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November 07, 2011

CBS Leads More Solid Media Results

Given the increased importance of macro issues on the stock market and record high correlations among individual stocks, I am expanding media company earnings analysis this quarter to touch on all companies and major trends, not just Northlake positions.

Media earnings season continues to roll along. The message so far is that media fundamentals are largely intact in the previously bullish zone with the possible exception of cable systems owners. However, something else is obvious. Analysts are skeptical and investors do not care about third quarter results, fourth quarter guidance, or earnings beats and guidance driven by sale of digital rights to the likes of Netflix. All that matters is that media companies, particularly those exposed to advertising, have limited visibility on 2012.

Analysts and investors are obsessing over any sign that advertising has slowed or will slow. Clearly, the extremely robust strength in ad demand and ad pricing has moderated. Ad pricing is still at premiums to prices in May's upfront. Certainly, that is a bullish barometer. However, premiums are lower than they were a year ago at this time and comparing scatter, or spot, pricing on a year-over-year basis also indicates a deceleration. The fact that scatter pricing seems highly correlated with individual network rating performance is another sign the ad market has cooled.

The Street is clearly worried that low visibility and the uncertain macroeconomic environment will result in an abrupt collapse in the ad market in early 2012. The precedent is 2008/2009 following the Lehman bankruptcy.

I suspect this skepticism is going to continue until either the economy and ad market hold together or fall apart. Media stocks at very reasonable valuations if the bull case wins out. Upside of 20-40% is possible. The bear case is declines of similar magnitude.

We have yet to hear from Liberty Media, Viacom, AMC Networks, and Disney. Those are coming next week. Among those that have reported, I would rate CBS first, Discovery Communications second, News Corporation third, and Comcast fourth in order of attractiveness. Each has good fundamentals, arguably with upside to 2012 earnings estimates. Northlake's individual stock strategy is to be narrow and focus on the best ideas within media. Thus, clients own CBS and Discovery. But remember, the economic outlook rules and even the best reports will make you little money until the Street is willing to take a bullish look at 2012 advertising.

Here are quick recaps of the latest earnings reports:

News Corporation beat pretty much across the board. Led by Cable Networks, all segments are on a solid footing except for Publishing. The company's cable nets seem likely to have the highest growth rates and comments on the ad outlook were second most positive to CBS. Share buybacks are providing meaningful support to the stock. The UK scandal is on the back burner for now and seems unlikely to cause significant new problems.

Scripps Interactive (SNI) had a mixed quarter with the key takeaway being lower than expected advertising growth. Most financial measures were largely in line though as cost came in lower than expected. Management "saved" the quarter by affirming full year guidance, implying a strong fourth quarter. Analysts compute that the company needs mid-teens ad growth in 4Q to make the guidance. That seems like a stretch but one month into the quarter management probably has good visibility. Ratings remain inconsistent. Food has recovered but HGTV is still lagging and Travel is encountering its first difficult ratings period since being acquired by SNI.

DirecTV (DTV) had a strong quarter showing that there is still growth for multichannel television if you can gain market share. The free NFL Sunday Ticket promotion for new subs worked very well as gross adds, churn, subscriber acquisition costs, and monthly ARPU all were as good or better than expected. Marketing costs were up but management notes that may be a good investment as the company has 1 million new subs to target for retention a year from now versus the usual 300,000 after the start of football season. Latin America continues to show exceptionally strong growth although there was no blowout above expectations. Share repurchases remain robust.

CBS again crushed estimates due to the combination of high margin Netflix revenue and expense control. The street seems unwilling to pay for the digital revenue for the time being and is skeptical that margins can be maintained. Some of the margin gain is coming from programming which is bucking the trend throughout the industry. There was no change in the usually confident tone of management. 4Q looks very strong and upfront cancellations for 1Q12 are no worse than normal, maybe a little better. If you believe in the economy and ad market in 2012 there is no better place to invest in media than CBS.

Disclosure: CBS and DISCK are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. VIA.B, AMCX, DISCK, CBS, and DTV are net long positions in the Entermedia Funds. The Entermedia Funds are long/short equity hedge funds focused on media, entertainment, communications, and related technologies. 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 November 7, 2011 09:10 AM in CBS