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August 02, 2008

Why Is CETV Struggling When I Think It Will Double

Central European Media Enterprises (CETV) remains my favorite media stock for all time horizons. Despite my enthusiasm the shares have performed poorly this year. Although, within the media stock universe, the 20% drop since June is not unusual. Neither is the 36% decline from the 52 week high.

However, there is one big difference. CETV is beating consensus handily and estimates are rising while virtually ever other company in media is missing consensus and estimates are falling. As a result, CETV shares have gotten to ridiculously cheap levels given the outstanding historical and projected growth profile – 8 times 2008 Estimated EBITDA. EPS are too volatile because the company's euro denominated debt causes foreign exchange fluctuations to distort results but on normalized numbers the stock trades at 16 times 2008 and 13 times 2009. CETV's EBITDA and P-E valuation is similar to other TV based media assets such as CBS, Disney, News Corporation, Viacom, and Scripps Interactive.

You might be thinking valuation is in line with the group so why do you say it is cheap. The answer is growth and an almost perfect track record of beating estimates. In its just reported 2Q08, CETV saw revenue rise 41% and segment EBITDA grow 53%. Year to date, revenues are up 45% and EBITDA is up 64%. In 2007, revenues and EBITDA grew 39% and 46%, respectively. Barring a major slowdown in Central and Eastern European economic activity, no signs of which have yet appeared, growth in 2009 should be at least 15-20% in local currencies. Sure, CETV's reported results have benefited from the weak dollar but local currency growth has been in the range of 15-25% across the entire company for the past several years.

Growth emanates from rapidly growing economies in the region which is driving per capita income and spending leading advertisers to aggressively grow their budgets. CETV's stations are ratings leaders pretty much across the board and operating management is widely acknowledged to be best in the business. Besides growing interest from advertisers, CETV has aggressively raised ad prices to begin to close the monumental gap that exists between rates in Western vs. Central and Eastern Europe.

There are two bear arguments that have been circulating....

First is the macro argument: Central and Eastern European economies will rapidly decelerate due to rising inflation and slowing global growth. If this happens, CETV's 2009 outlook is not nearly as good as I or the consensus believes. Revenue projections are too high and best in class operating margins will come under pressure.

I can accept this argument and I understand why a short would take a position on it, a long would sell, or a potential long would pass. However, as I mentioned so far CEE economies are holding up just fine. Inflation pressures are a problem but for CETV they also make the ad prices increases easier to implement. I also believe that CEE economies are much less reliant on natural resource based growth than other emerging markets. The growth in the region is a function of low cost labor and manufacturing leading to very rapid growth in foreign direct investment. Maybe I am naïve but I don’t see this trend abating due a cyclical downturn given that the FDI is designed to lower cost structures for companies that are currently seeing lower growth in their mature home markets and open new opportunities in aster growing markets.

The second bear argument revolves around valuation. If you read analysts reports, they will tell you the stock is trading at 10 times EBITDA. Only one of the six reports I read reviewing 2Q results bothered to point out that two of the six countries CETV operates in are at breakeven.

Croatia just had its first ever EBITDA positive quarter following a period of investment that moved the station from #3 to ratings leader. Revenues have grown north of 60% per quarter since 4Q06. EBITDA is on its way toward $30 million in 2010. CETV just paid $172 million for 80% of the money losing #3 station in Bulgaria. I am extremely confident that if Croatia were sold today the price would be at least $250-300 million.

CETV has been in Ukraine for many years. Since 2004, revenue growth has been 30-40% with uneven EBITDA due in part to CETV's lack of control over day-to-day management of its station. The company just completed acquisition of the control stake in the station. Ownership is now 90% and will move to 100% at the end of this year. The two step buyout places a value of $800 million on Ukraine. Two recent events make this look conservative. First, CETV just issued detailed five year guidance for Ukraine projecting 2012 revenue and EBITDA of $500 million and $200 million, respectively. Second, Modern Times Group, one of CETV's primary competitors, purchased the #2 station in Bulgaria for almost $1 billion. Bulgaria's population is about 1/7th the size of Ukraine's.

I believe that at least $1.2 billion in hidden value exists at CETV in its Croatian and Ukrainian operations. Analysts and investors are ignoring the fact that these businesses are operating at breakeven providing zero value in any EBITDA, DCF, or EPS based valuation.

Back out $1.2 billion and the EBITDA multiple is 8 times. Given the growth profile and history of consistently meeting or beating expectations, the shares surely deserve a premium to other TV based media assets. Even if you are worried about CEE economies, you have to admit that parity valuation with mature assets that are lucky to grow in the mid to upper single digits discounts the risk.

And if you are worried about emerging markets you are probably paying up for defensive stocks like Procter and Gamble. Did it ever cross your mind that one of the reasons that P&G is defensive is because of rapid growth in emerging markets? Now consider the fact that P&G is one CETV's major advertising customers.

I stand by my belief that CETV shares should be trading near $130 on 2008 prospects. If the company hits my 2009 estimates, I see the shares doubling. It will take a better market environment, improved sentiment toward emerging markets, and less risk aversion from investors to get the stock moving. But given this kind of upside, cheap valuation, great management, and an almost perfect track record at the operating level, the risk-reward trade off is the most compelling in the media universe.

Posted by Steve Birenberg at August 2, 2008 02:32 PM in CETV