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May 17, 2010

Media Stocks Ignore Solid Quarterly Earnings

One of the oddities in specializing in media stocks is that most all of the companies report quarterly earnings within a tight two week window including the last week of the first month of the new quarter and the first week of the second month. This quarter media earnings season overlapped with two trips to NY related to my son's graduation from NYU. The busy schedule kept me from providing the usual in depth earnings analysis of Northlake's holdings in Virgin Media, DirecTV, Liberty Starz, Discovery Communications, and CBS. Fortunately, each company at least met expectations with several exceeding Wall Street estimates.

In lieu of detailed company-by-company analysis, here is a general review of the entire media earnings season followed by some comments on how stocks reacted.

Second Quarter 2010 Media Earnings Recap

The latest earnings season for media stocks is now about two weeks in the past. Even before the market turned lower a pattern had emerged. Media companies would report better than expected or in line results and the stocks would trade lower. Most companies showed upside at the revenue, EBITDA, and free cash flow lines built upon upside to key financial drivers including advertising growth, movie box office performance, or subscriber metrics like net additions or ARPU. In other words, from a purely fundamental standpoint, media companies reported excellent first quarter results.

It hardly mattered to the stocks, many of which have traded down close to 10%since reporting. Granted media stocks have been leaders with many up 100-200% since the March 2009 lows. Most stocks were trading at 52 week highs entering earnings season. With the benefit of hindsight, the expectations bar was clearly too high. This was even the case for companies who produced "beat and raise" quarters including Time Warner, Viacom, Discovery Communications, HSN Inc., and Scripps Interactive.

Periods like this are tough if you are long stocks. I take solace in knowing that value was built during the first quarter as evidenced by rising 2010 and 2011 estimates and numerous increased share buybacks or dividend increases. In the short run that has not done any good but I am confident that most media stocks will make new 52 week highs later this year if the U.S. economic recovery remains on track.

Northlake Media Stock 1Q10 Comments

Virgin Media saw its operational and financial turnaround accelerate. Unlike most media stocks, the shares responded well. VMED shares ultimately gave back the post-earnings gains due to weakness in the Euro and Pound and fears about European economic growth. I think the weakness will prove temporary as new management is finally exploiting the competitive advantage of Virgin's high speed broadband network. I think there is a lot more to come for the stock now that Virgin's balance sheet has been refinanced.

The highlight for Discovery was 9% growth in domestic advertising. Revenue and EBITDA slightly exceeded estimates. Trends in the U.S. and abroad were both good. The company raised 2010 guidance indicating that April was as good, or better, than the first quarter. Despite the good news, DISCK shares sold off in a perfect example of "sell the news" and "good news already priced in." DISCK remains the best growth story in traditional media and a large share buyback announcement lies ahead in the second half of 2010 providing a catalyst for shares and for DISCK to close the gap with DISCA.

CBS merely hit estimates, which was not good enough for the stock even ignoring the market decline. We like what we heard on the advertising outlook, however, which was better than CBS' closest peer, News Corporation. Some investors are worried about rising programming expenses that led the Entertainment segment, dominated by the CBS Network, to slightly lag on profitability. Nonetheless, 2010 estimates rose slightly coming out of the quarter giving more comfort to my bullish outlook for the shares.

DirecTV had another solid quarter. Subscriber growth in the U.S. missed expectations but ARPU was better than expected as was expense control. Latin America beat estimates across the board. The big news was the company affirmed a massive share buyback equating to one-third of the shares outstanding by the end of 2011 by establishing new balance sheet targets. Slowing sub growth in the U.S. and an intense competitive environment with Dish Network, cable, and telcos remain worrisome but DTV remains the poster for returning free cash flow to shareholders, the holy grail of media investors at the moment. DTV is the only media stock to trade up and hold its gains off the quarter indicating investor preference for cash return to shareholders.

Liberty Starz had good news with the report that it grew subscribers at Starz and Encore from the December quarter. Subscriber losses are one of the primary concerns of investors in the story. The balance sheet is underleveraged leaving lots of room for share buybacks. However, repurchases slowed during the quarter creating some concern about possible big increases in programming investment in original series. The shares are extraordinarily cheap and I trust Liberty Media management to realize the value as they have done with their other tracking stocks. Northlake's LSTZA positions are generally small as they were obtained in a transaction involving DirecTV. I would like to add to the holdings on a pullback to the upper $40s.

Disclosure: VMED, DISCK, CBS, DTV< and LSTZA are widely held by clients of Northlake Capital Management including in Steve Birenberg's personal accounts. Steve Birenberg is sole proprietor of Northlake Capital Management, LLC. VMED, CBS, LSTZA, DTV, TWX, VIA.B, HSNI, and SNI are long positions in the Entermedia Funds. DISCK is a net long position at Entermedia vs. a short in DISCA. NWSA is a net long position at Entermedia vs. a short in NWS. Steve Birenberg is co-portfolio manager of the Entermedia Funds, owns a portion of the Funds' investment management company, and has personal monies invested in the Funds.

Posted by Steve Birenberg at May 17, 2010 10:13 AM in Media