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May 23, 2011

CBS and Virgin Media Momentum Continues

CBS and Virgin Media (VMED), two of Northlake's larger holdings thanks to excellent stock price performance, reported earnings a few weeks ago. Both companies reported good results supporting the higher stock prices and setting the stage for future gains.

Entering the report, I was a little worried about VMED due to strict austerity measures in the UK economy including higher valued added taxes. At the VMED analyst meeting we attended a few months ago, the company warned that early 2011 would be challenging. The quarter has hardly a blockbuster but mid single digit revenue and EBITDA growth built on inline to better than expected subscriber growth and ARPU was an excellent performance in a tough environment. Taking the quarter as a sign that austerity is not crimping growth, VMED's 2011 outlook looks better than feared. The company is coping well with a tough environment, probably a sign that that its best in the UK broadband network remains a competitive advantage that the focused management team is exploiting. Free cash flow continues to rise rapidly and the Board is exercising an aggressive share buyback program including purchases at the current prices at the 52 week high. VMED is near my low to mid-$30s price target but I think the bias is higher on the assumption 2012 economic growth in the UK improves. The share buyback, free cash flow, and excellent management execution provide downside protection that makes waiting for comparisons to ease the best course of action.

CBS reported blowout results benefiting from strict cost controls and good ratings that limit the need for aggressive programming spend. I have felt for several months that analyst estimates were way too low for 2011 due primarily to overly pessimistic expense assumptions. In addition, the national TV advertising market remains more robust than most observers had predicted. This combination is creating very high operating leverage, driving margins to previously unexpected levels. I see this situation as sustainable through 2012. Analyst estimates rose sharply following the quarter but remain too low in many cases. Free cash flow is being returned to shareholders with aggressive share buybacks and meaningful dividends. Many investors continue to see CBS as a cyclical play. No doubt the high exposure to advertising brings cyclical but overlooked is the rising importance of subscription and retransmission fees, derisking of programming investment via presale of international rights, and permanent cost controls. Along with the aggressive capital allocation strategy, these factors make CBS look more like premium valued cable networks. I think the stock can work to the mid $30s in 2011 assuming the economy remains on a recovery path.

Disclosure: CBS and Virgin Media are widely held by clients of Northlake Capital Management, LLC including in Steve Birenberg's personal accounts. Steve is sole proprietor of Northlake, an SEC registered investment advisor. CBS and Virgin Media are net long positions in the Entermedia Funds. Steve is co-portfolio manager of Entermedia, owns a stake in Entermedia's investment management company, and has personal monies invested in the Funds.

Posted by Steve Birenberg at May 23, 2011 09:23 AM in CBS