tempo and Noggin. These networks are achieving critical mass in distribution, crossing the 20 million and 40 million subscriber levels. As this occurs, advertising revenues should gain steam. These networks will never gain the full 90 million household distribution of MTV and Nickelodeon but could help drive corporate growth. I'd like to get a better handle on the potential long-term contribution of the emerging networks since I am cautious about the long-term growth rate of the fully distributed domestic networks.

Finally, there was a fair amount of discussion of the company's new media initiatives which include gaming and alternative distribution channels for video. Management said that these areas can generate over $500 million in revenue this year, which would be about 5% of the corporate total. Viacom owns lots of cable networks that reach younger demos so if online presence can be established, presumably there would be incremental upside relative to other entertainment companies which reach an older audience.

Posted by Steve Birenberg at May 11, 2006 11:07 AM in Viacom