After Rough Stretch CBS Stabilizing

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CBS reported a mixed quarter against low expectations.  The highlight of the quarter is the company is returning to growth on the operating income line with a big accelerating ahead on 2016 on the back of political advertising.  CBS shares have perfomed poorly this year as earnings estimates moved steadily lower.  At one point, Northlake felt that CBS could earn $4.65 in2016.  That now looks more like $4.00.  Weak TV ratings, a lesser number of shows sold into syndication, and advertising declines impacting all TV companies have led to reduced expectations.  It appears the worse is over as several of these trends are stabilizing or reversing and for the first time in recent memory CBS reported earnings and Wall Street analysts did not reduce their estimates.

We have stuck with CBS because the company is very shareholder friendly with buybacks and dividends and because the company is relatively well protected from fears about cord cutting and cord shaving.  CBS remains the most popular network in America and is included in all the skinny bundles of less TV channels being offered by cable and satellite companies or OTT providers.  This means that CBS has mostly locked in a ramp in revenue and profit contribution as retransmission fees escalate over the next four years.

We are also pleased to see CBS as a leader among traditional TV companies in testing ideas for the new digital age of TV.  The company offers CBS All Access and Showtime as OTT services and has launched on online only news service.  As a leading producer of TV shows, CBS is also well positioned to benefit from demand for new TV shows that is coming from OTT providers like Netflix and Hulu.

CBS shares look cheap at 12X stable 2016 earnings estimates.  We think a couple quarters of stability are enough to allow the multiple to expand and drive the shares higher.  We have been overly patient with CBS in the past year but 2016 sets up well so it is worth hanging on for at least a little longer with the support of the best management team in the business.

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’s regulatory filings can be found at www.sec.gov.  CBS 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.

Disney Reassures with Good Quarter and Commentary

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Disney (DIS) reported better than expected 4Q15 earnings, a great relief to investors following the controversial 3Q 15 report in August that send DIS and other media stocks into a spiral of declines ranging from 20-30% in just a few weeks.  The issue in August was a lowering of guidance due to foreign currency hedges expiring and a reduction in the subscriber base at ESPN.  IT was the ESPN news that caused trouble for DIS and media stocks as it ignited fears that cord cutting and cord shaving had reached a tipping point.  Given the reliance of TV networks and cable and satellite providers have on subscription fees and advertising via ratings, accelerating subscriber losses would quickly damage the profitable and heretofore steadily growing TV business.

Northlake felt that investors overreacted to the ESPN news because we did not see a massive acceleration in cord cutting/shaving that was implied by the plunge in stock prices.  Furthermore, we believed that confusion surrounding Nielsen data probably led Disney to include a couple of years of sub losses into one guidance update.  With Disney making no further changes to their ESPN guidance and stating that they have seen no pickup in sub losses recently, investors are feeling a lot better about this important asset for DIS that represents around 20% of the company’s financial profile.  Also comforting investors has been the latest set of earnings reports from satellite, cable, and telco companies that show no acceleration in sub losses.

With less concern about the imminent demise of ESPN’s economics, investors are free to focus on many other positives at DIS.  The new Star Wars movie hits theaters in December and all indications are it will be a smash hit  Early consumer product sales and interest in the video game produced by Electronic Arts are positive signs.  DIS can also look forward to the opening of ts resort in Shanghai next spring.  The resort will produce a loss in in its first year but offers big long-term promise on its own and to help build interest in Disney properties in China.

Other positives emerging from the latest report include better than expected programming expense guidance for 2016 for ESPN, improved advertising growth at ESPN and ABC, and a continued aggressive pace of share buybacks to utilize the company’s excellent balance sheet.

DIS shares have recovered all but 3% of August’s 20% plunge.  Northlake sees the potential for DIS shares to rise another 10-15% over the next six months.  The big upside may be in the rear view mirror after the shares doubled in less than three years form our initial purchase but we think this quality company is worth an investment for at least a little while longer.

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.

All Quiet On Liberty Front For Now

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It was a quiet quarter for the Liberty Media family of companies owned in Northlake client portfolios.  We could get some fresh news on these event driven stocks later this week when Liberty hosts its annual analyst meeting in New York.  We will be attending this year.

Liberty Media (LMCA) remains tied to its 60% stake in Sirius Satellite Radio (SIRI).  SIRI shares have performed and are trading near 52 week highs after another good quarter of subscriber and financial growth.  At some point, SIRI and LMCA will merge or spilt, an event we feel will be bullish for LMCA shares.  While we wait, SIRI continues to be on a good growth path with better competitive position than the market appreciates.

Liberty Broadband (LBRDA) is a lead investor in Charter Communications.  Charter is trying to get regulatory approval to merge with Time Warner Cable.  We believe the odds are good despite rejection of Comcast’s attempt to merge with Time Warner Cable.  A merger would be very bullish for LBRDA, so we are patiently waiting on the FCC.  We think a close in the spring of 2016 is a good target.

Liberty Global (LBTYK) is an operating company and the largest cable company in Europe.  The company’s third quarter report showed signs of the acceleration we are expecting in subscriber, revenue, and cash flow growth.  Management guidance for further acceleration in the fourth quarter gives us confidence that much higher share prices lay ahead for LBTYK.

Liberty Global LiLAC (LILAK) was recently spun out of LBTYK.  LILAK has cable assets in Puerto Rico and Chile.  The spin was designed to separate Europe from Latin America and create vehicle for LILAK to consolidate the fragmented cable and telecommunications industry in Latin America.  LILAK announced it is in merger discussion with Cable and Wireless earlier this month.  We should know the outcome of these discussions by Thanksgiving.  A merger is highly accretive for LILAK and would be a big bullish catalyst for the shares.

LMCA/LMCK, LBRDA/LBRDK, LBTYK, and LILAK  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 LMCA/LMCK, LBRDA/LBRDK, LBTYK, and LILAK 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

Activision: The New KING of Mobile

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Activision Blizzard (ATVI) announced strong quarterly results that beat street estimates on sales and earnings per share while raising full year guidance. The updated full year guidance is slightly below street consensus estimates, but seems understandably conservative ahead of ATVI’s launch of the next iteration of their most important franchise, Call of Duty: Black Ops III, which could make or break their full year results.

The bigger story at ATVI is the announced acquisition of King Digital Entertainment (KING), a leader in mobile gaming and creator of popular franchises such as Candy Crush. From a financial perspective, the deal appears to be good for ATVI. The company estimates that the acquisition will be highly accretive, adding approximately 30% to next year’s earnings per share, implying a jump from previous estimates of $1.57 to $2.04. KING currently trades at a large discount to established gaming companies like ATVI due to a comparative lack of diversity in game offerings and potentially declining interest in currently popular franchises.

The KING acquisition appears to be a great use of overseas cash that is currently earning nothing. Instead of waiting for clarity from the Federal Government on the possibility of repatriating overseas cash at a discounted tax rate, or choosing to pay full taxes to bring the cash back to the U.S., ATVI chose to buy a hopefully steady stream of free cash flow. The deal also strategically diversifies ATVI by bolstering their mobile game offerings and creating a new avenue for growth. Additionally, there may be revenue synergies from cross-promotion of the combined company’s franchises, which could help lower marketing expenses and drive incremental sales.

Overall, the KING acquisition appears to be good for ATVI as long as income from Candy Crush and other KING franchises does not decline faster than currently expected. The KING deal in combination with ATVI’s exciting pipeline of upcoming product launches and strong execution leave us feeling positive on the company’s outlook. ATVI has already been one of Northlake’s biggest winners this year rising 80% from the low $20’s to the mid-$30’s. While we plan to take a deeper look at the risks related to the KING acquisition, we currently believe that shares of ATVI could trade at 20x 2016 EPS of $2.04, pushing the stock into the low-$40’s.

ATVI 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.  ATVI 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.

Underlying Shifts Large But Mid Cap and Growth Survive Another Month

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There are no changes to the recommendations from Northlake’s Market Cap and Style models for November.  Mid Cap and Large Cap growth remain the favored themes.  As a result, client assets invested in the models will continue to be held in the S&P 400 Mid Cap (MDY) and the Russell 1000 Growth (IWF) for at least another month.

While there is no change in the recommendation from either model, there was significant underlying movement in both models.  The Market Cap model moved in favor of small caps and the Style model moved in the direction of value.

Three indicators in the Market Cap model moved from large cap to small cap to November.  Each indicator is in the internal group and is related to stock market breadth: Stocks Above 200 Day Moving Average, Stocks Above 50 Day Moving Average, and Net New Highs.  These indicators switched in favor of small cap as a result of large and broad-based rally in the market in October.  Strong, positive market breadth is usually a leading indicator that more volatile small cap stocks will outperform and lead the market higher.

Prior to the November readings, the Market Cap model was close to moving from a mid cap signal to a large cap signal.  With the three indicators just described moving toward small cap, the overall model is now back firmly in mid cap mode.

The Style model shifted in favor of value for November and another month of similar of readings would shift the overall model to a neutral reading from favoring growth.  This is a significant change as the growth recommendation has been in place since November 2014.  Three indicators shifted from growth to value for November.  As in the Market Cap model, indicators related to stock market technicals flipped.  In the case of the Style model, the change came from leadership for beaten down industries within value during October’s big rally.  Energy, commodity, industrial and emerging market stocks led higher as investor concerns about instability and downward trends in currency and commodity markets eased.  Wall Street is less concerned about a global recession than a few months ago.

During October, the Market Cap model lagged the market’s gains.  For all of 2015, the Market model is performing in line with S&P 500.  The Style model matched the market in October as growth and value each fully participated in the rally.  Year-to-date, the Style model is performing very well, producing a price only return of almost 6% against a gain of just 1% for the S&P 500 and a low single digit percentage loss for the value indices that have been avoided.

MDY and IWF 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.