CBS reported another solid quarter, supporting our view that it is among the best positioned traditional media companies in a challenging landscape as viewers use different devices to watch TV and new entrants like Netflix offer alternative viewing options.  With the exception of Time Warner, which is being bought by AT&T, CBS has been the best performing entertainment stock over the past year, up more than 15%. Viacom, Fox, Disney, and Discovery Communications, all companies where like CBS the primary business is TV networks, are each down between -10% and -25%. We think CBS can continue to outperform its peers and see some signs that stock performance for the group could improve.

The strength at CBS comes from its narrow focus with most of the revenue and operating profits coming from broadcast TV and the premium pay channel Showtime.  The company is not burdened by a large portfolio of cable networks that are struggling with cord cutting, cord shaving, skinny bundles, and viewer fragmentation leading to weak ratings.  The CBS broadcast network has must have programming that supports its inclusion in any bundle of channels that viewers may choose and any device and through any distribution mechanism.  Big time sports like the NFL and still relatively highly rated entertainment programming leave CBS as a must by for advertisers seeking the reach advantage of TV.  Having of the industry’s most successful programmers, Les Moonves, as its CEO also supports the outlook for the company.

These competitive advantages were evident in the most recent quarter where revenues grew 4%, operating cash flow grew 5%, and EPS grew 19%.CBS has been astute at using its free cash flow, balance sheet strength, and divestitures to dramatically reduce its shares outstanding and support EPS growth.  The company announced further good news on the capital allocation front with its third quarter results.  The share buyback of $500 million per quarter will be supplemented with a $1 billion buyback in the fourth quarter as CBS completes the divestiture of its Radio business.

One major uncertainty hanging over CBS is whether it will merge with Viacom.  Both companies are controlled by Sumner Redstone and his family.  We are neutral on the merger possibility, balancing CBS strong management against the struggling business fundamentals at Viacom.

CBS estimates are rising due to better than expected operating performance and greater share buybacks.  There also looks to be somewhat better sentiment toward TV networks owners as new OTT services like Hulu and DirecTV now allow affiliate and retransmission fess to stabilize (or in CBS case accelerate).  We think the shares can work toward $60-65 as confidence grows in the stability of CBS business amid technological change.  A P-E of just 14X 2017 estimates would target the low $60s and still leave the shares at a meaningful discount to the market.

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.  CBS is a net long position in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.