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Despite Economic Worries, Media Companies Finish Successfully

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The second week of earnings from media companies reinforced the theme that, despite economic worries, positive business trends remain in place

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A second week of earnings from major entertainment and cable/satellite companies revealed the same positive trends as the initial batch of earnings (see August 9 article, Wall Street Mostly Happy With Media Earnings So Far). Advertising growth has slowed at national TV networks, but remains at acceptable levels with a post-Olympics pickup widely forecast. Political advertising is beginning to kick in, especially for local TV stations. Cable and satellite companies lost video subscribers, pulling overall multichannel subscribers into negative territory vs. a year ago. However, the loss of subscribers is decelerating, suggesting over-the-top driven cord-cutting remains more a fear than a reality. Capital spending upticks at Charter Communications (CHTR) and Cablevision (CVC) seem company-specific but are worth watching in case a new round of network or box upgrades is coming that would restrict the free-cash-flow story driving outstanding performance of cable stocks.

Affiliate fee and retransmission revenues continue to grow strongly, implying that content providers are maintaining the edge over multichannel TV distributors. The flip side is that video margins remain under pressure at the cable and satellite companies.

There was less discussion of regulatory and legal issues on the calls than I expected with the exception of Dish Networks (DISH), which is at the center of disputes over Aereo, Hopper, and affiliate fee fights. I expect the focus on regulatory and legal issues to pick up post-Labor Day, although a tight presidential race leaves the long-term conclusions unpredictable.

Finally, the one consistent positive across the media stock landscape is capital allocation. Companies continue to return excess cash and capital to shareholders with large share repurchase programs and rising dividends. I heard nothing on conference calls to indicate that this bullish trend is starting to wane.

Overall, against a skeptical investor base and weakening global economic growth, media companies produced good results in the June quarter. More importantly, other than an Olympics-driven advertising and ratings slowdown away from Comcast's (CMCSA) NBC Universal networks, the outlook for the third and fourth quarters looks quite firm. Media stocks seemed poised to continue outperforming the market, especially those that are domestically focused, have accelerating free cash flow growth, and have strong television ratings.

Here are brief comments on the major companies that reported last week presented in the order in which the conference calls occurred.
  • Cablevision is showing improving subscriber metrics, but the cost remains steep as financial results at the operating profit and EBITDA line are under a lot of pressure. Against industry trends of low to mid-single digit EBITDA growth, Cablevision reported a decline of over 7% for its cable operations. Given management turmoil and lack of confidence in Jim Dolan's leadership, the company is performing reasonably well. Debt levels should be restricting share repurchases but management firmly reiterated its commitment to share buybacks. I remain long Cablevision via a fully hedged position.
  • Charter Communications reported mostly as expected on the subscriber and financial fronts. The big news was new CEO Thomas Rutledge announcing that Charter would accelerate its transition to an all-digital network. This means pulling capital spending forward into 2012 and 2013, putting pressure on free cash flow. Initially, investors were disappointed and the shares were under pressure. A secondary offering by Charter's private equity backers pushed the shares down even more. However, since the equity offering the stock has moved steadily upward and it is making new highs today. Investors have already seen the payoff from all-digital networks at Comcast and Time Warner Cable (TWC), so the timing difference on free cash flow is not too troubling. Rutledge's great reputation certainly helps as well, especially given Charter's low penetration levels in video and, especially, broadband. Charter could have the highest growth rate in the multichannel distribution industry, leaving plenty of theoretical upside in the shares.
  • Disney (DIS) reported better than expected earnings and slightly weaker than expected revenues. Outstanding performance on operating margins in every division drove the earnings upside. Margins at the theme parks were most notable and are a bullish sign for the future. Disney shares are the most expensive in media but that is not unusual. As long as media stocks are in favor the stock should perform well, but I think better value with more catalysts exists elsewhere.
  • Liberty Media (LMCA) announced it was spinning off Starz as an asset-backed security. Starz's recent history as a tracking stock was mixed. The difference now is that company is going to be spun off with a capital structure more favorable to stockholders and a commitment to use the significant free cash flow to aggressively buyback shares. New Liberty Media will be even more exposed to its 46.3% stake in Sirius XM Satellite Radio (SIRI). It is not clear what impact the Starz split will have on a resolution of Liberty's ownership of Sirius. Liberty is pushing hard for a major share repurchase plan at Sirius as the first step. As long as Sirius performs well at the operating level, Liberty shares look very attractive. So far, everything at Sirius is working perfectly with sub growth, low churn despite the price increase, firm domestic auto sales trends, debt refinancing, and progress penetrating the used car market.
  • Dish Network reported better than expected subscriber growth, but like Cablevision, it came at a steep cost with a double-digit decline in EBITDA. Little fresh news concerning Dish's spectrum plays or strategy was revealed. The conference call did contain in-depth discussion of industry issues on retransmission and affiliate fees as Dish is taking the lead in fighting TV network owners. The ongoing battle with AMC Networks (AMCX) was a focus as was an interesting discussion about ESPN that supported Disney's leverage with distributors.
  • News Corporation (NWSA) reported results that were slightly below Street estimates. The company also issued guidance for its fiscal year that began on July 1. A forecast of high single digit to low double digit growth in operating income was below Street forecasts. However, adjusting for an incremental $100 million in spending to build the education division that will be housed at the new publishing unit, the forecast would have matched analyst estimates. While analysts knew that education investment was coming, it was not yet incorporated in their models. I suspect that guidance will prove conservative, but for now I think it keeps a lid on News Corporation shares. Another headwind is a slight slowing in the pace of share repurchase pending the split of the company late this year. Very cheap valuation and industry leading growth at its cable networks makes News Corporation shares are very attractive looking out a year or two.
  • AMC Networks reported another high growth quarter although the positive surprise many expected did not occur again as it did last quarter. Highly rated programming at the AMC Network is driving results and thus far programming expense growth is not a problem. There is a problem, however, with the loss of carriage for all of AMC's networks on the Dish platform. Charlie Ergen seemed very firm that AMC's networks just aren't popular enough to support paying high affiliate fees for the rights. He seems to be using AMC as a test for the whole industry. AMC believes the carriage blackout is related solely to the VOOM lawsuit between the two companies (Cablevision is also a plaintiff) and thus will be resolved. AMC also notes that losing that 13% of its subs will have a larger and obviously very material impact on its financials results. While there is significant upside from a victory in the VOM lawsuit and reestablishment of carriage on Dish, I think the Street is too complacent on the risk of an extended blackout or the tradeoff of VOOM victory upside for carriage. As a result, I sold my entire position in AMC Networks on the post-earnings pop.

This column was previously published by SNL Kagan on www.snl.com.
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Position in CVC
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.

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