Comcast and Liberty Global Remain Leaders in Bullish Cable Industry

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Cable stocks have performed well this year due to a combination of steady moderate growth, industry consolidation rumors, and companies returning cash to shareholders via dividend increases and share repurchases. The most recent set of quarterly earnings reports support current bullish trends in these areas. Northlake clients own positions in Comcast (CMCSK) and Liberty Global (LBTYK) and I think plenty of upside remains.
Comcast reported another quarter of better than expected results. Consolidated revenues grew 7% with operating cash flow up over 8%. Comcast gets over 60% of its revenue from its cable business and despite all sorts of doom and gloom about cord cutting, this division reported revenue and cash flow growth of 6%. The company is losing cable TV customers although at a slower pace than a year ago. Growth continues in high speed internet and in small and mid-size business accounts. Comcast’s NBC Universal division enjoyed 9% revenue growth and 21% EBITDA growth as it continues to look that Comcast made a well-timed initial and final investment in NBCU ahead of an accelerating turnaround.
Comcast continues to aggressively buy back its own shares, leveraging the 8% cash flow growth into 30% EPS growth. Leverage continues on the conservative side given the stability of the company’s operating and financial model. This means share buybacks should remain aggressive and the dividend should continue to rise. Comcast shares trade at just 6.5 times 2014 EBITDA, a discount to other cable companies and entertainment companies. I see no reason for the discount to persist given that cable consolidation is being driven by a desire to reach the scale that Comcast already has achieved. Continued steady cable growth and the NBCU turnaround can comfortably propel the stock in the mid $50s.
Liberty Global reported its first quarter since closing on its acquisition of Virgin Media. The report was messy since Virgin was only owned for a few weeks of the quarter. Adjusting for currency, the acquisition, and other one-time items, LBTYK reported rebased revenue and EBITDA growth of 4%. This met street expectations but was a little slower than recent quarters. I thought the conference call was slightly defensive as management defended its move into the UK via Virgin, responded to the tough competitive environment in the Netherlands (negative EBITDA growth), and noted that it was beginning to shift its strategy in Germany from subscriber growth to harvesting the financial benefits of subs added over the last few years. Over the next few years, LBTYK will enjoy very rapid free cash flow growth with which it will continue its multi-decade history of aggressive share repurchase and growth via acquisition. Slowing capital spending as a percent of revenue could allow free cash flow per share to rise to over $10 in the next few years, easily supporting a stock price north of $100. A slight pickup in rebased growth may be necessary for the stock to take the next leg up but I am very confident that a little bit of patience will be very well rewarded.
Comcast and Liberty Global are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov. Comcast and Liberty Global are net long positions in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, entertainment, leisure, consumer retail, communications, and related technologies. Steve is portfolio manager of Entermedia, owns a controlling stake in Entermedia’s investment management company, and has personal monies invested in the funds.

Media Earnings Pretty Solid and Future Still Bright

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Over the past two weeks, most of the major media companies have reported second quarter results. This summary will take a look at the entertainment companies held by Northlake clients. These companies are primarily content producers. A separate blog post will review the cable companies that provide the pipes through which we consume the content.
Current entertainment companies held by Northlake clients include CBS Corporation (CBS), Disney (DIS), Liberty Media (LMCA), and Starz (STRZA). Direct competitors including AMC Networks, 21st Century Fox, Time Warner, Scripps Networks, and Viacom also reported so we have a pretty good idea on the state of the TV advertising market and TV network business heading into the new fall TV season that commences after Labor Day.
Overall, the industry seems to be in good shape. Advertising trends, probably the best measurement of industry and investor sentiment generally met or exceeded expectations in the second quarter. Management commentary indicated that strength continues in the third quarter, particularly after backing out the impact of 2012’s heavy political advertising and the distorting impact of last year’s Summer Olympics. The TV networks are also in good shape on retransmission and affiliate fees paid by cable, telco, and satellite companies. This revenue stream has been front and center recently, as CBS and Time Warner Cable, two industry heavyweights, are currently in nasty negotiations with Time Warner Cable customers blacked out from CBS TV programming. This revenue stream is growing mid-single digits to low double digits at most TV networks with no signs of letting up. Retransmission and affiliate fees are extremely high margin and the primary driver of healthy industry fundamentals on a financial basis.
There are a couple of thorns in the outlook for TV networks and their parents. First, ratings for the broadcasters (NBC, CBS, ABC, and FOX) were quite weak as a group last TV season. Cable networks saw ratings growth but across the universe there was mixed performance. Short-term broadcasters are losing market share to cable networks while cable networks face fragmentation of audience. Long-term, all networks face a challenge from online video, both access to their own programming and competition from the likes of Netflix, Amazon, and YouTube.
Second, programming costs are rising as networks compete more aggressively and produce better quality TV shows to improve ratings and justify the rising retransmission and affiliate fees with better programming. Although not alone, huge success by AMC Networks with Mad Men, Breaking Bad, and Walking Dead has had a significant impact on the industry. Other networks see the unique programming and step up their games. That means more original productions and often more expensive original productions, together driving programming cost inflation in the high single digits. This cost growth in well in excess of industry ad growth and pressures an otherwise positive margin outlook.
Within Northlake’s current holdings, CBS and Starz had positive earnings surprises and saw their stock prices rise. Disney beat its earnings forecast but mostly on timing differences and has its shares have fallen since the report. Liberty Media is an asset play but is primary content business, 53% ownership of Sirius XM Satellite Radio, continues to perform very well adding new subscribers and producing free cash flow. Here is a brief recap of each earnings report:
CBS reported very modest growth against tough comparisons but once again exceeded Wall Street expectations. Overall, the company should grow revenue and operating cash flow by high single digits to low double digits in 2013, an excellent result in a generally sluggish environment for large corporations. EPS should grow faster as the company continues to aggressively repurchase shares including another big bump in the authorization last month. Ad trends should pick up over the second half of the year as the company recoups ad time devoted last year to Presidential debates and political conventions and does not face Summer Olympics on NBC. Another catalyst is coming next year with the divestiture of the Outdoor business and another increase in the share buyback. The primary risk is a poor ratings performance at CBS in the upcoming TV season. I thik the shares can reach the low $60s, another 20% upside, based on a P-E of 17 times 2014 earnings of $3.60.
Disney results were in line with estimates on revenue and ahead on operating profits and earnings per share but the stock has sold off on lower guidance for the September quarter related mostly to timing issues and a write-off on The Lone Ranger. Disney will grow revenues and earnings mid to high single digits this year. I anticipate acceleration over the next few years as the company exits a period of heavy investment in programming, acquisitions, theme parks, and cruise ships. The story really accelerates in 2015 when Star Wars films comeback to theaters. Free cash flow is et to grow rapidly and eventually DIS will accelerate its already meaningful share buyback program. It may take a little patience but DIS has the most potential of its peers looking out several years.
Starz easily beat Wall Street expectations but most of the upside came from its home video division and accounting catch up related to its recent renewal with Time Warner Cable. The core business of Starz and Encore pay TV channels was mostly on target with modest subscriber growth. Share buybacks are ahead of schedule and remain a major part of the story as the company remains under its debt leverage target. Starz is doing a good job of finding low cost replacements for its 2016 loss of Disney films having recently signed agreements for catalog titles from 20th Century Fox and MGM. The pay TV business needs some big new program hits to really juice the story but share buybacks and the possibility the company is sold or merged provides upside to the stock.
Liberty Media has seen the underlying value of its assets soar as 53% owned Sirius XM and 27% owned Charter Communications perform well. LMCA still trades at 10-15% below asset value and has numerous avenues for creating additional value by restructuring its ownership of Sirius or driving cable industry consolidation through Charter. Although a much smaller investment for LMCa, the company’s almost 30% stake in Live Nation Ticketmaster is paying off big time as LYV shares have almost double this year. I was also pleased to see the company execute a forward purchase contract for $380 million of its own shares. This represents an acceleration of the company’s recent pace of share repurchase and provides a nice boost to net asset value for continuing shareholders. Continued growth in its portfolio companies, restructuring actions, share buybacks, and the discount to net asset value create plenty of additional upside in LMCA shares.
CBS, Disney, Liberty Media, and Starz are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov. CBS, Disney, Liberty Media, and Starz are net long positions in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, entertainment, leisure, consumer retail, communications, and related technologies. Steve is portfolio manager of Entermedia, owns a controlling stake in Entermedia’s investment management company, and has personal monies invested in the funds.

Mid Cap and Value Get Another Month to Shine

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There were no changes to Northlake’s models for August. The Market Cap model continues to recommend Mid Cap and the Style model still favors Value. As a result, client assets dedicated to these models will be maintained in the S&P 400 Mid Cap (MDY) and the Russell 1000 Value (IWD).
The Market Cap model had little underlying movement in its indicators and remains solidly in mid cap territory. This means that the interest rate, economic, and stock market technical indicators are pretty much split between favoring small cap and large cap.
The Style model had some slight movement toward growth with one factor changing in each direction. The consumer vs. cyclical factor, a stock market indicator, shifted from value to growth reflecting improved relative performance of consumer stocks over the past seven months. On the flip side, the yield curve factor, an interest rate indicator, moved from growth to value as the yield curve steepened with 10 year Treasury rates rising while short-term interest rates remained stable. The model factors also consider their own level even when their particular recommendation remains this same. Slight movement on this front led to the weaker value signal for August.
After struggling for much of this year, the Market Cap model performed better in July. MDY gained 6.7%, better than the 5% gain for the S&P 500. Strong performance for mid caps is expected in a bullish environment. The Style model matched the market with IWD, the Russell 1000 Growth (IWF), and the S&P 500 all rising about 5%. The Market Cap model and some nice gains in individual stocks like Apple, Comcast, Liberty Media and Liberty Global, contributed to a good month for Northlake client portfolios relative to the market.
MDY and IWD are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov.