CBS reported 3Q19 earnings in line with reduced Wall Street expectations in its last quarter as standalone company.  The merger of Viacom and CBS to create ViacomCBS should close in the first half of December.  CBS shares represent the newco as Viacom shareholders will exchange their shares for CBS shares.

CBS shares have declined sharply since the last quarterly report in August as filings the company made in conjunction with the merger indicated a lower than expected level of profitability.  This is mostly because CBS management is projecting a large increase in spending on programming to support new initiatives in DTC/OTT streaming services at CBS All Access and Showtime.  In addition, CBS sees an opening to produce programming to sell to other streaming services such as Netflix, Amazon Prime Video, and Disney Plus since many media companies are no longer selling programming to these competitors.  All Access and Showtime are positioned as niche services so they do not need the massive level of new, original programming required by the broad-based services like Netflix.

The higher content spend came as a surprise and further undercut investor confidence that newly formed ViacomCBS can be successful.  When the merger was announced, analysts thought the new company could earn about $7.50 in EPS in 2020 after giving credit to a projected $500 million in cost saving synergies.  Following the filings by CBS and Viacom, the estimate is $6.50.

This is clearly disappointing news as is the lousy performance of CBS stock over the past year.  The best case scenario for the short-term is that the estimates are washed out and may even prove conservative.  With the shares at just 6 times earnings against the average stock at 17 times, it does seem like the bar is very low.  However, other media stocks threatened by the transition to streaming and other secularly challenged companies in various industries also have extremely depressed valuations.  The multiyear run for high growth stocks has led to a barbell where “winners” get astronomical valuations and “losers” see historically depressed valuations

We have been wrong on CBS over the past year, repeatedly expressing that the shares had valuation support.  Nonetheless, we are sticking with the call as the catalyst of the merger closing should allow management to clear the air.  If the stock recovers some of its sharp losses over the next three to six months as we expect, it will be time to reevaluate.

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.