A Bubble in Stock Splits

Several companies held in Northlake client portfolio recently announced stock splits. Discovery Communications (DISCK) and Liberty Media (LMCA) announced stock splits that will become effective over the summer. Apple (AAPL) also announced a split effective in early June. These announcements follow Google issuing new non-voting shares as a 2 for 1 split. As a reminder, what used to trade as GOOG is now GOOGL and new non-voting GOOG shares were distributed to create a 2 for 1 split.

Discovery will complete a straightforward 2 for 1 split by issuing one new DISCK share for each currently outstanding share of DISCK and DISCA. DISCK is non-voting stock, while DISCA has one vote. There are also ten vote per share DISCB shares. Discovery has been a heavy buyer of its own stock, focused on the lower priced DISCK. The buybacks had reduced the liquidity in the DISCK shares which were recently trading at a wider discount to the DISCA shares. The plan announcement worked beautifully as DISCA, and DISCK both rose sharply with DISCK rising several percent more and reducing the discount. The new DISCK shares will be distributed on August 6th.

Liberty Media will distribute two shares of newly created, non-voting Class C shares for each share of LMCA and LMCB on July 10th. This is effectively a 2 for 1 split but instead of giving each shareholder an extra share of what they already own, new non-voting shares will be issued. This is similar to the Google split without the added complication of changing ticker symbols. The concept for both companies is to issue shares that do not dilute the control of current shareholders, in particular, the control of the founders. In the case of LMCA, investors are interpreting the issuance of new LMCC shares as a signal that Liberty may have a large acquisition up its sleeve where they would be willing to issue equity. In turn, that would mean, that management sees the current valuation of LMCA and LMCB as full --- you issue shares instead of paying cash when the shares are richly valued. The combination of issuing non-voting shares and the possible implications are contributing to lagging performance for LMCA so far this year.

AAPL is keeping this pretty straightforward by completing a 7 for 1 split. Yes, 7 for 1 is unusual but like most splits it just additional shares of what you already own and Apple only has one class of stock to begin with. Apple investors will receive 7 shares of AAPL for each current share they hold on June 9th. AAPL is signaling its confidence in the company’s outlook with the split and also bring the shares down to a more normal price (around $90 at today’s near $630).

Splits have no economic impact. You own the same value in the stock as you owned previously. Splits can signal confidence from management. Splits can also be used to accomplish other corporate purposes such as what Google, Liberty Media, and Discovery Communications did as described above.

AAPL, DISCK, GOOG, GOOGL, and LMCA are 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. AAPL, GOOG, GOOGL, and LMCA are net long positions 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.

News On Northlake Stocks

Several stocks in the Northlake portfolio have had newsworthy items over the past week. Here is a recap of the latest news, all of which I think is positive.

Disney (DIS) completed the sale of almost all of its radio operations to Citadel Broadcasting (CDL). DIS shareholders received .0768 shares of CDL for each share of DIS they owned. DIS received $1.35 billion in cash from CDL. I plan to hold CDL and will look to add to the small positions if the shares come under pressure as DIS shareholders sell their small holdings. The profile of a DIS and CDL shareholder would seem to have little in common which could lead to lots of selling. Given that the DIS deal about doubles CDL shares outstanding, I think supply-demand imbalances could put some downward pressure on CDL. That was not the case yesterday when CDL rallied on the first day of post-closing trading. CDL has a current yield of over 5% which should limit downside....

Central European Media Enterprises (CETV) announced that it was acquiring 5% of its Romanian operation form its long-time partner and current senior executive Adrian Sarbu. CETV now owns 95% of Romania with Sarbu holdings 5% that has a newly restructured put option. CETV paid $50 million for the 5% stake, placing a value of $1 billion on Romania. I expect Romania to produce about $85 million in EBITDA this year, putting the multiple at 12 times. This actually seems a little cheap to me given that Romania has been growing at 30-40% per year and is projected to sustain a growth rate in excess of 20% for several more years. I suspect that CETV held the upper hand in the negotiations given Sarbu's small minority stake. I am always happy when CETV is able to buy more of its own operations and it is even better when the price is right. I remain a buyer of CETV which has lagged over the last month.

Endeavor Acquisition (EDA) released 2006 and 1Q07 financials for American Apparel and also filed the proxy. These filings indicate the acquisition of American Apparel remains on track for a 3Q07 closing. I have not had a chance to read all the filings but the headlines suggest that everything is on track. Management indicated that same store sales remain strong in 2Q and 1Q EBITDA suggests that the company is on track to meet 2007 guidance. The shares have moved to new highs since the filings. I still think EDA can reach $14-18 assuming American Apparel is able to maintain operating momentum in the first few quarters following the closing of the deal.

Rogers Communications (RG) announced the purchase of five traditional over-the-air TV stations in Canada. All major cities except Montreal were included. It is not a huge deal at $350 million Canadian but based on Canadian press reports it looks like a favorable deal for RG. RG shares remain right at their 52 week high and the prospects for further upside remain as wireless and cable drive mid-teens growth in operating profits and significant free cash flow begins to flow. A price target of at least $45 is realistic.

Disney Pulls Back But Its Not Due To Pirates

Pirates of the Caribbean: Dead Man's Chest (POTC) continues to rule the box office. Nevertheless, Disney (DIS) shares have sold off since the movie was released. I wouldn’t chalk that up to any disappointment over the film, however.

In the early part of last week, before catching a downgrade on Thursday, DIS shares actually outperformed the market. I'd suggest that was the trading action related to the movie. Since then, I think the downgrade (built off the belief that street estimates for DIS EPS growth in 2007 are too high) and geopolitical tensions drove the shares lower. The quick strengthening in the dollar also probably contributed as DIS is sensitive to international travel at its Orlando theme park.

I maintain my view that 2007 results will not disappoint. Continued margin expansion at the theme parks, growth at ESPN, a solid upfront for ABC, and the flow through of profits from DIS very successful winter 2005 thru summer 2006 movie slate provide enough upside to meet consensus estimates. I think this fundamental strength will be evident when the company reports its June quarter. Recent sellers, shorts, and downgraders will regret their positions come the August 9th reporting date. One signal I could be right is that DIS shares finished up yesterday despite a second downgrade. I helped a tiny bit by adding DIS to a new client account.

Going back to the box office....

POTC fell about 54% last weekend from its record setting opening weekend, a performance that gives little guidance to box office observers who are trying to gauge its legs. A drop of 60% plus would have been a reason for concern while a drop of 40% would have put the film in the running for #2 all-time behind Titanic and ahead of Shrek 2. I standby my assumption that the film will gross over $400 million domestically.

Based on early international box office reports, a total of over $500 million abroad seems in the cards. In fact, with the film still only open in about 1/3rd of its foreign markets, Variety speculated the international haul could exceed $600 million making POTC the third ever film to cross $1 billion worldwide (Titanic, $1.8 billion; Return of the King, $1.1 billion).

Despite a solid weekend for POTC and in line openings for the two new films, Little Man and You, Me, and Dupree, total weekend box office fell for the first time in 8 weekends. The decline of 7% is nothing for box office bulls to be alarmed about. Last year, two of the summer's most popular movies, Charlie and the Chocolate Factory and Wedding Crashers both opened. Additionally, not be lost is the fact that the prior weekend was up an astounding $70 million, or 46%, from a year ago, and this past weekend was up 7% from 2004.

Year-to-date box office is up over 6%, implying attendance growth of about 3% this year for the supposedly dying theatre business. That myth will suffer another blow this weekend when I expect comparisons to return to positive territory. This continues to bode well for Regal Entertainment (RGC), whose shares have performed very well relative to the market's decline. I guess I'm not the only one who sees value.

Cars Not Quite As Good As Expected; Overall Box Office Up Again

Cars opened at the low end of expectations with $63 million failing to provide a catalyst I had been counting on for Disney (DIS). I think the opening will hurt sentiment for DIS stock because it will make it easy for naysayers to get traction with the "they overpaid for Pixar" theme. However, DIS shares fell sharply late last week as expectations for Cars starting to come in so I don’t think there is a lot of downside left relative to the market unless the film drops much more quickly than expected at next weekend's box office or weekday grosses with kids now out of school are weak.

I am staying long DIS for Northlake clients because I think fundamental momentum is excellent with ABC, ESPN, the TV stations, the movie studio, and the theme parks all performing very well. Additionally, the shares could get another pre-opening lift ahead of the release of the summer's most anticipated movie, Pirates of the Caribbean: Dead Man's Chest , due in theatres on July 7th.

The overall box office was healthy again for the weekend, up vs. last year for the fourth straight weekend....

The top 12 films grossed 8% more than last year and all films in release were up 4%. Remember, $63 million is a huge opening and only for a Pixar film is that considered a disappointment. The weekend saw 5 films gross over $10 million with none of the leading films showing unusual declines. The top ten was filled with films appealing to all important demographic groups supporting my contention that if there is decent product the box office can still grow at its historic rate.

Year-to-date the box office is now up about 5%, with the second quarter tracking for a double digit gain. Comparisons remain easy for the next 6 to 10 weeks, so I am also sticking with my long position in Regal Entertainment (RGC). RGC went ex-dividend last week on its 30 cent quarterly payment. The shares are down about 5% before the dividend since I made the initial purchases for Northlake clients. I remain confident that a target in the $23-24 range is realistic as summer box office momentum sticks.