A Bubble in Stock Splits

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Several companies held in Northlake client portfolio recently announced stock splits. Discovery Communications (DISCK) and Liberty Media (LMCA) announced stock splits that will become effective over the summer. Apple (AAPL) also announced a split effective in early June. These announcements follow Google issuing new non-voting shares as a 2 for 1 split. As a reminder, what used to trade as GOOG is now GOOGL and new non-voting GOOG shares were distributed to create a 2 for 1 split.

Discovery will complete a straightforward 2 for 1 split by issuing one new DISCK share for each currently outstanding share of DISCK and DISCA. DISCK is non-voting stock, while DISCA has one vote. There are also ten vote per share DISCB shares. Discovery has been a heavy buyer of its own stock, focused on the lower priced DISCK. The buybacks had reduced the liquidity in the DISCK shares which were recently trading at a wider discount to the DISCA shares. The plan announcement worked beautifully as DISCA, and DISCK both rose sharply with DISCK rising several percent more and reducing the discount. The new DISCK shares will be distributed on August 6th.

Liberty Media will distribute two shares of newly created, non-voting Class C shares for each share of LMCA and LMCB on July 10th. This is effectively a 2 for 1 split but instead of giving each shareholder an extra share of what they already own, new non-voting shares will be issued. This is similar to the Google split without the added complication of changing ticker symbols. The concept for both companies is to issue shares that do not dilute the control of current shareholders, in particular, the control of the founders. In the case of LMCA, investors are interpreting the issuance of new LMCC shares as a signal that Liberty may have a large acquisition up its sleeve where they would be willing to issue equity. In turn, that would mean, that management sees the current valuation of LMCA and LMCB as full — you issue shares instead of paying cash when the shares are richly valued. The combination of issuing non-voting shares and the possible implications are contributing to lagging performance for LMCA so far this year.

AAPL is keeping this pretty straightforward by completing a 7 for 1 split. Yes, 7 for 1 is unusual but like most splits it just additional shares of what you already own and Apple only has one class of stock to begin with. Apple investors will receive 7 shares of AAPL for each current share they hold on June 9th. AAPL is signaling its confidence in the company’s outlook with the split and also bring the shares down to a more normal price (around $90 at today’s near $630).

Splits have no economic impact. You own the same value in the stock as you owned previously. Splits can signal confidence from management. Splits can also be used to accomplish other corporate purposes such as what Google, Liberty Media, and Discovery Communications did as described above.

AAPL, DISCK, GOOG, GOOGL, and LMCA 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. AAPL, GOOG, GOOGL, and LMCA are net long positions in the Entermedia Funds. Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.

CBS Healthy Despite Share Turbulence

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CBS Corporation (CBS) reported slightly better than expected March quarter results. It was not enough to turn the recently negative sentiment in the shares, however. The day after the report CBS closed down a little over 2% after falling nearing 5%. Year-to-date CBS is down 11% despite good earnings, positive news on capital allocation, and a confident management outlook.

I think the stock is caught up in two negative trends. First, consumer discretionary stocks, including media, are seeing heavy profit taking after huge gains in 2010 thru 2013. Second, I think a lot of hedge funds and mutual funds with a growth strategy have used CBS and other media stocks as core holdings. CBS has been caught in the rotation from growth to value that began in early March despite the fact that there seems little to worry about on business fundamentals.

The key driver of CBS shares is the fact that the company will likely buyback nearly 20% of its shares this year without stretching its balance sheet at all. In fact, next year an additional 15% buyback looks likely if the company merely reaches its debt target…a leverage level that is still investment grade.

The share buybacks are being driven primarily by excellent business fundamentals. CBS has performed well on advertising, grown its subscription fees, increased profit contribution from content it creates, and strictly managed its expense structure to produce record high profit margins. The company has also managed its asset mix including the spinoff and upcoming exchange offer for its outdoor business. The bottom line is CBS is a more profitable, less cyclical, better managed, more shareholder friendly company than it has ever been.
Investor concerns surround a mixed advertising environment over the past six months, long-term worries about the TV business model, and the upcoming Aereo decision at the Supreme Court. One possible new worry is that following this year’s accelerated share buyback, the company could turn its eye toward acquisitions.

Despite the recent pullback, the stock has done very well, up 10 times from the summer of 2009. Nevertheless, CBS still trades at a discount to its peers, which I see as unwarranted. I think the pullback has created a buying opportunity and believe the stock can move to the high $60s or 17 times 2015 earnings. Even better, I think you can make a strong case that 2015 estimates will prove too low by 6-8% based solely on the reduced shares outstanding from the upcoming CBS Outdoor (CBSO) exchange and further buybacks.

CBS is 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 regulatory filings can be found at www.sec.gov. CBS is a net long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.

Quiet Quarter at Liberty Media

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Liberty Media (LMCA) had a quiet March quarter earnings report. Earnings do not really matter to LMCA as the stock trades relative to its asset value. As a reminder about 2/3rds of the asset value is a 51% stake in Sirius XM (SIRI). Another 25% is a 26% stake in Charter Communications (CHTR). The other large investments are a 30% stake in Live Nation Ticketmaster (LYV) and ownership of the Atlanta Braves baseball team. By the time LMCA reports each of its publicly held investments has already reported so focus is more on commentary plans for those investments or for the structure of LMCA.

SIRI reported a good quarter that seemed to offset recent investor worries about the company’s growth trajectory. Financial metrics were good but the focus is on subscriber metrics and those were mixed but did not produce some hoped for upside in net subscriber guidance. LMCA indicated that SIRI would be buying back its own stock aggressively and that LMCA would not be participating in the sales. This is a nice vote of confidence in SIRI.

CHTR and LYV reported good results as well in the past few weeks so it appears that the core assets of LMCA are good shape. This means focus can be on the future of LMCA. Earlier this year, management announced a plan to create two tracking stocks: Liberty Broadband for CHTR and associated smaller investments and Liberty Media for SIR, LYV, the Braves and other remaining investments. In a slight adjustment to the plan, Liberty Broadband will now be a separate company rather than a tracking stock. I see little impact from this change as there are plusses and minuses to the tracking stock structure.

LMCA shares have dropped 12% this year mostly reflecting a sharp decline in SIRI doe to the aforementioned fears about is future growth. A recovery in SIRI shares is necessary to get LMCA moving again to the upside. I think continued good earnings reports from SIRI, including a pickup in subscriber growth will be the catalyst. SIRI’s massive share buyback will also help. SIRI is not unlike DirecTV (DTV) which has thrived a a stock even as the growth rate slowed because management used the high free cash flow to fund a consistent, large share buyback over many years. SIRI shares are still more highly valued than DTV on traditional measures which creates some of the controversy. But DTV does now have 20% plus growth in free cash flow in its profile, something for which SIRI deserves a premium valuation.

Ultimately, an investment in LMCA is an investment in John Malone, oe of the most successful investors in recent history, especially when it comes to media investors. I have said it before but here it goes again: In Malone We Trust.

LMCA is 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. LMCA is a net long position in the Entermedia Funds. Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.

Liberty Global Growth Acceleration Beginning

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Liberty Global (LBTYK) reported improved March quarter earnings after several expected but slower growth quarters. What LBTYK calls rebased revenue grew 2.3% just slightly below estimates of 3%. The upside surprise came in operating cash flow which saw rebased growth of 6%, well ahead of consensus for 4%. An investment cycle, cost related to several large acquisitions, and a few markets with increased competition had slowed revenue and operating cash flow growth to the low single digits. As management has promised, these headwinds are about to give way and become tailwinds. The big pickup was expected in 2H14 so the March quarter surprise was welcome. I do not expect the June quarter to be quite as strong but the new trend is clear and visibility has dramatically increased.

The stock has responded bouncing 8% and recouping almost the entire 10% 2014 decline. One headwind remains: the company is awaiting regulatory approval of its acquisition of the leading cable company in the Netherlands. During this period, LBTYK will be unable to buyback stock, a major part of the investment thesis. This is widely known, however, and during the March quarter, the company accelerated its share buyback into the weakness in the stock giving great confidence that once the acquisition is approved the buyback will comeback at even stronger levels.

Following a series of acquisitions in Germany, England, and the Netherlands, and the subsequent investment cycle to upgrade in those markets and others to enhance the speed and quality of the company’s cable systems and set top boxes, LBTYK should enter a period beginning in 2015 where capital spending drops significantly as a percent of sales. Capex peaked at 23.4% of revenue in 2Q13. In the most recent quarter, capex was 20.1% of sales. This allowed free cash flow to grow 47% in the March quarter. LBTYK should see capex fall into the upper teens as a percent of swales over the next few years. Coupled with mid-single digit revenue growth, margin expansion as acquisition synergies kick in, and continued massive share repurchase, free cash flow per share could explode.

Bullish analysts, with whom I agree, think that free cash flow could be near $7 per share in 2017. Today, LBTYK trades at about a 7% free cash yield. If the company made $7 in free cash flow per share in 2017 and the stock held the same free cash flow yield, the target would be $100 against current prices in the low $40s. There is always something happening at LBTYK on the acquisition front and broadband is a competitive business with tough foes in all countries. It may not be a straight line but the upside along with one of the highest quality management teams I know makes LBTYK a uniquely good investment opportunity.

LBTYK is 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. LBTYK is a net long position in the Entermedia Funds. Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.

Discovery Communications Ride Gets Even Bumpier

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Discovery Communications (DISCK) reported a slightly disappointing March quarter results. Most of the miss was not at the domestic or international cable networks. However, investors are treating the stock harshly even after poor year-to-date performance. In hindsight, I should have sold DISCK when the company went on its European acquisition spree as it was out of character with the historic corporate strategy as the company entered free-to-air, sports networks, and fiction programming. I put too much stock in the excellent management team and accepted its judgment that strategically the acquisitions made sense to support and extend the company’s long-term growth profile.

Earnings estimates have been coming down for DISCK and are being taken down another notch today. Management guidance suggests one more tough quarter followed by acceleration in revenue, cash flow, and earnings growth. With the stock down 20% year-to-date and now trading at a discount to its peers, I think the shares are pretty washed out. It has been a painful four months but I think the best course of action is to sit tight and look to the next quarterly report to as a catalyst for renewed appreciation potential.

Looking more carefully at the quarter, U.S. ad revenue fell a little short of estimates, growing 5%. Affiliate fees grew as expected, leading to U.S. growth overall in themed single digits. International saw ad revenues grow 23% and affiliate fees up 10%, both in line with estimates. Higher corporate expenses were the primary culprit in the earnings and operating cash flow shortfall although international margins were a bit light.

Management maintained full year guidance but signaled that 2Q would be the toughest compare of the year due to a recent asset sale, the timing of content sales, and cancellation of an important TV series for Discovery Channel. If management is right, 2Q will see flat to low single digit decline in organic growth. In addition, the closure of more European acquisitions will dilute margins in international, something investors do not like, especially given my earlier comments about the shift in corporate strategy.

DISCK is now trading at less than 15 times 2014 earnings. If growth accelerates in 2H14, this will seem like a bargain. Placing well-earned trust in management, I choose to believe and sit tight for another quarter.

DISCK is 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.

Content Engine Driving Disney to Great Heights

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Disney (DIS) reported a big beat to March quarter earnings expectations with EPS of $1.11 vs. consensus of 96 cents. Revenues also were ahead of expectations at $11.65 billion vs. estimates of $11.23 billion. The primary driver of the upside was the film studio but strength was pretty much across the board with exception of advertising sales at ESPN and ABC.

If there was one thing that drove the results, it was the incredible success of Frozen. DIS is unique in that hit content filters through the entire corporation and large franchises like Frozen can drive financial returns for multiyear cycles as consumer products, theme park and cruise ship attractions, Broadway shows, and Disney-themed cable networks benefit. While there will always be misses on big budget films (John Carters, Mars Needs Moms, and Lone Ranger in recent years), the company is in the midst of a powerful content cycle that includes Avengers and the individual characters, steady success at Pixar, a revived traditional animation studio helped by Pixar leadership, and newly acquired Star Wars. 2015 shapes up really big with the next Avengers film and the first of three new Star Wars film.

DIS growth is likely to slow a little in the next couple of quarters as a round of big increases in sports rights hits ESPN. The company recently held an analyst day devoted solely to ESPN so I think the street is well aware of what is coming. Even in a giant quarter at the movie studio, cable networks, dominated by ESPN, represented 59% of total company operating income, so there could be a little turbulence in the stock price even as theme parks, the film studio, interactive, and consumer products continue to benefit from the red hot content engine.

Northlake recently subscribed to a new research service, MoffettNathanson Research, that specializes in media and communications. Craig Moffett and Michael Nathanson are analysts I worked with in the past when they were at Bernstein Research. This morning they are out with a brief note on DSI reminding investors of the 2005-2007 content cycle and how the company consistently beat earnings estimates driving the stock price. The comparisons to the current period seem apt. With content driving growth, steady gains at the ESPN, solid theme park performance and excitement likely to build about Shanghai Disneyland, and a big share buyback, DIS shares should be able to sustain a premium P-E multiple. 20 times what may prove to be a conservative 2015 consensus estimate of $4.60 gets the stock to the low $90s. In a suddenly tough tape for consumer growth stocks, DIS looks like a good choice.

DIS is 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. DIS is a net long position in the Entermedia Funds. Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.

Value and Mid Caps Still in Favor

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There were no changes in Northlake’s Market Cap or Style models for May. The Market Cap model continues to recommend mid cap and the Style model still favors value. With no changes for May, client positions in the S&P 400 Mid Cap (MDY) and the Russell 1000 Value (IWD) will be held for at least another month.

The Market Cap model saw some movement toward large cap as the trend indicators moved from a neutral reading to favoring large cap. This is no surprise as small and mid caps fell last month, while large caps had a small gain. The trend indicators measure recent performance and widely used by used by short-term traders. In the model, they are present to add timeliness and provide balance against the economic indicators which look at monthly data over longer time frames. Overall, the indicators in the Market Cap model are mixed but trending toward large cap. The conflict is between indicators that are picking up a good and possibly firming economy and trend and technical indicators reflecting the rotation in the market away from small cap and growth stocks.

The Style model has moved to a stronger value signal even though no underlying indicators shifted for May. Please recall that in April the indicators shifted sharply in favor of value. Those indicators remain deeply in value territory this month. The Style model is picking up generally improved economic and the stock market’s rotation from growth to value. Another way to think about it is that the stock market and the model are shifting toward later cycle views.

Last month the models put in a mixed performance. The Market Cap model’s mid cap signal held up a lot better than small caps but still produced a loss with the S&P 500 in positive territory. The style model did well gaining about 1%, ahead of the S&P 500 and the flat performance for the Russell 1000 Growth index. To get a better gauge of the rotation in the market, small cap growth fell 5% last month. Year to date both models are in positive territory but trail the appreciation in the S&P 500 by approximately 1%.

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.