ViacomCBS (VIAC) reported more disappointing news with its 4Q19 earnings report and 2020 guidance.  The stock is now down about -40% since last summer when the company first lowered its outlook.  Investors had thought that management had given a conservative outlook back then but this appears to have not been the case.  Management credibility is now low contributing to the latest shellacking in the stock.  Northlake credibility on VIAC is also low but that said we still think it is too cheap to sell using any normal valuation metric.  The 2020 outlook finally seems to be de-risked even as longer term risks remain related to NFL rights, subscriber counts, and the rate card on affiliate fees.  Based on free cash flow compared to peers, we could see downside to the mid-$20s, or another 15-20%.  Should the company hit its 2020 guidance, we see upside of 25% to 40%.

VIAC’s problems are mostly twofold.  First, the company is dramatically increasing its spending on programming for its own networks (CBS, MTV, Nickelodeon), its new streaming network (CBS All Access), and to sell to other networks and streaming services (Netflix).  This is a large upfront investment of cash flow.  All media companies are upping their content spend.  A particular challenge for VIAC is that earning a return on increased investment at their traditional channels is increasingly difficult.  At the same time, the company’s efforts in streaming are modest.  VIAC currently has only 11 million paid streaming subscribers and 22 million ad-supported viewers, while competition from already established much larger players like Netflix and Hulu and new entrants aiming for greater scale like Disney+ and HBO Max make it seem likely to be challenging to earn a return in streaming.  VIAC expects paid subscribers to grow 45% to 16 million and ad-supported viewers to grow 36% to 30 million by the end of this year.  Selling to third parties is a high return business but not enough to drive financial success on content investment.

The second problem is that it appears the deterioration in Viacom’s cable channels has been much worse than expected.  This lowers the base for future growth even if the company’s strategies to invest in its business work.  Viacom’s networks are losing cable subscribers faster than expected and those it is keeping are bring in lower affiliate fees than expected.

The merger of Viacom and CBS was designed to address these problems by giving the company more scale from which to invest and by using CBS’s must have TV network and TV stations to protect Viacom’s cable networks.  Management’s newly articulated strategy and hopefully the end of estimate reductions are potential positives.  As we move through 2020, hitting numbers, resolving the future of the company’s NFL rights, selling assets, paying down debt, and buying back stock are all potential catalysts.  Management was very confident in its guidance and offered supporting detail in response to repeated questions from analysts.

Northlake has been wrong on CBS and now VIAC.  We think the stock is washed out or very close to it at $28 with much more upside than downside.

VIAC 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.