CBS reported better than expected 4Q17 results but in what has been a consistent pattern for several years, the shares did not respond favorably.  There has been a long list of issues for CBS shares mostly focused on the changing consumption of television as viewers migrate to services like Netflix and Hulu and younger viewers eschew traditional network programming all together.  A new issue for CBS is that its controlling shareholder, National Amusement, seems determined to force a merger with Viacom (also controlled by National Amusement).  Recent reporting on the matter appears to favor Viacom shareholders and management relative to CBS, which leaves CBS shares under pressure.  The Viacom merger discussions should reach a conclusion within the next few months.

At this point, although we have reservations about the long-term strategic value of the merger, we believe the announcement will be met with relief and should spark a rally in deeply oversold and undervalued CBS shares.  The primary risk in the merger for CBS shareholders is that CBS is forced to pay a premium for Viacom shares – something we see as undeserved – and that National Amusement is willing to sacrifice CBS’s highly regarded management to force a merger.  At just over 10X confidently provided 2018 guidance, we feel these risks are already heavily discounted in CBS shares.  Thus, we plan to let the CBS-Viacom merger discussions play out and revisit our investment thesis on CBS shares once we know the details.

In the meantime, the latest quarterly results and the accompanying management commentary give us confidence in the near-term and long-term outlook for CBS.  Earnings results at the operating level met expectations in what continues to be a challenging environment for traditional TV networks.  Growth is modest against tough comparisons to 2016 when CBS aired the Super Bowl and enjoyed heavy political ad spending.  Underlying drivers are clearly positive, however.  Political spending is poised for a huge year with recent special elections indicating heavy TV spending will again be the norm after the Trump campaign managed to get by on free and social media.  More importantly, CBS’s initiatives in direct to consumer digital streaming are running ahead of schedule and lead its traditional media peers by a big margin.  CBS now has 5 million combined subscribers for its CBS All Access and Showtime OTT products, which combined are tracking to generate over $500 million in revenue in 2018.  CBS is managing this transition well as it continues to monetize its large programming library and production by selling some rights to Netflix and other third parties primarily in international markets.  Finally, CBS continues to increase the predictability of its revenue and profit stream through growing retransmission fees paid by cable and satellite operators and local TV station affiliates.  This revenue stream grew 31% in the quarter and is locked in at a high growth rate for at least 3 to 5 years.  There is also a built in hedge as a cable or satellite subscriber lost to All Access or one of the new cable-like OTT services pays CBS a greater monthly subscription fee.

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.