Discovery Communications Still Going Strong

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Discovery Communications (DISCK) reported another good quarter, matching or exceeding most Street estimates. Revenues grew 11% and EBITDA rose 12%. EPS of 62 cents was a penny ahead of consensus. The company slightly raised guidance to reflect the better than expected second quarter performance. In addition to the solid financial report, the company announced accelerating share repurchases. DISCK was late to the stock buyback game much to the charging of Wall Street. This now appears to be in the past. Share buybacks provide some downside protection and also enhance EPS growth.
The closely watched domestic advertising growth was 14%, indicating that operating fundamentals have not yet been impacted by the slowing economy. Comments on the ad market for the rest of the year were positive, getting a boost in 4Q from the strong upfront selling season. The positive tone of DISCK’s advertising surely influenced management to raise guidance. Recent ratings performance has improved at most the company’s large networks, providing another boost to the outlook. Affiliate fee growth in the US was 4%, nothing exciting but poised to improve in a few years as contracts are renegotiated.
Trends abroad remain robust with EBITDA up over 30%. Foreign exchange helped but ad and affiliate growth 17% and 12% excluding currency is excellent. DISCK’s sizable and fast growing international operations set the company apart from other cable network companies.
In the aftermath of the call several analysts pointed out that DISCK could likely grow through a recession, as it did in 2008/09. Ratings strength and successful rebranding domestically, continue share gains against Broadcast TV, and international provide DISCK a cushion unique amongst major US entertainment companies.
Overall, DISCK shares remain a good value, combining defensive and offensive characteristics. Balance is a good thing in these uncertain times for the global economy.
Disclosure: DISCK is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, an SEC registered investment advisor. DISCK is a net long position in the Entermedia Funds. Steve Birenberg is co-portfolio of Entermedia, owns a stake in Entermedia’s investment management company, and has personal monies invested in the Funds. Entermedia is a long/short equity hedge fund focused on media, communications, and related technologies.

Starz Aligning While Capital is Quiet

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Liberty Starz (LSTZA) and Liberty Capital (LCAPA) reported largely uneventful second quarter earnings. Both stock still offer excellent value on an asset basis. LSTZA also has a solid underlying business producing moderate growth and significant free cash flow.
LSTZA reported slightly better than expected second quarter results. Revenue rose 5% and EBITDA rose 6%. Subscribers were flat with Starz channels up and Encore channels down. Given all the concern about cord cutting and cord shaving and the direct attack by Netflix on pay TV movie services, I think these sub numbers are good news. In fact, this makes the second straight quarter where subs surprised to the upside. Despite a cash hoard that now stands over $1 billion, LSTZA did not buy any shares again this quarter. The lack of share buybacks is due to the pending spin-off of QVC from the Liberty Media empire and an ongoing strategic review of what do with the valuable LSTZA assets. Pending negotiations with Netflix over renewal of digital rights to Disney and Starz movies that LSTZA controls until 2015-2018 is the next catalyst. With the right outcome, the share repurchase is released and the underlying value of the business is enhanced. I can see the stock in the $90s in that scenario. Downside is protected by the cash reserves, cheap valuation, and John Malone’s support.
LCAPA had an extremely quiet quarter. Share buybacks were minimal. Most likely, the pending QVC spin has the company sidelined. The pending offer to take control of Barnes and Noble remains outstanding. Management offered no fresh comments. On the conference call Malone said if his lawyers were not so cautious he’d be a buyer after all his stocks had gotten hit in the recent market rout. The QVC spin cold be complete by the end of September pending a judicial ruling. It could slip to the end of December. For LCAPA, restart of the share repurchase is the next catalyst. Of course, movement in Sirius XM shares (SIRI) is critical as they represent almost half of LCAPA’s asset value. Each penny move in SIRI is worth about 30 cents in LCAPA all else equal. Looking a little further ahead, the standstill with SIRI (LCAPA owns 40%) expires in Spring 2012. SIRI will also be in a position to buyback its own shares at that point. I expect a complicated transaction that spins SIRI and closes the 30% discount at which SIRI shares are reflected within LCAPA. This scenario could get LCAPA north of $100 if SIRI bounces back above of $2.
Disclosure: LSTZA, LCAPA, and DIS are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, an SEC registered investment advisor. LCAPA AND LSTZA are net long positions in the Entermedia Funds. SIRI is a net short position in the Entermedia Funds. Steve Birenberg is co-portfolio of Entermedia, owns a stake in Entermedia’s investment management company, and has personal monies invested in the Funds. Entermedia is a long/short equity hedge fund focused on media, communications, and related technologies.

Les is More at CBS

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Les is More! CBS delivered another outstanding quarter. Led by Les Moonves, CEO and President, CBS continues to put in by far the best performance of any media company.
CBS reported EPS of 58 cents, well in excess of the 45 cents consensus. Revenues were just a bit ahead of expectations at $3.59 billion vs. consensus of $3.55 billion. EBITDA of $873 million was $110 million ahead of consensus as once again margin performance was outstanding. EBITDA margins of 24% are way ahead of even the most aggressive analyst estimates.
$100 million of the $110 million EBITDA beat came from the Entertainment segment. Upside from the domestic Netflix deal likely accounted for a lot of the gain. Analysts and investors will surely fret that this is one-time but as Moonves noted deals recently announced with Netflix abroad and Amazon in the US are not in the 2Q numbers.
Strength was also seen at Showtime leading the Cable Networks segment to beat EBITDA expectations by over 9%. Local Broadcasting assets performed inline with expectations which is not bad at all given very tough comps in political and a lull in auto ads due to the crisis in Japan. Only Outdoor fell a bit short of expectations.
CBS is benefiting from the fact that it does need to replace DVD sales revenue. Instead as it leads the industry in selling content to Netflix and other online video distributors, all of the upside is incremental revenue at extremely high margins.
Investors will worry that advertising will falter along with the economy. I think CBS has some defense against this line of thinking given a just completed very strong upfront and a big 2012 with political and Olympics tightening the market.
CBS has generally traded at a discount to other entertainment stocks due its heavy reliance on advertising. Under Moonves, the company is performing beautifully on advertising while diversifying into content and subscription fees. Both the new areas have more upside.
Superb execution, strict cost controls, diversification from advertising, and aggressive return of cash to shareholders warrants multiple. Positive business momentum and these factors provide protection against economic concerns. In a decent market, CBS can trade to the mid $30s. It remains my top pick in media and communications.
Disclosure: CBS is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, an SEC registered investment advisor. CBS is a net long position in the Entermedia Funds, long/short equity hedge funds focused on media, communications, and related technologies. Steve is co-portfolio manager of Entermedia, owns a stake in the Funds’ investment management company, and has personal monies invested in the Funds.

Growth and Mid Caps Favored for August

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As I suspected might occur, Northlake’s Style model shifted from Value to Growth for August. The Market Cap model is unchanged for August. It continues to favor Mid Cap. As a result of the new Growth signal, all client positions in the Russell 1000 Value (IWD) have been swapped into the Russell 1000 Growth (IWF). Positions in the S&P 400 Mid Cap (MDY) will be maintained for at least another month.
With just a few exceptions, the Style model has favored Value since mid-2009. The reason is that Value usually performs better in the early to mid-stages of economic expansions. Value includes sectors like financials, industrials, and basic materials. Each of these sectors is cyclical and benefits from the economic strength and bullish Wall Street money flows. The economy began recovering in late 2008 and early 2009 so a Value signal made sense for most of the time since then.
What has changed over the past few months is decelerating economic growth. The economy is still on a positive track but growth has lessened as evidenced most starkly by weaker than expected job numbers. Last week’s weak GDP report clearly revealed the slowdown in the pace of economic recovery. In a lower growth economic environment, growth stocks in sectors like technology and health care make sense because they do not require the strong tailwind of economic growth to produce good earnings or rising stock prices.
Looking back at July, the models performed poorly. MDY fell about 3.5%, worse than the 2.2% loss for the benchmark S&P 500. Value also lagged with IWD also dropping 3.5%, trailing both the S&P 500 and Growth, which fell just 1.3% as measured by IWF.
So far this year, the models have a mixed performance. The yearlong Mid Cap signal has been accurate with MDY the best of major market cap indices, up 4% against 2.9% for the S&P 500 and 1.9% for small caps. The Style model fell short so far in 2011 with the yearlong Value signals up 1.1% against 2.8% for Growth. The just completed Value signal has been in place since December 2010. During that time, Value gained 8.5% and Growth gained 10.3%.
Disclosure: IWF and MDY are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, an SEC registered investment advisor.