CBS has been the most frustrating stock in the Northlake portfolio.  The company has consistently met or exceeded earnings estimates, steadily increased its dividend and share buyback, pruned its portfolio wisely to reduce advertising exposure and cyclicality, and is the clear leader among broadcast and TV network companies with its OTT strategy.  However, none of this has mattered.  CBS shares have declined steadily since last August from a high of $68 to last night’s closing price of $49.

Despite doing almost everything right, CBS has been tarnished by legitimate secular concerns facing traditional media:  cord cutting/subscriber loss, declining TV ratings, and weak or declining advertising trends.  Those are fair reasons to sell or short the stock and we have explained numerous times the errors we have made with our media stock investments by emphasizing value vs. investor sentiment about the long-term secular issues.

The second culprit has been the ongoing saga about CBS and Viacom merging.  CBS investors hate the idea given that Viacom’s business has performed abysmally over the last three years and the two company’s common controlling shareholder appears ready to force the merger on CBS, even if it means the CBS management team that has steered the company so well through stormy waters is pushed out.

Thankfully, last night’s 1Q18 earnings report has provided relief for CBS shareholders.  The stock is trading up over 5% in response to a very strong report pretty much across the board.  EPS and revenue produced material upside surprises driven by both advertising and content businesses.  Equally important, CBS announced that its two OTT services, Showtime and CBS All Access have a combined five million subscribers.  CBS stands out from its peers in having successfully launched direct-to-consumer services.  CBS is also included on all but one of the rapidly growing cable substitute OTT services.  This strategy has real economic benefits since it means CBS subscribers are growing (while other TV networks are declining) and the new subs pay a higher fee to CBS directly than what the company earns from its traditional cable and satellite customers.

If today’s big up move is going to mark the bottom for CBS shares, the next step has to be a satisfactory resolution of the Viacom merger discussions.  We see a lot of potential value creation in the merger for CBS shareholders as long as the purchase price is fair and CBS management initially is in control.

On a standalone basis, we thing CBS can trade back to the low $60s based on a P-E of 12 times 2018 consensus earnings estimates.  This is a premium to other TV-centric media stocks but CBS has earned a premium.  With a well-structured Viacom deal completed, we think the shares can reach $70 in 2019 based on significant EPS accretion to current CBS earnings estimates near $6.  It has been a long painful stretch for CBS shareholders.  We believe the end has just begun.

CBS is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.