Shares of ViacomCBS (VIAC) performed poorly prior to the economic shutdown and COVID-19 crisis and have fallen further.  The stock is now about 50% lower than its mid-February level even after rallying 70% from its March low.  Of all the investments Northlake has owned over the past couple of years, VIAC has performed the worst and flummoxed us the most.  Wall Street views the company as subscale and unable to invest enough to transition its business from traditional media to streaming media.  We think this argument has merit but we have continually thought it was reflected in the company’s valuation.  Today, VIAC shares trade a price-earnings ratio of less than 5X.  To put that in perspective, the average stock trades around 18X earnings assuming pre-COVID levels.  To us, VIAC has been and remains too cheap.

The company’s 1Q20 earnings report showed initial impacts of the economic shutdown.  Advertising in the U.S. and abroad fell sharply at the end of March, stabilized in April, and is showing a slight improvement in May.  The other main revenue line is affiliate fees.  This is a tale of two businesses.  Local CBS stations are driving 20% growth in affiliate fees as the per subscriber fee catches up to the still leading nightly viewership of broadcast television.  On the other hand, Viacom’s cable networks including MTV and Nickelodeon are under pressure from cord cutting and probably at best producing flat revenue.  The story on affiliate fees received a boost recently as VIAC was able to gain carriage for all of its leading broadcast and cable networks on YouTube TV.  This should lead to better overall subscription growth over the next twelve months and also is the first sign that the merger of CBS and Viacom is paying dividends.  Another potential positive is coronavirus driven boost to local TV news ratings on CBS stations.  We believe this could pay off later this year and in 2021 when negotiations for carriage renewal on these stations comes up with other cable, satellite, and streaming services and the local network affiliates.

The biggest controversy at VIAC is how the company is positioned for the transition to streaming TV.  The company has mid-size entrants with Showtime, CBS All Access, and Pluto TV.  However, the reach of these services pales in comparison to Netflix, Hulu, or Disney+.  Those companies have committed to massive investments in new content to fuel their growth and create a competitive moat.  This is where VIAC bears argue that the company is subscale such that to increase the content investment to compete will overwhelm the company’s financial resources.

As noted above, we believe there is merit to the bear case for VIAC.  Yet with the stock trading at 5X earnings, we believe the shares have been penalized too deeply.  Initial green shoots from the merger of Viacom and CBS give us confidence management is taking the right steps near-term and long-term.  The valuation argument for VIAC has not worked for several years but we are sticking with VIAC shares for a further significant bounce.

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.