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February 28, 2007

Expecting A Strong Quarter From Central European Media Enterprises

Central European Media Enterprises (CETV) should report robust 4Q06 growth. I am forecasting revenues to rise 17% and EBITDA to grow 22%. Strong ratings in 2H06, a return to positive comparisons in the Czech Republic, improved execution in the Czech Republic, and favorable currency comparisons support the growth profile.

CETV shares are up about 15% this year despite getting shellacked for 8% in the last two days. CETV shares often trade up aggressively ahead of earnings and then sell off sharply following earnings regardless of the news. A 15% gain certainly qualifies a strong up move but maybe the recent sell-off will allow the shares to rally if the company reports a clean quarter and offer encouraging 2007 commentary as I suspect.

The biggest swing factor and focus of investor attention will be on TV Nova in the Czech Republic. Earlier this year, CETV reset the operating strategy and expectations for TV Nova. The goal was to improve ad pricing in the Czech Republic which was unchanged since 1999 despite great growth in the economy. Nova's competitor initially decided to steal market share by not raising prices. In the new TV season that began last fall, the price increases held and Nova's rating surged. I think it is possible that Nova will surprise significantly to the upside in 4Q relative to expectations included in the table below......

CETV doesn't usually offer guidance until the 1Q call in May. However, I think there is some pressure to update guidance in the Czech Republic, especially if I am correct that an upside surprise is coming. Several analysts have already raised 2007 EBITDA estimates for Nova to $150-160 million vs. guidance issued last summer of $135 million. If CETV refuses to endorse higher numbers the stock will probably sell-off. Currency again is looking like a significant benefit putting further upward pressure on the guidance.

Here are my estimates for 4Q06 on a country by country basis excluding a start-up network in Ukraine that will lose several million dollars in 4Q on less than $1 million in revenue. Following each country is the expected revenue, the revenue growth rate, expected operating cash flow, and the expected operating cash flow growth rate:

Romania: 49,062 34.3% 22,244 24.7%
Slovak Republic: 23,853 17.6% 9,742 56.2%
Slovenia: 16,117 -6.6% 6,312 -30.9%
Ukraine: 35,329 25.7% 16,353 35.9%
Czech Republic: 70,000 7.1% 39,000 24.5%
Croatia: 7,255 38.5% (5,361) -15.2%
Total: 201,616 16.7% 88,290 21.7%

The big EBITDA gain in Slovakia is tied to the turnaround in the Czech Republic as these tow countries are using similar operating strategies. I think my estimates in Slovenia may prove low as local tax issues that pressured results earlier this year have abated. Romania and Ukraine remain key growth drivers but the results can be volatile from quarter to quarter depending on the timing of programming.

For 2007, I am forecasting a 20% revenue gain and 40% growth in EBITDA. These figures would be before any increase in guidance for the Czech Republic. I expect continued growth of 20-30% in Romania and Ukraine, a return to growth in Slovenia, a lessening of losses at the start-up in Croatia, and the turnaround in the Czech Republic to hit full stride.

Besides the guidance for Nova in 2007, questions that could come up on the call include recent rating trends and potential acquisitions. Ratings in Romania, Ukraine, and the Czech Republic turned downward late in 4Q. Part of the downturn was due to cannibalization of viewers by flanker channels owned by CETV. Ratings have rebounded in early 2007 and historically there is not a great correlation between ratings and revenue as overall market growth has been the key driver. However, competition is getting a little tougher so I am anxious to hear management's commentary related to the recent ratings volatility.

With 2007 EBITDA approaching or exceeding $300 million, CETV's balance sheet is getting underleveraged at just 1.5 times EBITDA. Using this capacity for further acquisition in Central and Eastern Europe is possible. Management would buy more assets if the price is right and acquisition activity in the region has been high. Some of the balance sheet capacity is clearly reserved to increase ownership and take control of the license in Ukraine. This all but a done deal but a lawsuit involving CETV's local partner has got things hung up. Any shift in management's commentary about the acquisition environment would be a big deal.

CETV shares are trading about 13 times 2007 estimated EBITDA. Given the growth rate and the attractiveness of CETV as an acquisition target for a larger media company, I find this valuation compelling. Univision was taken private at about 16 times EBITDA and always traded at around 14 times. I think CETV deserves a similar multiple as the growth rate is much higher, compensating for the valuation discount given to emerging markets.

I think the shares have upside to $90-100 on 2007 estimates and $120 plus on 2008 estimates. A takeout of CETV would have be north of $120 to satisfy me and Apax Partners, a private equity firm that bought out half of Ronald Lauder's controlling stake last August. In fact, Apax has blocking right son any deal less than $120. I think that gives investors a good idea of what a very smart insider thinks these shares could worth in the next few years. I couldn’t agree more.

Posted by Steve Birenberg at February 28, 2007 01:43 PM in CETV