Key Questions Heading Into Earnings Season

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With quarterly earnings reports set to pour in starting next week, I thought I’d provide a brief overview of what to look for in each of Northlake’s individual stock holdings. Given recent volatility in stocks prices and growing concerns over the future of the US economy, 3Q earnings and guidance commentary may be the most important issued in several years.
Apple: With the stock surging to new highs, the bar has been set much higher for the quarter. Leaving aside the “beat and raise” mentality surrounding the shares, I’ll be focused on overall margins and average selling prices for iPods. With NAND prices up, the massive beats in the last couple of quarters due to margin expansion are unlikely to repeat. This quarter could represent a normalized quarter, so I’d like to know whether margin levels are sustainable for FY08. One factor that will influence the answer is ASPs on iPods. The refresh of the iPod line announced earlier this month could boost ASPs which have trended sharply lower over the past year as the Shuffle and Nano have gained share relative to hard rive, high capacity iPods. Will the Touch and 160GB Classic shift ASPs upward?
Central European Media Enterprises: Will results in Ukraine bounce back such that the low end of 2007 guidance is increased? Will the surprising revenue gains in Croatia hold and lead to a quicker turn to profitability than expected? Are local currency revenue gains holding? Are estimates in Czech Republic, Romania, and especially Slovakia too low? Keep in mind that CETV is a big beneficiary of dollar weakness against the Euro.
For Comcast, Disney, Endeavor, NII Holdings, Regal Entertainment, and Rogers Communication, please follow the “Continue Reading” link immediately below….

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Box Office Update

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The weekend box office fell 2% for the top 12 grossing films. This breaks a string of 10 consecutive up weekends. The drop-off vs. last year is less than $1.7 million so it is possible, but doubtful, that when actual results as opposed to estimates are tallied the winning streak will continue.
The box office has also been up ten consecutive weeks, with the week ending July 12th being the last down comparison. Over the 70 days, the domestic box office total just over $2 billion, up 17% or $295 million, from 2006. At times I wonder about my own and others fascination with the box office totals but the bottom line is this is a big business. I follow lots of companies that don’t pull in $2 billion in revenue in a year!
The third quarter which began on June 29th for the theatre companies ends this coming Thursday. If the weekend comparison holds for the full week, the quarter will end up 15%. The year to date total through three quarters will be up 7.8%. As I have noted several times recently, analysts are seeing the big gains and estimates have risen steadily for Regal Entertainment and the other leading theatre chains. Regal shares have bounced back strongly and now sit just 4% below their all-time high, even after paying out $2.90 in dividends this year, including the going ex-dividend for 30 cents the week before last. With interest rates still well below levels of a few months ago, the shares still look attractive with easy box office comparisons continuing in the fourth quarter and a healthy current yield of 5.4%.
While the box office fell short this past weekend, there was good news for a couple of studios. Sony held the top spot with the third installment of the Resident Evil franchise. The film showed little deterioration from the first two installments. Lionsgate shareholders should also be happy as Good Luck Chuck opened to a slightly better than expected $14 million. Lionsgate has had a series of disappointments at the box office so far this year so the shares may respond to some good news.

More Debate on Comcast

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Following my post yesterday on Comcast, my buddy, hedge fund manager and soon to be anchor on the Fox Business Channel, Cody Willard, replied with a bearish view of the stock. Among Cody’s objections to my ongoing bullish stance on Comcast is, “$14 billion of market cap losses for wasting tens of billions of shareholder dollars building centrally-controlling systems is still just the beginning, IMHO. The point is that the company is in a secular declining industry since its entire model remains centered on controlling what and how and where and why people consume video.”
I am sorry Cody but I would hardly call it a waste of money to build a network that supplies cable TV to 24 million homes, broadband internet to 13 million homes, and telephone service to 3 million homes. These homes pay Comcast an average of $96 per month on which the company earns an EBITDA margin of 40%. Even with the high level of capital spending required to install new customers for each service and maintain the competitiveness of the network, Comcast is presently generating $2-3 billion of free cash flow….

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Mea Culpa on Comcast

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Mea culpa. Comcast made a new low for this latest down move yesterday, falling more than 3% on what looks like its highest volume day ever before recovering slightly to lose 2.7%. This action occurred after the stock rose a whopping 11 cents in Tuesday’s 335 point advance in the Dow. I feel your pain. As with all the individual stock and ETFs held in client accounts, I am long the stock in my own account.
The latest downdraft came after Comcast present at two Wall Street conferences over the last few days. This is secondhand but I am told that management was quite subdued in both presentations. They did not deny that recent hints they had provided that estimates for basic and broadband subscriber growth had to come down were real. The odds of a loss in basic subscribers in the seasonally strong 3Q now appear to be high….

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Forget The Time Warner Breakup Stories

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I want to echo the comments about Time Warner made yesterday by Chris Atayan, my RealMoney.com colleague. Despite renewed speculation, a breakup of the company is unlikely to add value in the near-term. Time Warner is overanalyzed and sum of the parts has been modeled exhaustively. If the sum of the parts were significantly higher than the low $20s, the stock would be higher. Put Comcast’s multiple on the Cable segment, Viacom’s multiple on Filmed Entertainment and Cable Networks, Yahoo’s multiple on AOL, and give the publishing a modest premium to the current newspaper multiples. What you get is low $20s. Sure, if private market values or public auction were used the sum of the parts could be 20-30% higher but no one is suggesting that Time Warner’s segments are going private with the exception maybe of AOL and publishing.
The problem with Time Warner shares is that the two biggest drivers of value, Cable and AOL, are both out of favor. I think that cable will re-emerge as a profitable investment theme when 3Q and 4Q results are announced. If you want to play that, Comcast is a pure play. I think AOL has issues because it is a weak brand with poor demographics. That doesn’t mean that the weak 2Q and lowered guidance won’t be reversed in coming quarters. It does mean that AOL will at best mathc the growth rate of online advertising. It is not worth a premium valuation to Yahoo. Film, Publishing, and Cable Networks are mature. At times they will accelerate (as film is doing now due to a successful year against easy comps for Warner Brothers), but these businesses won’t move the stock valuation needle meaningfully.
Chris is right. Time Warner should keep buying back stock, dramatically raise its annual dividend, and focus on managing and investing in the different businesses. That might not be enough for impatient investors but over a 12 month or longer time horizon it is the best recipe to get the stock price up independent of a big rally in Comcast, Yahoo, and Google.

NY Times Shares at 20 Year Low!

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New York Times shares traded below $20 yesterday for the first time since April 1997. As recently as June, NYT was over $26. The stock was over $30 almost two years ago exactly. In 2002, NYT shares briefly traded over $50.
NYT’s fall yesterday was matched by new lows for McClatchy and Lee Enterprises. Gannett held just above the multi-year low it made in early August. The culprit for yesterday’s action was a downgrade to sell for NYT, MNI, and LEE from Merrill Lynch analyst Karl Choi. The impetus behind the downgrades was a lowering of Merrill’s 2007, 2008, and long-term newspaper advertising growth rates. For 2007, the forecast now calls for a 7% decline vs. a 4% decline previously. The 2008 forecast is now -5%, down from a decline of under 1%. While Merrill looks for a slight rebound in 2009, the long-term forecast is now for an annual drop of 1% in newspaper advertising. These forecasts include the benefit of growth in the industry’s online advertising revenue.
Massive market share loss in classified advertising to the internet is the secular headwind that is killing newspapers. In 2007, total newspaper advertising is expected to be about $46 billion. Classified represents about $11 billion, with real estate and help wanted around $4 billion each and automotive around $3 billion….

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Review of Recent Market Action

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Periodically when the market is in an unusually volatile period I like to look at a performance of a wide variety of indices in order to see if there are any anomalies. This time I decided to look at the recovery off the August 16th intraday low. You will remember that was the day where the DJIA reversed a 350 point intraday loss to close down just 16 points. Overall, I don’t see any trends in this data that would make me want to trade but there are some notable figures.
Since that time, most US market cap and style indices have recovered by a similar amount ranging from 7% to 9%. The NASDAQ and large cap growth, as measured by the iShares Russell 1000 Growth ETF (IWF) lead the way with recoveries of 9%. The Russell 2000 has been a laggard rising just 6.4% off its low. The worst recovery is in the Russell 2000 Value ETF (IWN) which has bounced just 5.4%. The heavy concentration of financials in IWN probably accounts for the weak recovery.
The divergences in performance have been greater when looking at returns in international indices. The EAFE has rebounded by 16% and emerging markets, as measured by the MSCI Emerging Markets ETF (EEM) has risen 23%. These two markets were the laggards form the July 19th highs to the August 16th lows so the outsized gains off the lows is not wholly unexpected. What might be surprising, however, is the fact that EEM is down just 2.6% since July 19th, the best performance/smallest loss of any of the indices I monitor. The DJIA, S&P 500, and NASDAQ are down from 4% to 4.5% since the high.
One other interesting return profile has been in Japan. As measured by EWJ in order to use prices during US trading on August 16th, the Japan has recovered 1.8% off its low. Using the Nikkei 225, Japan is down 11% from the July 19th high, the worst performance of any of the indices since that date.

Will Consumer Slowdown Cut Into Comcast’s Growth?

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Cable stocks have been poor performers all year. Things started badly when Comcast raised it s capital spending forecast in conjunction with its 4Q06 earnings reported. The second hit came with 2Q07 results when basic and broadband subscriber growth disappointed pretty much across the board. Access line losses for AT&T and Verizon, basic subscriber losses for cable companies, and broadband subscriber growth for all players came in short of estimates. Now fears of a consumer spending slowdown are adding to worries about broadband growth.
I chalked the 2Q07 shortfalls up to a combination of the housing slowdown and a regulatory driven need for the cable companies to focus on getting digital set top boxes into subscribers’ homes which distracted customer service from retention and new service sales. I strongly suspect that 3Q and 4Q results will improve sentiment as subscriber growth, revenue, and EBITDA growth targets are hit. Nevertheless, investors have been worried that broadband growth is going to mature more quickly than previously expected with a new push coming from a consumer spending slowdown.
On this front, Jessica Reif of Merrill Lynch had some interesting insights in a report she issued on Comcast earlier this week. In the report, Jessica slightly lowered her broadband growth estimates for Comcast while strongly reiterating her recommendation of the shares. Her key conclusions on broadband was that penetration rates are following a similar curve to cable and satellite TV which means that ultimately 90% of households will purchase broadband. With penetration at just 50% today, there should be plenty of growth left. Jessica also noted that while 2Q subscriber counts fell short if looked at from an incremental penetration perspective, the results were on the low end of historical 2Q results.
Most interesting though was a look back at 1990-1992 cable subscriber additions and 2001-2002 wireless subscriber additions. Both periods saw penetration levels begin close to where broadband is today. Both periods saw a sharp slowdown or recession in consumer spending. So what happened to subscriber growth? It slowed significantly but it remained positive. In fact, you can make a pretty strong case that cable fundamentals were “defensive” in 1990-1992 as downside sensitivity to consumer spending was not as great as for other industries.
I think this is likely to repeat if consumer spending slows now. Broadband and especially cable telephony are still early in their growth cycles. Rising penetration should allow overall revenue and EBITDA growth to hold at good levels (10% or better) even if a consumer led recession occurs. Add in the likelihood that second half results should accelerate and the frustrating period of performance for cable stocks, and Comcast in particular will come to an end. Soon.

About That iPhone Price Cut

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The following quotes come from a new report on the iPhone from Bernstein Research: “Apple could conceivably sell iPhone hardware at a substantial loss while generating greater profit per iPhone than it does from the highest end iPod…..this potentially gives Apple a storng incentive to price the iPhone aggressively to drive sales, even at the expense of cannibalization of the iPod business where ASPs and GMs (gross margins) are notably lower.”
I don’t mean to flippant or a bull with my head in the sand but this analysis is hardly consistent with all the doom and gloom from last week when the iPhone price cut supposedly indicated the product was a flop, or as Tero Kuittinen of RealMoney.com called it, “a platinum turkey.” On the day the price cut was announced I wrote, “since we don’t know how the revenue share works with AT&T on iPhone sales and subscriptions, the financial impact of a price cut, particularly if it stimulates demand, is hard to gauge, even more so with the deferred revenue accounting.”
Capturing the bearish spin that dominated coverage of the price cut, the next day Bernstein issued a bearish report on the price cut titled, “Big iPhone Price Cut and iPod Touch Product Positioning Both Raise Meaningful Questions.” To Bernstein’s credit, as usual they completed thorough analysis to answer the “meaningful questions” and published the results even though they appear to conflict with their initial assessment. This is a good example of why Bernstein’s research is highly valued on Wall Street.
I know Apple is way overanalyzed and I am more guilty than most in that regard. I also know that we all tend to talk our book. Again, I plead guilty. But the universal assumption that the price cut represented a problem and the skepticism of Jobs statement that Apple really wanted to accelerate sales and establish the iPhone ecosystem in the US as quickly as possible appears to have been misplaced. Or at least wrongly or insufficiently analyzed.

Central European Media Enterprises Gains Control of Ukraine License

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Central European Media Enterprises announced earlier this week that it had gained control of its broadcasting license in Ukraine. This is very good news as license control provides added protection against emerging market political and regulatory risk. CETV now controls its licenses in every country in which it operates (Czech Republic, Slovakia, Slovenia, Croatia, Romania, and Ukraine). The license control came without cost for CETV as ownership was established previously but the government had not completed the registration due to various issues within and without CETV’s control. The next step will be to increase Ukraine ownership above the 60% level and gain full management control. When CETV completed this process in other countries (most recently Slovakia), results accelerated dramatically and quickly. Last week’s news that CETV had sold a 3% stake to Ukrainian oligarch Igor Kolomoisky and invited him to join the Board is probably a prelude to the securing greater ownership in a partnership with Kolomoisky. Despite the shortfall and lowered guidance in Ukraine this year, all of this news is very positive for the longer term upside in Ukraine which has the potential to be CETV’s largest market in the next five to ten years.