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Why Diversification Is the MVP of Television Broadcasting
Posted by: Patricio Kehoe (IP Logged)
Date: October 23, 2013 10:19AM

The television broadcasting industry has suffered from the changes caused by technological innovation. Free internet platforms have become as popular as pay TV when it comes to video content consumption. However, while CBS Corporation (CBS) has its business web well spun, News Corporation (NWSA) seems to be swimming in a sea of uncertainty.

High Rate Programming and Advertising Gold Mine

With the entertainment segment as its pot of gold, CBS is the largest platform for original programming worldwide. It is also the home to names like Showtime, Simon & Schuster and CBS Television Networks. In addition, 50% ownership of CW, in a joint venture with Time Warner, gives this company a sustainable competitive advantage in the video content creation for television. Popular drama series, such as “CSI” or “NCIS” have generated a steady revenue stream, generating additional income through advertising.

Reaching 10% of all households without pay TV, and with record high broadcast ratings, this firm is a highly attractive platform for launching new shows and drawing in revenues. Since the potential audience for national broadcasters, like CBS, is much larger than that of cable networks, they receive much higher advertising rates. And that’s not all. The company has recently landed an agreement of retransmission fees from pay TV cable networks. Hence, when cable networks air shows, CBS receives a piece of the pie.

Also, when it comes to strategic business deals that diversify revenue streams, I think this broadcaster is a real winner. Streaming agreements for its CW content with Hulu and Netflix, as well as the renewal of its broadcasting rights with the National Football League (NFL) until 2022, are highly beneficial strategies. Furthermore, the firm’s 50% stake in TV Digital Guide is bound to boost the digital business segment, leading to an increase in positive cash flow levels.

It seems that investment guru Joel Greenblatt also feels bullish about CBS’s future, since he’s been buying large amounts of shares lately. However, since the stock is currently trading slightly above the industry average, at 21.3 times its trailing earnings, investors must take the price premium into account. This firm also offers an attractive annual dividend yield of 0.86%, therefore enhancing shareholder return on invested capital.

A Company Split That Raises Risks

What do Fox Sports Australia, The Wall Street Journal, The Sun and The Times (UK) have in common? They all belong to the new version of News Corporation. The recent company split in July. Strongly motivated by the discontent of investors, it separated the newspaper business from the entertainment segment. So, like most business models in the media sector, the corporation’s success will depend on its ability to deal with the challenge presented by new technologies.

News Corp is based in the UK and the U.S., yet a new revenue source has appeared from its activity in Australia. Its two main assets with solid growth prospects are REA Group, an online real estate market giant, of which it owns 61%, and pay TV distributor Foxtel. In this case, the firm entered a 50/50 joint venture with Telstra. The dominant cable sports channel nationwide, Fox Sports Australia, is also under the company’s wing. These new additions to the firm are meant to counteract the expected decline in sales in the print business.

However, pay TV penetration in Australia barely grasps one-third of total households. And since the current subscriber rate is minimal, it’s not safe to assume that these assets will be able to balance out losses in other sectors. Also, the fact that 60% of the company’s operating profit derives from the information segment is alarming, given the secular headwind this branch is facing. Additionally, the majority of newspapers are available online free of charge, putting the print industry at a competitive disadvantage.

Even though the firm’s Foxtel business leads the market as the only pay TV provider in Australia, it still depends on a substantial increase in household penetration. Also, with 49% of the corporation’s revenue income deriving from advertising, it’s highly vulnerable to shifts in the local economy. Investment gurus Daniel Loeb and Steve Mandel are well aware of the investment risk in News Corp, therefore they reduced their stake in the company by 40%. And I would advise to follow that path.

Diverse Entertainment Clears the Table

After analyzing these two industry players, I believe that CBS is the better investment option. A diversified structure, high audience ratings and the acquired rights to air valuable content like the NCAA’s March Madness, makes it a bulls-eye target for advertisers. This combination has resulted in high revenue and a healthy cash flow balance. Although News Corporation has a sixty year trajectory, its division left the company in a fragile state, depending too much on the print industry. Furthermore, News Corp is far more vulnerable to sudden macroeconomic shifts.

Disclosure: Patricio Kehoe holds no position in any stocks mentioned.

Guru Discussed: Daniel Loeb: Current Portfolio, Stock Picks
Joel Greenblatt: Current Portfolio, Stock Picks
Stocks Discussed: CBS, NWSA,
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