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August 03, 2012

CBS Shines, Discovery Good Enough

This week was a big one for media earnings. Besides Northlake holdings CBS and Discovery Communications, we heard from Viacom, Time Warner, Scripps Interactive, and Comcast Against a cautiously optimistic backdrop, the results came through inline to slightly better than expected with CBS leading the way again. The outlook for the rst of the year suggest modest growth in the September quarter, held back by market share losses to NBC's Olympics telecast, which is a huge ratings winner. Management teams were very confident across the board on a pickup in the December quarter as higher pricing on upfront ad sales kicks in and political spending tightens inventory and firms up spot pricing. Overall, the national TV ad market has weathered the first half economic slowdown well. Media stocks have further upside after above average performance so far this year as investors respond to higher estimates, increased predictably, and continued aggressive capital allocation leading to large share buybacks and dividend increases. In addition, there is no sign that cord cutting is a problem or that internet video is changing the basic economics of TV. That could change but for now with near-term business momentum and reduced secular fears, media stocks have room for higher valuation on stable to rising 2012 and 2013 earnings estimates.

CBS has been a leader among media stocks since the bottom in the summer of 2009. The most recent quarter presented some very challenging comparisons but once again the company came through. Operating margins again surprised to the upside as the company adds extremely profitable retransmission, digital rights, and syndication revenue. Revenue trends were flattish as expected but a big second half pickup is clearly coming with strength expected to continue into 2013 as long as the economy holds. CBS has transformed itself into a content driven company with much less reliance on advertising. The street has been consistently behind setting up a series of positive surprises. Earnings estimates may finally be catching up but the stock still trades at a discount to its cable network peers. Closing the gap can get the stock to the $40s.

Discovery Communications reported growth toward the top end of the industry for the June quarter but was a touch more cautious on the September quarter than some of its peers. Discovery skews female and faces a somewhat greater challenge for ratings and ad spending from the Olympics. Ratings at a TLC and Discovery Channel have been a little soft as well. None of this would be a problem except that Discovery shares trade one of the highest multiples in the industry. The premium is well deserved given industry leading margins, historic growth rates, and international exposure that should drive above average future growth. A lull in the share gains cold be at hand but if the December quarter accelerates, as management firmly believes it will, upside remains. 2013 looks good as well with new affiliate fee opportunities and dramatically reduced losses at start-up networks, especially OWN.

Disclosure: CBS and Discover Communications are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg's personal accounts. Steve is sole proprietor of Northlake, an Illinois-registered investment advisor. Regulatory filings can be found at www.sec.gov. CBS, Discovery Communications, and Comcast are net long positions in the Entermedia Funds. Entermedia is along/short equity hedge fund 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 August 3, 2012 09:01 AM in