SG Cowen report on Viacom, Inc. - $100 price target
(VIA’B: $75)
The Leader In Growth, Free Cash Flow Generation; $100 Target
Viacom is the fastest growing company in the major media sector. It has the highest
percentage of free cash flow to EBITDA ratio—a significant differentiating factor. Moreover,
its businesses are the least capital intensive. Viacom’s new scale provides it with a
significant competitive advantage that will foster future growth. Its numerous media
businesses are U.S. and global leaders and management wasted no time in utilizing its new
multi-platform strength. For example, it has cross-promoted its Survivor TV show, and
“wrestling” franchises like WWF away from competitors. Viacom has made itself more
important to its customers—viewers, advertisers, and program producers—through its
newfound scale, which can create new revenue opportunities for growth and economically
spread costs over a larger distribution base. Viacom’s core businesses are focused on the
fastest growing and highest profit businesses in the industry: cable networks, radio, and
outdoor advertising. These account for 58% of total cash flow. Add television and 80% of its
businesses are high free cash flow generators. We expect Cable Networks and TV to
produce significant revenue enhancements and cost savings. We increased our price target
from $85 to $100, based on 22.5-23x 2002E EBITDA.
Fastest Growth, Greatest Free Cash, Highest Profitability Among Majors
Cable Network, Radio Broadcasting Are “Sweet Spots” In Media
Multiple Platforms Attractive To Advertisers, Viewers, Programmers
Redstone And Karmazin Focused on Building Shareholder Value
Financial Flexibility To Further Build Value
Fastest Growth, Greatest Free Cash, Highest Profitability Among Majors
Our December 12 merger report on Viacom/CBS coined it “The One to Own.” There is no change in
our thinking: Viacom is the fastest growing major media company, and generates the highest
percentage of free cash flow from EBITDA among its peers, making it a standout investment. We
forecast that cash flow (EBITDA) could grow by 19% annually through 2002; free cash flow is also
forecast to rise at a 19% rate. Viacom has very low capital spending needs, making it an efficient user
of cash. We estimate capital spending as a percent of sales at just 3%, compared with an average of
7% for its peers. Capital spending, as a percentage of its EBITDA, is only 14% for Viacom compared
with an average of 38% for its peers—40% for Disney. This leaves it with the greatest financial
flexibility to buy back stock, reduce debt, or make acquisitions.
Cable Networks And Radio Broadcasting Are The “Sweet Spots” In Media
Our investment recommendations in the media industry have consistently focused on cable
networks and radio broadcasting, the two fastest growing and most cash efficient segments of
media. In one stroke, the merger of Viacom and CBS created the best of both worlds. Viacom’s
cable network management will be able to improve the results and create new growth
opportunities at CBS’s cable networks. It should extend the reach of CMT (Country Music
Television), which is in about 40MM homes. The expert TV station management of CBS should
help improve the performance of the Viacom TV stations, especially in key areas such as news,
where CBS brings expertise. The Infinity radio broadcasting unit should show rapid growth on
its own and could benefit from cross-marketing at MTV, VH-1, and other brands.
Multi-Platforms = Viacom Critical To Advertisers, Viewers, Programmers
We cannot overestimate the importance of the balance and diversity of Viacom’s media properties.
The company has a strong blend of national network properties with large viewing audiences,
making it very attractive for advertisers. The combination is also very attractive for content providers
because it can create value over these multiple platforms that smaller media companies cannot
match. For advertisers, Viacom offers Nickelodeon, MTV, and VH-1 to play the demographic scale
from ages 2-52; TNN and CMT from CBS will complement the respective VH-1 and MTV demos.
While the CBS Network offers massive reach, the combined Viacom cable networks offers targeted
demographics and scale. The ability to package these networks to an advertiser and customize
advertising to provide a solution to the customer is very special. Add Infinity and Outdoor Systems,
and the CBS Plus advertising organization should have a field day in developing programs for its
clients. For programmers, Viacom offers a similar “one stop shop.”
Redstone And Karmazin: Focused On Building Shareholder Value
An expert and skilled management team runs Viacom, led by Chairman and CEO Sumner
Redstone, and President and COO, Mel Karmazin. Their expertise and leadership is a primary
reason for our recommendation. Viacom has evolved during the seven years we’ve covered it;
i.e., its acquisition of Paramount and Blockbuster. Redstone essentially acquired the Paramount
Studio assets for free after selling Madison Square Garden ($2.2B) and Simon & Schuster
($4.4B). He also sold the Viacom radio stations at a top price of $1.7B. At Blockbuster, he
reinvented the business through revenue-sharing, which increased profits and cut capital needs
in half. We have covered Karmazin’s Infinity Broadcasting since its first IPO in 1986. He has
been the single biggest value creator in media. Karmazin is Viacom’s second-largest individual
owner with 13MM shares and options. Pairing his operating and strategic skills with his new
charge’s diverse asset base should provide a rewarding situation for investors. New Catalyst: Int’l Cable Networks Could Become Future Growth Driver
Viacom is in the early stages of generating meaningful profits from its international cable
networks in Europe and Asia. After several years nearing profitability, the effort made $50MM
in 1999. International distribution is expanding rapidly: MTV International alone reaches
240MM subscribers, up by 10% Y/Y. This compares with 87MM subscribers in the U.S., which
grew by 5% Y/Y. Worldwide, including the U.S. Nickelodeon and TV Land reach 157MM
subscribers, up by 15% Y/Y. Looking ahead, we believe that the networks could show geometric
growth in profitability. The years of building a national, pan-European, and Asian distribution
infrastructure, cementing local partnerships, and getting reach have come to fruition. Variable
costs, like labor, are relatively low. Programming costs for music, lifestyle, and children’s fare
are modest (unlike expensive sports rights). Today, with advertising growing at rapid 25-50%
annual rates, revenue expansion becomes very profitable. We understand that each international
effort, with the exception of a few Asian channels, is either making money or break-even. Thus,
as international cable gains more critical mass, we believe that investors will focus on it more
and more. With over $1.5B of cash flow at the domestic networks, international is below
analyst’s radar screens, but we believe that will change.
Financial Flexibility To Further Build Shareholder Value
Viacom has a very strong balance sheet, one of the leanest in the industry. It has a low debt to
cash flow ratio of about 2x; 4-6x multiples are common. Viacom continues to buyback large
amounts of stock using its free cash flow as Infinity does. Absent new and accretive acquisitions,
there is little motivation to reduce debt on an under-levered balance sheet. The public offerings
of Infinity Broadcasting and Blockbuster Video left Viacom with relatively low debt, as well. Our
current estimate of pro forma long-term debt is about $10B, giving the combined company
approximately $10-15B in excess debt capacity (assuming 5x debt/cash flow leverage, and
excluding additional cash flow from potential acquisitions) and an investment grade rating. A
high-valued currency in the form of Infinity stock, and a potentially valuable currency that
could be created by expected-Internet offerings, should create ample financial leverage—
management may effect share buybacks or significant, accretive acquisitions.
New $100 Price Target Implies 35% Appreciation Potential
We believe that the shares offer substantial price appreciation potential; therefore, we have
established a new 12- to 18-month price target of $100. This is based on an enterprise valuation
multiple of 22.5-23.0x 2002E EBITDA, a 20% premium to our forecasted 19% cash-flow
growth. This is within a 52-week multiple range of 13-27x. Viacom’s high free cash flow
generation, at 46% of EBITDA, is superior to its peers, which average 25% at Disney, Time
Warner, and News Corp. Those stocks are valued at a 30-50% premium to estimated growth
rates. In comparison, Clear Channel and Infinity, which generate 55-60% FCF/EBITDA, are
valued at 60% premiums to estimated EBITDA growth rates, even with the stocks off 20% from
their highs. Thus, we believe Viacom shares could trade closer to the broadcast valuations,
rather than the more capital intensive theme park, cable system, and newspaper operations of
other global players. In this context, our valuation and new price target may prove conservative.
We continue to strongly recommend purchase of Viacom stock. Our recommendation is based on a
mixture of positive momentum; the strength of the merged company’s high-quality cable network
and radio and TV broadcasting assets; and, the industry’s best-run run film studio (highest margin).
Moreover, we believe that the shares have unusually strong appeal because of the outstanding scale
and operating efficiencies we expect from the merging of the respective broadcast and cable network
operations. Viacom’s free cash flow generating characteristics are also superior to those of other
major media companies. Based on our price target, we believe that investors could anticipate returns
of 30-40% annually.
Superior Financials Produce Superior Returns: $100 Price Target
Our new 12- to 18-month price target for Viacom is $100 per share is based on an enterprise
value multiple of 22.5-23x 2002E EBITDA, and is up from the $85 target we set on April 28. At
that time, we forecasted 17% growth for the combined company. Our rationale, discussed
below, is based on comparing Viacom against itself and relative to its peers. The stock is trading
at an enterprise value multiple of 22x our 2000 EBITDA estimates and has traded in a 13-27x
multiple range over the past year; it is currently at 28x trailing 1999 results. Viacom stock
trades at a modest 14% premium to our 19% estimate of its growth rate. Our $100 price target
and 22.5-23.0x valuation multiple equates to just a 20% premium to its estimated growth rate.
Our analysis shows that on an absolute basis and relative to its peers, this appears very
reasonable. (See the table “Superior Financial Position Relative to Competitors” on the inside
cover of this report.) We estimate that Viacom will generate a very high percentage of free cash
flow to EBITDA, materially more than its global peers will. At a 46% rate of FCF/EBITDA it
compares well with Clear Channel and Infinity’s 55% and 59% respective FCF/EBITDA ratios.
Those companies are accorded enterprise value multiple premiums of 60% to their growth rates
by the market (even at current levels down 20% from their respective highs). In comparison,
Disney trades at a 20-45% premium to our 13-14% estimate of its growth rate, News Corp. stock
trades at a similar premium valuation to estimated 12-13% growth, and AOL/Time Warner is at
a 4-25% premium to 25% forecast growth. However, these companies generate proportionately
less free cash flow (15-38%) relative to their EBITDAs. Given that 80%+ of Viacom’s businesses
are high free cash flow businesses, we believe that companies like Clear Channel and Infinity
provide more relevant comparisons than capital intensive businesses in theme parks,
newspapers, and cable systems. The combination of rapid growth, high free cash flow
generation, and the ease of the merger with CBS, makes Viacom a leader in the group. |
