CBS Corp: Navigating the Media Challenges Well

In my last article I shared my thoughts on media companies in general. Here I will briefly introduce CBS Corp. (CBS, Financial) in terms of business model, how it has positioned the company to industry changes, earnings growth driver and risks. This should by no means be construed as a recommendation. My intention is to discuss qualitative factors.

CBS Corp. is a leading mass media giant. It has a broad asset mix of broadcasting networks, television stations, premium cable networks and TV production studios. The company is going through a multi-year transition from a heavy advertising-dependent model to a more diversified and higher margin revenue mix model. CBS’s growth in the next few years is very visible and predictable, driven by retransmission and reverse compensation growth, international syndication and licensing fees growth, and continuous expansion and monetization of the new digital distribution channel.

CBS has operations in the following segments:

• ENTERTAINMENT – 61% of consolidated revenue and 46% of consolidated operating income: The entertainment segment is composed of the CBS Television Network; CBS Television Studios; CBS Global Distribution Group (composed of CBS Studios International and CBS Television Distribution); CBS Interactive; and CBS Films.
• CBS Television Network through CBS Entertainment, CBS News and CBS Sports distributes a comprehensive schedule of news and public affairs broadcasts, sports and entertainment programming to more than 200 domestic affiliates reaching throughout the U.S., including 16 of the company’s owned and operated television stations, and to affiliated stations in certain U.S. territories. The CBS Television Network primarily derives revenues from the sale of advertising time for its network broadcasts. In addition, the CBS Television Network’s revenues include station affiliation fees.
• CBS Television Studios and CBS Global Distribution Group: CBS Television Studios and CBS Global Distribution Group produce, acquire and/or distribute programming worldwide, including series, specials, news and public affairs, and generate revenue principally from the licensing and distribution of such programming. The programming is produced primarily for broadcast on network television, exhibition on basic cable and premium subscription services or distribution via first”‘run syndication. First-run syndication is programming exhibited on television stations without prior exhibition on a network or cable service. The company subsequently distributes programming after its initial exhibition on a network, basic cable network or premium subscription service for domestic exhibition on television stations, cable networks or video-on-demand services (known as “off-network syndicated programming”). Off-network syndicated programming and first”‘run syndicated programming distributed domestically, as well as programming distributed internationally, can sometimes be sold in successive cycles of sales known as “first cycle,” “second cycle” sales, and so on, which may occur on exclusive or non-exclusive bases. Generally, license fees may decrease with successive sales cycles due to increased program exhibitions.
• Cable Networks - 16% of consolidated revenue and 33% of consolidated operating income: The Cable Networks segment is composed of Showtime Networks, which operates the Company’s premium subscription program services, Showtime, The Movie Channel , and Flix; CBS Sports Network , a sport cable network focused on college athletics and other sports; and Smithsonian Networks™, a venture between Showtime Networks and Smithsonian Institution, which operates Smithsonian Channel™ , a basic cable program service. CBS’s cable network derives its revenues from subscription fees and the sale of advertising.
• PUBLISHING - 6% of consolidated revenue and 4% of consolidated operating income: The Publishing segment is composed of Simon & Schuster, which publishes and distributes consumer books under imprints such as Simon & Schuster, Pocket Books , Scribner and Atria Books.
• LOCAL BROADCASTING - 19% of consolidated revenue and 27% of consolidated operating income: The Local Broadcasting segment is composed of CBS Television Stations, the company’s 30 owned broadcast television stations; and CBS Radio, through which the company owns and operates 117 radio stations in 26 U.S. markets.
• The CBS Television Stations group principally derives its revenues from the sale of advertising time on its television stations. In addition, the CBS Television Stations group receives retransmission fees from MVPDs for authorizing the MVPDs’ carriage of the company’s owned television stations.
• The majority of CBS Radio’s revenues are generated from the sale of local and national advertising. The major categories of radio advertisers include: automotive, retail, healthcare, telecommunications, insurance, fast food, beverage, movies and entertainment.

How is CBS different?

1. CBS has navigated the U.S. industry concerns admirably and leads that game by a good margin against the rest of the players. It is becoming more clear each day it is most likely going to be the winner with the changing environment, partly because of the nature of the business and partly because Leslie Moonves has done a fantastic job proactively addressing those concerns.

• Skinny Bundle – Skinny Bundle actually helps CBS as the per-channel fee is higher with skinny bundles and CBS is in every single one of them. Showtime and the Movie Channel are premium channels anyway and therefore insulated from the skinny bundle concern.
• Cord Cutting – CBS has captured the cord-cutters with CBS All Access. Although no disclosures on the number have been made public, management has indicated that it has exceeded their optimistic expectation.
• OTT and SVOD – CBS’s best adopted to SVOD and OTT. More syndication deals with SVODs than any other media company. The international market will help CBS further monetize the additional distribution opportunities for its content.
• Rating’s challenge – CBS has held the leading share of the broadcast viewership consistently for many years and had five to six spots in the top 10 prime time viewership shows. Not surprisingly, CBS’s ratings decline is much more muted than the other three Big 4 broadcasters on the Live + SD bases, and CBS’s ratings have improved on the C3 basis. It will only get better with the shift to C7 and the inclusion of more platforms.

2. CBS’s shows, especially the procedurals such as CSI and NCSI, have much better chance of becoming a hit show and thus more syndication opportunities both with TV networks and with SVODs. The licensing and syndication opportunity for CBS Corp (CBS, Financial) through both domestic and international SVODs cable channels is substantial. For CSI and NCSI domestic alone, there will be somewhere between $500 million to $600 million revenue opportunities in the next few years. CBS’s ratings have ranked No. 1 among the Big 4 for 13 out of the past 14 years.

The popularity of CBS’s shows could be explained by a few factors. First of all, CBS’s jockey, Leslie Moonves, who started his career as an actor, came from a creative background, which naturally makes him more focused on the content creation side of the business. Disney’s Bob Iger also came from a creative background. Secondly, a positive feedback loop works in CBS's studio's favor. Great talent create great shows. Great shows achieve great popularity and great ratings, which creates massive reach. CBS can leverage the popularity of CBS’s shows by launching more shows and by monetizing them in multiple ways. More shows and more monetization channels means more money for CBS, which will write a big bonus check for creative talent. If you want money and popularity, you come to CBS because CBS ranks No. 1 in terms of pay and ratings. However, If you want prestige, you go to Times Warner.

3. CBS is much better positioned to grow advertising revenues because one, its ratings are a world better than all other non-sports channels and two, it has successfully pioneered monetizing the mobile and OTT platform with dynamic ad insertion, providing another route for advertisers.

4. The single channel OTT opportunity for ShowTime and CBS All Access. CBS is targeting 4 million subscribers each for CBS All Access and ShowTime with $800 million aggregated revenue by 2020.

5.CBS has less exposure to high-cost sports rights compared to say Disney (DIS, Financial) and Fox (FOXA, Financial).

Earnings growth drivers:

Predictable and high degree of accuracy:

• Retransmission and reverse retransmission revenue growth opportunity

There is high visibility of the growth in retransmission and reverse compensation revenue as most of the multi-year contracts have been renegotiated. I estimate that CBS currently collects more than about $900 million in these revenues and in 2020, it will be able to collect $2 billion revenue from retransmission and reverse retransmission, which flow through bottom line dollar for dollar.

Domestic SVOD syndication for CSI and NCSI – CBS’s management team has indicated that a deal is very likely coming for CSI and NCSI’s syndication with major SVODs. CBS owns 50% of CSI (317 episodes) and 100% of NCSI (258 episodes).

Highly likely, decent degree of accuracy:

1. CBS All Access and ShowTime Single Channel OTT – CBS has demonstrated its ability to monetize the OTT market. CBS’s management team did a fabulous job rolling out CBS All Access, which is $6 per month, targeting the people who don’t have cable TV access, without hurting their relationship with the major MVPDs.
2. International syndication and licensing – CBS’s been growing international syndication and licensing for CBS’s highly successful shows such as CSI. The growth is driven by international pay tv penetration and international SVOD development. Assuming 10% growth for international syndication and licensing, this will add $1 billion incremental revenue and $300 million after tax income in 2020.

Likely but requires a substantial amount of judgment:

1. Advertising growth - Overall advertising volume in the U.S, is mainly driven by economic conditions, pricing is driven by macroeconomic conditions, ratings and availability of inventory. In general, broadcast networks’ advertising revenues have been greatly challenged by the inadequacy of Nielson’s measurement system, the emerging digital platform as well as the viewership shifting to Subscription VOD services, which are mostly ad-free. However, CBS has been the only Big 4 network whose ratings have actually improved despite of the challenges.

Jockey:

CBS’s CEO Leslie Moonves is first class with a respectable track record.According to CBS's website: (link)

Moonves came to CBS in 1995 as president of entertainment, after serving as president of Warner Bros. Television, where his team developed hit shows like “Friends” and “ER.” Once at CBS, Moonves and his team took the network from last to first place in the ratings, launching hit shows like “Everybody Loves Raymond,” “Survivor,” and “CSI: Crime Scene Investigation.”

Moonves was promoted to president and CEO of CBS Television in 1998 and became chairman in 2003. He was later named co-president and co-chief operating officer of Viacom and chairman of CBS in 2004, overseeing domestic and international broadcast television operations as well as its radio division and outdoor advertising operations. In 2006, when Viacom split its businesses into two publicly traded companies, Moonves was named president and CEO of the newly formed CBS Corp., which has since been one of the best-performing companies in media.

Under Moonves’ direction, the CBS Television Network has been No. 1 in viewers for 12 of the last 13 years, and currently has television's No. 1 drama “NCIS”; television’s No. 1 comedy, “The Big Bang Theory”; television’s No. 1 news program, “60 Minutes”; as well as time period-leading shows on virtually every night of the week. At the same time, the company’s premium cable service, Showtime Networks, has generated millions of new subscribers on the heels of its successful owned series, such as “Ray Donovan,” “House of Lies,” “Dexter” and “The Affair,” as well as the critically acclaimed, Emmy- and Golden-Globe-Award-winning series “Homeland.”

What I like about Mr.Mooves is his ability and determination in aggressively positioning CBS to adapt to the changing media landscape. CBS was either the first or among the first to roll out a number of adaptive technologties such as direct to consumer OTT app and dynamic ads insertion.

Risk – industry specific

As I mentioned in my previous article, there are a few very important questions that merit some serious thoughts before investing in media companies. They all apply to CBS.

1. When will the pricing escalator for affiliate fees and retransmission fees reach a tipping point? At what point would media companies lose their bargaining power in terms of getting the pricing escalators?
2. How are the challenges faced by the media companies similar to and different from the challenges faced by the newspaper businesses?
3. Is there a big fat sports right bubble? If so, who is going to be hurt the most?
4. If and when will the current pat TV ecosystem be broken?
5. What is the impact of Netflix, Amazon, Hulu, Sony Playstation Vue and the like on the pay TV ecosystem?
6. To what degree can we gauge the demographics of current subscribers and to what degree this information could be used to gauge the potential rate and magnitude of subscriber loss?
7. How do advertisers view the world? What options do they have? What is the advertisers’ ROI on pay TV versus the other platforms? How will the ROI change with less subscribers and more digital content?

I think the risk to CBS’s biggest growth driver – retransmission and reverse retransmission – is very low as they are contractually agreed upon by CBS and the MVPDs. The risk to ShowTime and CBS All Access roll out is also low as CBS starts from a subscriber base of zero and offers good value for the content. That being said, there are a few company-specific risks, for instance:

1. As CBS still has 51% exposure to the domestic advertising market a severe U.S. recession or severe domestic ratings decline will hurt CBS much more than other media companies who have more international exposures.
2. The nature of content license and syndication business makes it extremely unpredictable. Although CBS’s studio, along with the Warner Bro. studio, have demonstrated their ability to produce more hit shows than the rest of the TV studios, it is not guaranteed that they will be able to continue to achieve the level of hit show rates in the future. Should CBS fail to create as many as hit shows as it has in the past, the domestic and international syndication and license revenue will suffer. In 2014 CBS has about $2.3 billion revenue from syndication and licensing, a 25% decline of this high margin revenue will impact revenue by $500 million.
3. National Amusement controls CBS Corp. On September 29, 2016, National Amusements sent a letter to both CBS and Viacom, encouraging the two companies to merge back into one company. The obvious advantage in doing so is to increase the scale of the combined company. But the downside is also clear - Viacom (VIAB) has struggled badly in terms of ratings and adapting to the changing world while CBS has done a spectacular job in both areas and argubly has better growth potentials than Viacom (VIAB). Overall, I am skeptical of the notion that combining Viacome with CBS would be a winner for CBS shareholders in the long term but is sure looks like doing so would be beneficial to Viacom (VIAB).

Disclosure: No position.