Over the last 12 months, shares of U.S. media companies, according to Morningstar’s Diversified Media Index, are down by an average of 11%, underperforming the S&P 500 by 15%, due to: 1) lower-than-expected traditional advertising revenue growth stemming from increasing shifts to online and mobile spending, 2) investors’ perception of higher original programming expenditure requirements, stemming from increasing competition from Netflix and Amazon.
Viacom (VIAB) has been the hardest hit among the major U.S./global entertainment studios, declining by 31% in the last 12 months. I am taking a contrarian view; I believe shares of U.S. media companies, including VIAB, will rebound soon. Specifically, I believe investors’ outlook on the staying power (or lack thereof) of traditional advertising is too gloomy, while increasing competition from non-traditional studios represents just a short-term headwind. In particular, I find Viacom Inc. (VIAB) to be an attractive rebound play with significant value characteristics. Following are three reasons why I find VIAB to be a compelling value/rebound play. Note: VIAB is currently trading at a forward P/E of 8.6, with a market capitalization of $17.4 billion.
- The 6 major Hollywood studios retain significant earnings power and still dominate the global entertainment industry
By far the biggest concern for media investors has been the proliferation of broadband and mobile devices in developed countries (North America & Western Europe), resulting in a shift of advertising revenues from traditional media to less costly internet and mobile advertising, as well as a phenomenon known as “self-service rebundling,” where customers can cherry-pick content from online streaming services to create their own personalized bundles, leading to a wave of cord-cutting.
The recent underperformance of VIAB and other U.S. media stocks is certainly discounting such a scenario, but I believe such concerns are overblown. The number one reason is that “content is king,” meaning that customers are still willing to pay for top-quality content, the latter of which includes Hollywood-produced movies, ESPN-, Nickelodeon- and MTV-produced programming, as well as branded merchandise. This is evident from the industry’s record-high EBITDA margins of 27% (source: Standard & Poor’s), 5% higher from decade-ago levels. Within the North American film market, the 6 major Hollywood studios, i.e. Paramount (part of Viacom), 20th Century Fox, Warner Bros., Columbia, Universal, and Walt Disney Studios, have actually increased their market share; today, their combined market share is the North American box office is 80-85%–up from a trough of 64% (for the then 6 classic major studios) in the mid-1980s.
Most importantly, the size of the global media spending pie will continue to increase. McKinsey projects global media spending to rise from $1.6 trillion in 2014 to $2.1 trillion in 2019, a 5.1% annualized increase. Meanwhile, traditional TV advertising spending is still slated to grow at 5.1% annually, in line with the industry average. Encouragingly, cinema (box office) spending is projected to grow by 5.4% annually, above the industry average. The 3 main categories that are forecast to underperform include: consumer magazine publishing (-1.6% annually), newspaper publishing (-0.1%), and consumer books (+1.0%), none of which materially affects VIAB’s businesses.
- 2. Favorable growth and media spending trends in developing countries
As recent as 2014, traditional TV advertising spending (estimated at $183 billion) still made up 38.7% of overall global advertising spending; by 2019, this is estimated to hit $234 billion, for an annual growth of 5.1%. I.e. despite the proliferation of digital advertising, traditional TV advertising will still play a major role, thus benefiting VIAB and other major studios. This is mainly driven by ongoing, healthy growth in traditional TV advertising spending in developing countries. In addition, VIAB’s management asserted in the latest earnings call that they noticed a recent shift back to traditional TV advertising, given the increasing presence of “bot traffic” on the internet and the fact that digital advertising “has not generated the desired results” for advertisers.
VIAB’s sustained strength in its foreign operations support this thesis. E.g. despite the recent softness in its domestic advertising revenues, VIAB boosted international advertising revenues by 6% year-over-year on a constant currency basis for the six months ending March 31, 2016. International revenues make up only 19% of VIAB’s advertising revenues but with the firm’s reach of 510 million households in 180 countries, VIAB’s international operations will be a significant driver of both revenues and earnings going forward.
In addition, global box office revenues are projected to grow by 5.4% annually, from $37.1 billion in 2014 to over $48.3 billion in 2019; 34% of this growth will be driven by the rise in the Chinese box office, where VIAB and the major U.S. studios will earn a substantial portion of their revenues.
- 3. VIAB’ valuations are attractive
VIAB is trading at a 12-month forward P/E ratio of 8.6, which is 40% below its 14.1 five-year average multiple from 2011-2015. The firm expects its recent drop in domestic advertising revenues to be temporary and for its U.S. ads market to improve due to improved ratings at its MTV and Comedy Central subsidiaries, as well as improved ad targeting capabilities. I expect VIAB to grow its EPS by 10% over the next 12 months, especially as foreign exchange headwinds contract. Because of this, I believe its P/E ratio of 8.6 is too low. Applying a conservative P/E of 10, on a 10% higher EPS, I expect VIAB to rise by at least 20% over the next 12 months, equivalent to a stock price of $53 a share.
Disclosure: Neither I nor does my firm, CB Capital Partners hold any shares in VIAB.
Henry To, CFA, CAIA, FRM is Partner & Chief Investment Officer at CB Capital Partners. Established in 2001, CB Capital Partners is a global financial advisory and investment firm headquartered in Newport Beach, California, with an office in Dallas, Texas, Shanghai, China and an affiliate office in Mumbai, India. Visit http://www.cbcapital.com and http://www.cbcapitalresearch.com for more information.
