Macro Concerns Still Dominating Media Stocks

/0 Comments/in /by

Trading volumes on Wall Street are seasonally low in late August until Labor Day passes. But that has not led to a lack of movement. Stock prices are under severe pressure having given up most of the gain off the July yearly lows. The major concern continues to be the economic outlook. Data remains weaker than expected and the risks of a double-dip recession have risen in reality and in the eyes of investors. The stock market discounts the future so sellers are ahead of the economy. What makes investing so hard, particularly for shorter time horizons is that we won’t know the economic facts for a few months.
I’ve written regularly that the macro concerns are overwhelming individual company fundamentals. This is true whether the stock market is rallying or selling off. Another way to say this is that correlation among individual stocks, industries, and economic sectors is unusually high. In media, this means, sell all the stocks when economic concerns intensify and buy all the stocks when the economic outlook improves. It does not matter if third quarter guidance for advertising growth is better than expected when the sentiment toward the economy is negative. No one believes the advertising dollars will actually be sent. Instead, the assumption is that late 2010 and 2011 earnings estimates are too high.
For the time being, I expect this macro driven market to remain dominant. However, other than day traders, we can’t ignore micro level fundamental developments, and despite the late August lull, there have been a few items worth noting.
The biggest news was Netflix buying the streaming rights to Paramount, Lionsgate, and MGM films from EPIX. Netflix is betting its future on streaming hoping to finance expensive content purchases by attracting new subscribers and buying and shipping fewer DVDs. I understand Netflix approach and I give them credit for going all in but I am uncertain how this will play out. The only obvious winner appears to be Liberty Starz (LSTZA), which controls the streaming rights for Disney and Sony films to be produced and released through 2015. Starz has sold this content to Netflix for several years at a huge discount to the price paid to EPIX. Furthermore, Disney and Sony are more valuable than Paramount et al especially when considering scarcity since most of the rest of studio output is controlled by HBO.
The studios (Time Warner, News Corporation, Viacom, and soon to be Comcast) might be winners as the streaming rights are suddenly worth big money. This is a nice development given the collapse in DVD sales. However, the risk of substitution to box office, rental, VOD, and more DVD sales is high. The fight over windows for availability of studio content is what is really at stake, however. Windows have driven profits, so elevated uncertainty about future windows leaves the Netflix-EPI deal as mixed for studios.
Cable, satellite, and telco TV distributors seem like losers as a robust Netflix option threatens video subscriptions and premium purchases such as movie channels, VOD and DVRs. The timing could not have been worse for cable as 2Q10 subscriber counts showed a decline in video subs for the first time ever. In last week’s column for SNL Kagan, I mentioned that I was surprised the year-over-year drop in subs had not gotten more attention. That is no longer the case: the Wall Street Journal and Business Insider wrote about the drop in subs.
I still think that over-the-top-video is a much smaller threat than feared but in a market deep in negative sentiment, the combination of the Netflix-EPIX deal and declining subs came at a bad time. Despite the risks to cable and poor action in the stocks I remain long a lot of cable stocks at the Entermedia hedge fund as I feel the over top risk plays out very gradually over many years while declining capital intensity and rising free cash flow on still low to mid single digit revenue and operating cash flow growth is here today and for the foreseeable future. Domestic cable stocks are less attractive than the advertising driven stocks held in Northlake client accounts.
Disclosure: LSTZA is widely held by clients of Northlake Capital Management, LLC , including in Steve Birenberg’s personal accounts. LSTZA is also a long position in the Entermedia Funds. Steve Birenberg is sole proprietor of Northlake, an SEC registered investment advisor. Steve Birenberg is co-manager of the Entermedia Funds, long/short hedge funds focused on media and communications stocks. Steve also owns a portion of the Entermedia Funds’ investment management company and has personal monies invested in the Funds.

Mid Cap and Value Still in Favor for August

/0 Comments/in /by

There were no changes to Northlake’s Market and Style models for August. The market Cap model continues to recommend Mid Caps and the Style models still favors Value. As a result, Northlake client positions in the S&P 400 Mid Cap (MDY) and the Russell 1000 Value (IWD) will be maintained for another month.
The Market Cap model saw a few shifts in its underlying indicators with one moving from large cap to small cap and another shifting the opposite way. The overall model thus held quite steady. Moving to small cap was the market breadth indicator which reflects the broad rally in July that lifted all the major indices, sectors, and themes up in unison. Shifting to large cap was the coincident indicators factor. This factor reflects the ongoing economic recovery. Small caps make sense when the economy is doing quite poorly because cyclical influences mean the next move is likely up. Therefore, when things look bleak the riskiest trade makes sense. Now that a recovery is underway, even if it is stalling, it no longer makes sense to play the higher risk small caps. Overall, the Market Cap model continues to reflect a moderate economic recovery that is supportive of the stock market.
The Style model saw no changes in its underlying factors. The signal remains in a very strong Value position. Value stocks are favored in a moderate economic growth environment where cyclical economic growth can drive earnings of industrial, materials, and financial corporations that dominate value indices.
As noted briefly above, the July stock market rally was remarkably broad and consistent. The S$P 500 gained almost 7% and most all other major indices gained right around the same amount. MDY was up 6.8%, the small cap Russell 2000 (IWM) was up 6.8%, IWD was up 6.8%, and the Russell 1000 Growth (IWF) was up 7.2%. Little value can be added by Northlake’s model when the market moves in unison but neither can anything be lost. So far this year, both models have added value and outperformed the S&P 500.
Disclosure: MDY and IWD are widely held by clients of Northlake Capital Management, LLC including in Steve Birenberg’s personal accounts. IWM is a core position for selected clients of Northlake Capital Management. Steve Birenberg is sole proprietor of Northlake Capital Management, LLC, an SEC registered investment advisor.

Good Earnings Reports for CBS, Virgin Media, Discovery Communications, and DirecTV

/0 Comments/in /by

Over the past two weeks, three of Northlake’s media long positions reported second quarter 2010 earnings. In addition, the recently sold DirecTV (DTV) reported results. The other three companies to report were CBS, Discovery Communications (DISCK), and Virgin Media (VMED). All four companies met or exceeded consensus estimates on most important financial and operating metrics. Guidance and/or commentary on the second half of 2010 and 2011 was positive and generally better than current consensus estimates. CBS, VMED, and DTV shares responded positively, while DISCK pulled back after reaching an all-time high on the eve of the report.
CBS comfortably beat estimates across the board driven by double digit advertising growth and excellent controls. Following a couple of quarters where programming investments offset the advertising recovery, 2Q10 revealed the operating leverage inherent in CBS’ ad heavy business model. Management was firm in noting that cost controls would remain for the long-term. CBS has refinanced and improved its balance sheet which will lead to an announcement of higher dividends or a large share repurchase before year end. If the economy holds together, CBS shares can trade to the upper teens.
DISCK reported accelerating domestic advertising growth of 13% and continued 20% plus ad growth outside the US. Management made very constructive comments about long-term margin expansion and outlined plans for development of the new kids network, The Hub, and the Oprah Winfrey Network, OWN. The Hub launches in the fall and OWN in January 2011. With accelerating momentum in core channels like Discovery, TLC, and Animal Planet about to be accompanied by the elimination of startup losses and potential value creation at the new nets, DISCK shares can trade to the mid to the upper $40s. Helping matters is a long awaited announcement that the company will begin to buyback shares via a $1 billion authorization. This should be especially helpful to the DISCK shares which trade at over a $4 discount to the DISCA shares for no good reason. Management indicated they will buy back the shares “that make the most economic sense.” It seems pretty obvious to me that would the DISCK shares.
VMED continues to benefit from its superior broadband network, improved competitive position in TV programming, and very effective management. Growth in financial and subscriber measures continues to pick up leading to very strong free cash flow that has dramatically improved the company’s balance sheet and set up the potential for large share repurchases. Much of this positive outlook has been evident for over a year but the European sovereign debt crisis and the UK’s weak economy and deep austerity policy kept the shares under pressure. An easing of the crisis, most evident in sharp rallies in the Euro and Pound, has allowed VMED’s improving operating and financial performance to take center stage. The shares are nearing my initial target in the low $20s and may be due for some trimming but financial performance arguably justifies a higher target and suggests holding a core position makes sense.
DTV was sold from Northlake accounts ahead of its earnings report as I feared a slowdown in subscriber growth would lead to even more competitive conditions in the battle for subscribers in the mature pay TV industry in the US. My sell decision turned out incorrect as DTV reported better than expected US subscriber growth accompanied by higher ARPU (average revenue per unit or subscriber). Furhtermore, the rapidly growing Latin America operations accelerated again thanks to the World Cup. DTV raised its 2010 guidance at both business segments and authorized another large share repurchase. I still think competitive conditions in the US could upset the otherwise excellent DTV story and 2Q10 results did see a sharp increase in subscriber acquisition costs as the company is now giving HD away for free. However, extremely aggressive share repurchases, strong focus on segmented, higher end US subs, and rapidly growing LatAm operations should support the stock at current or higher prices.
Disclosure: CBS, VMED, and DISCK are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve Birenberg is sole proprietor of Northlake. CBS, VMED, DISCK, and DTV are net long positions in the Entermedia Funds. Steve Birenberg is co-portfolio manager, an owner of the Funds’ investment management company, and has personal monies invested in the Funds.