Hi! Welcome to Part 2 of Yet Another Guide to media stocks. This part will cover the networks. Before diving in, I'd highly encourage you to check out the intro section to the guide, which goes over why I'm doing this and dives into the most important thing hitting the media sector today: cord cutting. You can also find links to all of the pieces in this series here.
That out the way, on to part 2: the networks.
The networks are what you generally think of when you think of TV: the big 4 networks of CBS, FOX, ABC, and NBC. All are interesting, but from an investor's standpoint the most interesting are FOX and CBS. Why? Well, NBC is owned by Comcast and a small-ish piece of Comcast's overall value; similarly, ABC is owned by Disney and is a small piece of its overall value. Fox and CBS are major pieces of their publicly traded companies, and so investors can more or less "bet" on them by buying their stocks. So this article will tilt a bit heavier towards those two.
Let's start with a brief overview: the networks provide programming to their broadcast affiliates (who I discussed in part 1). This includes prime-time programming (think NCIS or The Good Place), as well as sports (NFL), national news, and late night shows (The Tonight Show). In most of the major metro markets (NYC, LA, Chicago, etc.), the networks also own their local broadcast affiliate, but that is a seperate business that can be analyzed and valued separately.
Networks make their money from two places: advertising and reverse retransmission fees. A reverse retrans fee is the fee that an affiliate pays the network for their affiliation; for example, Nexstar might pay CBS $1/sub for the right to be a CBS affiliate / carry CBS programming. Why would Nexstar pay CBS? Because Nexstar gets $2/sub from the local cable company in retrans fees, and they'd get a heck of a lot less if they weren't a CBS affiliate (note that I'm just using hypothetical numbers to make the math / visualization super easy).
I think the easiest reason to be bullish networks is they get way less money on a per eyeball basis than most cable networks. I pulled the chart below from this article (which is worth reading); note that the revenue is every cable channel a parent company owns so you can't really compare across companies (i.e. Disney includes ESPN, ABC, Disney Channel, etc.). The two I want to focus on are AMC and CBS. AMC owns AMC, BBC America, We TV, and one or two other niche channels. CBS is CBS (duh), but also CBS Sports Network. (Note: I'm not convinced the CBS numbers on here are perfect, but it's directionally correct so let's go with it). (post publishing note: I added a clarification post further discussing the sub number below)
Consider the ratings here: even ignoring major sports that CBS offers (and ignoring them is a huge task; CBS has the NFL, Masters, March Madness, SEC college football, etc.), CBS programming does multiples of the ratings of AMC. Below is a comparison of CBS ratings versus AMC (from tvseriesrating CBS and AMC page); impressively, CBS's least watched shows appear to have more viewers than AMC's blockbuster Walking dead, and the viewership numbers get wildly different from there. To be fair, The Walking Dead rivals CBS's shows in terms of viewership in the all important 18-49 demo, but if you're a cable company looking to retain video subs, doesn't having more overall viewers (particularly among older viewer who are paying the bills) matter more than having one show that is popular with the youths?
CBS made the point slightly differently in their CBS / VIacom investor presentations: the combined CBS / Via is responsible for 22% of viewing, but gets just 11% of affiliate / retrans share. That's a huge opportunity going forward, and one that I think could be aided by the increase in D2C services. I'll just show one simple example: CBS All access costs $5.99/month with ads, or $9.99 without ads. No cable company pays CBS even close to that much on a per subscriber basis, but I would guess a substantial minority of cable companies' viewership watches CBS. If someone cuts the cord and signs up for CBS All Access, that's a mammoth boost in revenue for CBS, even before factoring in that an All Access sub gives CBS a direct consumer relationship (tons more data) and allows CBS to increase their advertising inventory (they no longer need to give the cable company ad slots).
So the big bull thesis for the networks is pretty simple: they get paid a lot less on a per eyeball basis than anyone else, and if they can correct that over time their payments should go up. You can see lots of different avenues for them getting paid more: going D2C, skinny bundles (bundles of ~10 channels; because the skinny bundles lack legacy distributor's pricing power, they generally pay higher fees), or simply running a blackout or two until distributors pay them more. (Note that this is a very similar argument to what DISCA makes; I'll talk about DISCA in a different post but for a variety of reasons I like the argument more for CBS than DISCA. The main one is that I think a lot of DISCA's programming can be easily replaced for free online (i.e. Food Network can be partly substituted with free YouTube videos, and it doesn't take that much for personalities to launch their own food oriented youtube channels), but the same doesn't hold for CBS).
The bear thesis for networks includes a lot of the points I detailed in the local broadcaster post and intro (cord cutting, advertising revenue declines, etc.), so I won't rehash them. However, they include one other major point worth highlighting: sports rights fee escalation. This risk comes in two forms:
So sports are clearly a risk. However, I'm not sure if the risk is as bad as people think. Say CBS lost the NFL. They currently pay ~$1B/year for the NFL. They can take that money and spend it elsewhere: original programming, more college football, etc. The network would still have March madness (through 2032), the Master and PGA Championship (through 2030), some big live events (Grammys, Tonys), and the SEC (through 2024), along with the most popular original programming on television. Obviously that's weaker slate without the NFL, but honestly it's probably a better slate than ABC currently has.
Ok, hopefully I've covered the risks and some sources of upside for the networks. Let's talk valuation.
I'm going to show the valuation for CBS here. Fox isn't that different than CBS in terms of valuation; I've got them trading at ~9x EBITDA and ~10x unlevered FCF, and lower if you adjust for some extra goodies (they own their studio lot in LA, which is worth >$1B, they've got a tax shield worth >$2B, and they've got a substantial stake in Roku). So most of what I say here will apply to FOX.
There are a few ways to look at CBS's value. The first would be to simply value the whole company; they look pretty cheap on those metrics.
You could also do a SOTP if you wanted. NXST trades for 7-8x EBITDA, so you'd probably value local at around that. Entertainment and Cable Net are tough cookies; there's no perfect pure play comp for either, and historical transaction multiples are pretty high (T / TWX was 12-14x and is probably the best comp, but CBS itself is a much better asset than TNT / TBS / CNN, while HBO is a way better asset than showtime). Publishing (Simon and Schuster book publishing) probably deserves a pretty low multiple, though you could talk yourself into it having some strategic importance (publishing books gets you a foot in the door / first look at potential future IP). Anyway, I'm not going to put a SOTP here, as I don't think any of the parts are so different that it materially changes the overall multiple / valuation. I just wanted to point that out. There has been some buzz that the new CBS will sell off some noncore assets, so a SOTP might be more meaningful than normal...
There are three other complications to CBS's valuation. These are more company specific than sector specific, but I wanted to touch on all of them.
First, political spend. CBS's LTM earnings capture the tail end of 2018 political spend. To account for the cycles in political revenue, it's probably more accurate to look at local and maybe even entertainment on 2 year average earnings. As I've noted before, 2020 is probably going to be a blockbuster year for political advertising, so earnings should have some natural tailwinds in the near future.
Second, investment into D2C. CBS and most content companies are making huge investments their D2C apps. This investment comes in three forms: first, the actual investment needed to launch a D2C app. Think tech spend, marketing, customer acquisition costs, etc. Second, they are mammothly stepping up their investment into content to make their consumer apps viable. The company is making a bunch of new originals shows for both CBS and Showtime (Why Women Kill, tons of Star Trek shows, etc.). Those shows cost money (on their Q3'19 earnings call, CBS noted that content spend was up ~20% YoY ), but they probably will represent a good investment long term as they continue to build the CBS All Access App / Showtime D2C business. Third, they are forgoing licensing revenue to get more content onto their apps. Think of NBC pulling Parks and Rec and The Office from Netflix to bring it onto their new app. I believe Netflix was set to pay ~$100m/year for each of those shows. That's $200m in very high margin revenue that NBC is forgoing in order to build out their own app. CBS owns a bunch of classics (Cheers, Star Trek, Twin Peaks, CSI) and some of the most popular shows currently on TV (NCIS). Are any of those as valuable as The Office? No, probably not. But a lot of them would have a lot of value, and CBS is forgoing that value to build out their D2C app. If I wanted to absolutely maximize CBS's near term cash flow, I think you'd be shocked how high I could get it by shutting down All Access and selling off / licensing the back catalog to the highest bidder. Is that the right move for long term shareholder value creation? I doubt it. But I point it out because I wanted to highlight that CBS is trading at a very low multiple and their earnings are significantly depressed by several expenses / forgone revenue streams that are currently running through the income statement but should create long term value.
Third, CBS in this form won't last for long. The company is merging with Viacom (they will finish the merger tonight; I wrote a decent bit of this around Thanksgiving). I think a lot of people are questioning the merger. I'm surprised by that; yes, Viacom has some headwinds facing it, but there are clear synergies between the two companies and the scale of the two will be important going forward (I believe both Greg Maffei and John Malone said they were surprised by how negative the market was since the merger's announcement.). You can find the CBS / Via proxy here; it includes lots of forward projections. I won't go through them here, but I'll note if you give them credit for some of the synergies they think they'll achieve and simply take the lowest projection for each of the two companies, the new company stock is even cheaper than standalone CBS.
More importantly than the combined companies being cheap, I think there are real near term and long term synergies to having CBS and Viacom together. Viacom owns Nick, MTV, and Comedy Central; that's a lot of potential content that CBS will be able to bring onto CBS All Access. I believe The Simpsons has been the most popular thing on Disney+ so far, and Family Guy is really popular on Hulu. Viacom already licensed South Park to HBO Max and has sold a lot of Nick shows to Netflix in its "arm dealer" strategy, so there's unfortunately no near term upside to putting all of their stuff onto All Access, but there's still a really deep library over at VIA that CBS can use to deepen out All Access. For example, I don't think Chapelle Show or Key and Peele have been licensed yet, and I believe there are plenty of Nick shows yet to be licensed (just last week CBS and Nick announced a bunch of children's programming heading to All Access). Add all of those to All Access the the depth of the inventory starts to look really interesting.. You could also see lots of potential to mine classic Nick shows for future IP in a variety of forms, and while the Paramount movie studio has been mismanaged for quite sometime, it contains a bunch of iconic properties (Titanic, Godfather, Forrest Gump, as well as more commercial stuff like Mission Impossible, Star Trek, and Transformers) that can eventually go on the All Access service (again, adding depth to the inventory) or even be relaunched / remade in the future. Scale is the name of the game in streaming, and you can see how a combined CBS + VIA gets you a lot closer to the scale they'll need to be a viable standalone streaming service.
CBS vs Fox
So far this post has focused on CBS. The most direct investing alternative to CBS is FOX, so I think it's a fair question to ask why not invest in Fox versus CBS?
The first thing to point out is that Fox owns two main assets: Fox the network and then Fox News, and the value of Fox News drastically overwhelms the value of Fox, so much so that an investment in Fox is more a bet on the future of Fox News than it is anything else. Fox's cable segment, which mainly contains Fox news, delivers ~5x the EBITDA of the TV segment, which includes the Fox network and fox affiliates. I don't think this is a completely fair comparison, as Fox recently paid up to get Thursday night football, and they haven't fully reset all their affiliate fees to cover that (so TV earnings are arguably depressed in the near term), but still, Fox news is the big driver here. See breakout of earnings below:
In the present, having the majority of value come from Fox News is a good thing. For a significant minority of America, Fox News is the must have channel and the only source of news they'll trust, but I'm not sure how durable the Fox News moat is. Consider:
So while the near term for Fox News looks good, I think there are a lot of tailrisks to them longer term. Given how big a driver of Fox's earnings they are and how quickly I think the wheels could come off in the tail scenarios, that's a tough bet to make.
Also, if I compared the Fox network to CBS, I simply like CBS's strategy more. Fox is all in on live: news, sports, etc. That's great in the near term, but sports rights will continue to be bid higher and higher until the sports teams take all the economics for themselves (or simply go direct). I prefer a combination of sports and live in the near term with some programming that builds longer term value that can help transition you to a D2c world (like what CBS is doing): major sports rights which force distributors to carry you / viewers to turn in, but then lots of scripted content as well which helps to build up long term portfolio value (i.e. CBS airs How I Met Your Mother or NCIS; those programs go for ten years and gather a following, in part because they're advertised during the NFL. Eventually those programs have a lot of library value). Look at Fox's schedule currently: Thursdays they air Thursday Night Football. Fridays are WWE. Saturdays are college football. Sundays are NFL and their animation domination block (Simpsons, Family Guy, etc.). All of that drives great near term viewing, but none of it drives longer term library rights (Fox doesn't own the rights to the animation block anymore; Disney does); in fact, I believe Fox doesn't own the long term rights to any of the shows on air for them anymore. Contrast that with CBS: basically every day of the week they're airing original programming. That's a whole lot of shots on goal to build up hits / library value. CBS doesn't own all of the content they air, and obviously some of the shows will be duds, but I like that they have some sports rights to force carriage, and then lots of shots on goal to build up library value and potentially release a hit.
Before wrapping this up, I wanted to quickly touch a bit more on advertising. It's easy to focus on things like retrans and reverse retrans, but advertising still makes up a really big piece of network's revenue. Below is a breakdown of CBS's LTM revenue just to give you an idea of how big advertising revenue is.
You can see a bull thesis and bear thesis to the advertising pretty easily. I've basically covered them both already, but to quickly recap: the bull thesis is that advertising demand remains really strong. You can't listen to an earnings call without media CEO's talking about how strong the advertising market is, with both upfront and spot rates growing massively as advertisers are desperate to reach consumers in brand safe ways. In addition, next year's political advertising market is going to be bonkers. The bear thesis is that ratings continue to decline, and eventually advertisers aren't going to pay up to reach a declining audience (right now price increases are more than making up for eyeball decreases, but eventually that can't hold. If price stays flat, we're going to see mid-single digit declines (or more!) given the drop in eyeballs / ratings, and if we ever see a recession and pricing declines, look out below...).
I'm much more worried about the later than the former, but I do think there's some interesting upside to advertising as we move more and more into a D2C world. AT&T highlighted this when they bought Time Warner, but the ability to use cable channels for targeted advertising has the possibility to dramatically increase advertising rates. Again, I'm more worried about advertising revenues declining than I am excited about advertising increasing, but I figured it was worth highlighting because there's pretty large upside there.
Odds and ends