No one likes a negative Nancy, so I decided to take a break from our Dumb Investment of the Week series and write a positive article for a change. Don’t worry. I’ll be back with more pessimism next week.
As the US stock market has risen ever higher over the past few years, the valuations of many companies have gone from cheap to reasonable to overvalued. At Strubel Investment Management, we have increasingly been turning to overseas companies for value. Recent events in the Ukraine and Crimea have put Russian companies on sale at a discount of anywhere of 10% to 30% from their pre crisis prices.
One company in particular intrigued us: CTC Media (NASDAQ:CTCM). CTC Media is Russia’s largest independent media company. Three other large companies—Gazprom-Media, VGTRK (Rossiya), and National Media Group—all have varying degrees of government- or state-sponsored enterprises as significant owners. Additionally, Channel One, a popular television channel, is directly controlled by the government, which owns a 51% stake.
CTC Media operates three free over-the-air television channels in Russia: CTC, Domashny, and Peretz as well as Channel 31 in Kazakhstan.
CTC channel offers entertainment programming that targets viewers from age 10 to45, and families. Domashny is a women’s lifestyle channel, targeting female viewers age 25 to 59. Peretz targets 25- to 49-year-old viewers and offers “edgy, thrilling, and action content.” Channel 31 airs a variety of programming and targets viewers from 6 to54years old.
Together, these Russian channels scored a combined 15.1% audience share in the 10-45 demographic in 2013Q4, giving it second place among its competitors. In first place was Gazprom-Media stations with 22.7%, third place was VGTRK (Rossiya) with 12.4%, in fourth was Channel One with 11.4%, and in fifth place was National Media Group with 8.4%.
CTC Media airs both original programming and rebroadcasts licensed programming from other sources and realizes almost all of its revenue from advertising sales.
While the television market in Russia (and worldwide for that matter) does face some challenges, let’s start with what we like about the company.
What We Like about CTC Media
Competition Is State Run
The most interesting thing about CTC Media is that its largest competitors are all state run or have significant state ownership. The world of entertainment is fast paced with fickle audiences and ever changing tastes. I believe CTC’s independent, creative individuals have the freedom they need to create programming that best resonates with audiences. The other type of programming that seems to be successful (at least in the United States) is the loud, large, commercially driven blockbusters. (Think Transformers, the endless Star Wars movies and shows, etc.) I have yet to encounter state run and state controlled media companies that consistently produce content that audiences prefer to alternatives.
Over the past decade in Russia, we have seen audiences migrate away from the big state run channels to newer independent channels.
The slide below from CTC Media’s FY2013 year-end presentation shows just that. (CTCM is considered second tier in the graph below.)
The major state run channels lost almost 20 percentage points in audience (10 to 45) share over a decade. The major beneficiaries of the shift have been second tier and non-FTA (free to air) channels. While the increasing irrelevance of the state run media companies offers an opportunity, it is a double-edged sword as CTCM now faces increased competition from other independent channels. We will cover these threats in the section on Risks.
One of the biggest problems in the corporate world today is out-of-control compensation that rewards empire building and the obsessive focus by investors and Wall Street on top line sales growth. These factors have created a culture that encourages companies to use shareholder cash for acquisitions rather than returning it to shareholders via dividends.
A 1999 KPMG study found that “83 percent of mergers were unsuccessful in producing any business benefits regarding shareholder value.” A McKinsey & Company study (no date given) found that 61 percent of all acquisition programs were failures because the acquisition strategies did not earn a sufficient return on funds invested. Here are some other quotes about the dismal rate of success from mergers and acquisitions: “70 percent of mergers fail to achieve their anticipated value…” from Weekly Corporate Growth Report. “Most [mergers] fail to add shareholder value…” from Harvard Management Update.
What is attractive about CTCM is that they return almost all excess cash to shareholders via dividends and share buybacks. While we’re not a big fan of share buybacks, I do like CTCM’s habit of paying a substantial dividend. Unfortunately, CTCM has yet to commit to a formal dividend policy
Clean Balance Sheet
CTC Media also has something that is virtually unheard of in media companies (or virtually any industry for that matter): a debt free balance sheet (as shown below).
While modern financial theory would tell you that CTC Media is being run sub-optimally, I disagree. CTC has maximum financial flexibility to take on the changing TV landscape in Russia and is well positioned to survive any economic turmoil.
Large Western Investors
One of the biggest risks in investing in Russia is that Russian companies tend to be run for the benefit of the state; Western investors are simply along for the ride. While most Western companies are run to enrich the pockets of the top executives, it is rare to see significant government interference. In Russia, Putin and a tight circle of oligarchs make the rules. Run afoul of them, and bad things will happen.
CTC Media counts two Western companies as large shareholders: (1) Modern Times Group, a Swedish media conglomerate, owns 38% of CTC Media; and (2) Telcrest Investments owns another 25%. Both groups have three members on the board of directors, including a co-chairman. These two large investors give Western minority owners (although Telcrest Investments investors include several Russian entities including Bank Rossiya) two deep-pocketed institutional shareholders in their corner, should something happen.
While CTC Media is an attractive and well-run company, it is not without several risks.
Risks for CTC Media
Fragmenting TV Market
The greatest risk to CTC Media is the increasing fragmentation of the television market in Russia and the rise of mobile devices.The chart from the previous section depicting the fragmentation for the Russian TV market shows that while CTC is gaining share on the three state-controlled media companies, a host of competitors are cropping up and gaining share as well.
Among all audience shares, CTC has lost ground over the past five years, dropping from 9.0% share to 6.7% share.
This is tempered by the fact that CTC Media has been somewhat successful in gaining share in specific target markets as shown below.
Both Peretz and Domashny have gained share over the past three years, and the decline in CTC is less severe among the target market. Also tempering these risks is the fact that advertising rates have increased enough to offset the loss in market share.
Below is the advertising revenue growth for CTC Media for the past three years.
Transitioning Shareholder Base
Another risk for CTC Media investors is that the company does not slot nicely into one of the few “shareholder niches,” such as growth stock, dividend stock, value stock, and so forth.
Previously, the company met the requirements for a growth stock. Audience share was rising and revenue and income were rising rapidly along with it. The company had a high growth phase from 2002 to 2008 before the recession hit. Over the last few years, the company’s growth has slowed, and adjusted operating income has yet to hit prerecession levels.
The data used for the chart is below. Impairment charges were excluded from operating income because the goal was to show the underlying performance of the company in regards to revenue and income.
The stock has fallen sharply from its highs, the P/E multiple has dropped to below 8, and the dividend yield is now almost 8%. The problem is the company does not fit as a traditional dividend stock either. It has no set payout ratio; dividends are paid based on the whims of the board. Here’s what CTCM’s website says:
CTC Media is a growth company and we are therefore committed to investing in the development and expansion of our operations. We do not have a formal dividend policy but our philosophy is to return an appropriate amount of cash to shareholders when we do not need all of the cash we are generating for investments in the future growth of the business.
Furthermore, the amount of the dividend paid each year varies, so CTCM will never meet the requirements to be included in any of the “dividend aristocrat” indices.
The price of CTCM is likely to remain depressed until the company’s growth initiatives are successful, the dividend policy is formalized, or until enough value investors swoop in. In the meantime, investors may realize some limited upside with a cooling of the situation in Crimea and Ukraine.
While we haven’t made an investment in CTC Media yet, we are strongly considering it.
What do you think?