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How Much Value Viacom Shareholders Have Lost and Why

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Until Nickelodeon turns around, Viacom will not be a winner even with success at its smaller networks.

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Recently, SNL Kagan published an article discussing the sharp drop in ratings for Viacom's (VIA) flagship Nickelodeon channel. Since last fall, Nick's ratings have been consistently down 20%-30% on a year-over-year basis. There is no question that this is of great concern to investors, and Viacom shares have severely lagged the market and peer cable networks companies since the ratings decline first came to light.

Viacom management firmly states that they believe Nielsen's ratings data is flawed. They point to data from Rentrak (RENT), which shows just a small decline in ratings, consistent with a pattern seen across many cable networks for the past six months. Investors and analysts are not buying management's explanation. Instead, they are focused on Viacom's overall advertising growth, which is barely positive against gains of mid-single digits to mid-teens for other national cable network companies. In addition, despite complaining about Nielsen, management has effectively accepted the ratings by dramatically increasing its investment in new programming for Nickelodeon.

Most of the speculation on what went wrong at Nickelodeon has focused on Netflix (NFLX). Nickelodeon programming is available on Netflix and many observers believe children are watching what they want on the over-the-top service rather than accepting Nick's linear programming schedule.

SNL Kagan's Adam Swanson took another view. Swanson noted that programming on two newer Viacom networks, Nick Jr. and Nicktoons, used to appear on Nickelodeon. For example, Nick Jr. was once a successful programming block on Nickelodeon – so successful that it was spun off to create Nick Jr. Perhaps viewers of Nick Jr. and Nicktoons used to watch Nickelodeon?

I am not sure we will ever fully understand what has happened to Nickelodeon's ratings. However, I think one way to look at it for Viacom investors is to compare the economics of the three networks. The economics of cable networks are quite good given the dual revenue stream of advertising and affiliate fees. It is totally understandable that Viacom management would want to launch the new networks given how a fully distributed cable network with modest ratings can create hundreds of millions or billions of asset value for shareholders. This was especially the case several years ago before the recession, Netflix, cord cutting, cord shaving, and over-the-top services became significant concerns.

SNL Kagan projects that Nickelodeon will have 100.6 million subscribers in 2012, producing operating cash flow of $1.361 billion. Viacom and other cable network stocks trade around eight times operating cash flow so arguably Nickelodeon is worth over $10.9 billion or about 33% of Viacom's total enterprise value of $32.8 billion. Viacom shares are valued 1.0 to 1.5 multiple points below its peers due to the Nickelodeon concerns. Thus, you could say that the ratings issues at Nickelodeon are costing Viacom shareholders $1.4 billion to $2.1 billion in value.

According to SNL Kagan, Nick Jr. is in 85 million homes and will generate operating cash flow of $106 million in 2012. Nicktoons is in 68 million homes and generating $50 million in operating cash flow. Both networks are growing with SNL Kagan forecasting 2015 operating cash flow to be 28% above 2012 for Nick Jr. and 53% higher for Nicktoons. Nickelodeon is growing but more slowly with 2015 operating cash flow expected to 19% higher than 2012. Of course, due to Nickelodeon's much larger size, the incremental operating cash flow of $250 million in 2015 is more than the combined projected operating cash flow that year for Nick Jr. and Nicktoons.

Given that they are growing faster, let's give Nick Jr. and Nicktoons a slightly higher multiple. At 10 times operating cash flow, the networks are worth $1.57 billion today. This is at the low end of the $1.4 billion to $2.1 billion value destruction we calculated at Nickelodeon -- a neutral trade at best if the new networks are cannibalizing Nickelodeon ratings.

Looking ahead to 2015, let's say a mature Nickelodeon is worth seven times operating cash flow or more than $11 billion. Valuing Nick Jr.'s and Nicktoons' $210 million in projected operating cash flow at nine times creates asset value of $1.9 billion. The newer networks have increased in value by $500 million. A meaningful amount for sure but relative to the $11 billion value of Nickelodeon, the incremental value creation is marginal.

To repeat, we may never know exactly what is happening with Nickelodeon's ratings, specifically whether the development of Nick Jr. and Nicktoons is partially or mostly to fault for the ratings slide. However, I think it is fair to say that fixing Nickelodeon is priority one for Viacom investors. Success at smaller networks built off of Nickelodeon programming and branding is not enough to drive value for Viacom as a whole.

To their credit, Viacom management is taking the ratings challenge at Nickelodeon head on with dramatic increases in programming investment. I chose to take a wait-and-see-attitude and sold my Viacom shares at the end of February. My thesis remains that the industry-wide ad recovery has matured and entered a normal phase. Ratings winners will be rewarded on Wall Street. Until Nickelodeon turns around, Viacom will not be a winner even with success at its smaller networks.

This column was previously published by SNL Kagan on www.snl.com.
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Entermedia is a long/short equity hedge fund focused on media, communic= ations, and related technologies. Steve Birenberg is co-portfolio manager o= f Entermedia, owns a stake in the Funds' investment management compan= y, and has personal monies invested in the Funds. CBS and Discovery Communi= cations are widely held by Northlake Capital Management, LLC, including in = Steve Birenberg's personal accounts. Steve is sole proprietor of Nort= hlake, a long only registered investment advisor.

The information on this website solely reflects the analysis of or opin= ion about the performance of securities and financial markets by the writer= s whose articles appear on the site. The views expressed by the writers are= not necessarily the views of Minyanville Media, Inc. or members of its man= agement. Nothing contained on the website is intended to constitute a recom= mendation or advice addressed to an individual investor or category of inve= stors to purchase, sell or hold any security, or to take any action with re= spect to the prospective movement of the securities markets or to solicit t= he purchase or sale of any security. Any investment decisions must be made = by the reader either individually or in consultation with his or her invest= ment professional. Minyanville writers and staff may trade or hold position= s in securities that are discussed in articles appearing on the website. Wr= iters of articles are required to disclose whether they have a position in = any stock or fund discussed in an article, but are not permitted to disclos= e the size or direction of the position. Nothing on this website is intende= d to solicit business of any kind for a writer's business or fund. Miny= anville management and staff as well as contributing writers will not respo= nd to emails or other communications requesting investment advice.

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