Smooth Sailing At CBS

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CBS reported a good quarter beating consensus EPS estimates comfortably with small upside in revenues.  The implication is good performance on profit margins and that was indeed the case especially in the core entertainment assets (CBS Network and content production) and the local TV stations.  Advertising drove the upside, with a gain of 31% exceeding expectations.  It was a strong quarter for advertising but the Super Bowl drove the outsized gain.  Normalizing for that the gain was about 12%, still easily outperforming all peers.

We have stuck with CBS despite the turmoil in media driven by concerns about cord cutting and declining ratings because we believe that it is the best media positioned company to withstand these secular challenges.  CBS has only one meaningful network that is reliant on advertising and affiliate fees and that network has been #1 for years and controls much can’t miss content such as the NFL and NCAA basketball and the Emmy Awards and hit shows like Big Bang Theory and NCSI.  CBS is unlikely to be excluded from any traditional or new bundle and the fees it receives still leaves it underpriced relative to the ratings it delivers.

CBS is still more exposed to advertising than most other media companies.  However, management has steadily diversified and is in the process of exiting the radio business.  At that point advertising will be about 40% of revenues, down from 70% less than ten years ago.  At the moment, TV advertising markets are quite strong even with online advertising gaining share.  The dichotomy of strong advertising and weak ratings may not last forever.  We are confident that CBS has one of the best management teams on the creative side as evidenced by its consistent victory in the ratings wars over the past 15 years.

CBS has also been in the news recently as its controlling shareholder, Sumner Redstone, suffers from ill health and court battles over his competency.  CBS management has made it clear it would like to purchase the control stake from Mr. Redstone’s holding company, National Amusements.  This would be a big bonus for shareholders but not something for which we are holding our breath.

We have not talked much about the quarter as little changed beyond increased confidence in the outlook for CBS in 2016 and 2017.  Based on EPS of $4 in 2016 and $4.30 in 2017, we think CBS can trade in the mid-$60s, providing almost 20% upside over the next 6-12 months.

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: Consumer Products Frozen, ESPN Melting

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Disney (DIS) reported a rare miss on sales and earnings in the fiscal second quarter of 2016. The disappointing results were driven by weakness in the consumer products and media networks segments. The studio segment continued to produce excellent results, driven by Zootopia in the quarter. Parks and resorts also performed well in the quarter, but missed slightly on revenue. While it is concerning to see DIS miss overall expectations during an extended stretch of massive success at the box office, we believe the recent headwinds are short-term in nature. Over the long-term, we expect DIS to continue to successfully monetize its valuable intellectual property – including Star Wars, Marvel, and Pixar – across each of its operating segments.

Consumer products faced headwinds from difficult year-over-year comparisons to Frozen merchandise. On the call, DIS noted that there was also an impact from a timing issue on minimum payments that it receives from vendors who license their intellectual property for products. Additionally, DIS wrote off inventory and decided to shut down the low-margin Infinity division, which was producing interactive toys and video games. Infinity was an experiment for DIS, and they cited inventory management issues as a factor in realizing that in-house video game production was not part of their core competency. DIS will now exclusively license its content to video game producers going forward.

Media networks experienced some ad weakness at ESPN due to obligations to advertisers to make up for lower than expected ratings on the New Year’s Eve college football semifinals. This was not completely unexpected, but was still disappointing. Investors remain concerned with the future of ESPN, which is being squeezed on the cost side by increasing sports programming costs, and the revenue side by slowing affiliate fee and advertising growth due to subscriber declines driven by ongoing changes to consumer viewing habits – cord cutting and cord shaving. Despite these concerns, DIS reaffirmed its outlook on cable networks affiliate fees and operating income for the balance of 2016. Interestingly, DIS commented that they are negotiating distribution agreements with several over-the-top TV partners, including Dish Network’s Sling TV’s newest multi-stream option and Hulu’s upcoming skinny bundle.

Looking ahead, DIS is planning to open its new theme park in Shanghai next month. This should help drive substantial growth once the initial opening costs have been recouped. The upcoming film release slate looks as strong as ever over the next couple years, with good visibility into planned key franchise titles. However, the recent box office success will also lead to more difficult comparisons, which could lead to slower than expected growth. Overall, we believe DIS is an attractive long-term investment, but expect the stock to linger in the low-$100’s until there is more certainty on the future of ESPN’s business model.

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. 

Liberty Global On Track Despite Weak Start to Year

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Liberty Global (LBTYK) reported slightly disappointing 1Q16 earnings.  However, the 2016 was maintained and the long-term story is intact.  Management made a strong case that any shortfalls were not unexpected based on internal budgeting and investors and analysts seemed to buy it as the shares finished positive after starting lower in response to the headlines.

Revenue growth was in line with expectations at 3% adjusted for currency and one-time items.  Operating cash flow fell short of estimates with growth just under 3%.  New subscribers also fell short of expectations as price increases in Germany and Switzerland held back growth.  The United Kingdom, LBTYK’s largest market, had its best first quarter ever for subscriber growth and is seeing early benefits as it extends it cable network into new neighborhoods. Free cash flow also fell short of expectations but this was clearly explained as timing differences and

Despite the slow start, we remain confident that LBTYK will meet its goals for 2016 of 5-7% growth in revenue and operating flow and $2 billion in free cash flow.  This should provide a boost a boost for the shares.  Also helping will be renewed share repurchases that have been prohibited while the company completes the acquisition of Cable and Wireless on behalf of its Latin American subsidiary.  Nearly $4 billion in buybacks should occur in 19 months from June 1 through 2017.  We also expect a spinoff of the Latin American subsidiary to occur later this year.  Already separately traded, the Liberty LiLAC (LILAK) is worth about $5 per LBTYK share.  We think a spin can unlock some incremental value by simplifying the company and enhancing the ability to grow in the fragmented Latin American telecom economy.

Competition has stiffened in Europe for LBTYK making growth harder to come by and keeping investors on the sidelines.  As growth rates pick up later this year and the stock buyback kicks in, we expect renewed investor interest in LBTYK to finally get the stock moving toward our price target in the low $50s.

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.

Liberties on Plan Post Trackers

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Liberty Media reported results following its split into three tracking stocks.  Northlake sold the shares that track ownership of the Atlanta Braves, the team’s new stadium, and the real estate development adjacent to the stadium.  We continue to hold shares in Liberty Sirius (LSXMA/LSXMK) and Liberty Media (LMCA/LMCK).  We read nothing in the quarterly reports and heard nothing on the conference calls that dissuade us from our view that both stocks have attractive upside.

LSXMA/K tracks the controlling ownership in Sirius XM Satellite Radio (SIRI).  SIRI reported a good quarter a couple of weeks ago so nothing new came out of Liberty as it relates to the outlook for SIRI.  Management did offer several comments on the ultimate combination of LSXMA/K and SIRI.  The comments were in line with our expectation that this could occur within the next two years.  SIRI is aggressively buying back its own stock and Liberty’s interest is now up to 63%.  At the current pace that ownership will exceed 80% by the end of 2017 at which point we feel a combination is highly likely.  LSXMA/K trade at an 11% discount to SIRI, which is hard to explain given that Liberty controls the company.  As long as SIRI fundamentals look solid, we sit and wait with knowledge that eventually we get upside as SIRI shares rise and an 11% bonus as the discount in LSXMA/K narrows.

The story is much the same at the new LMCA/K.  In this case, Liberty owns 35% of Live Nation Entertainment (LYV).  In turn, LYV shares make up about 82% of the value of LMCA/K.  The discount to net asset value for LMCA/K is around 18% as there is less clarity on the path forward for LYV and LMCA/K and there are other assets including cash that create uncertainty.  We still feel that the 18% discount is much too wide providing incremental upside as LYV continues to grow adjusted operating income at 10% a year.  Much has been made of the shift in consumer preferences form buying things to buying experiences.  LYV’s dominant global position in concerts and ticketing provides one the best experiences for consumers, especially the highly desired and hard to reach millennials.  LYV is also benefitting from the shift of economics in the music industry form album sales to touring.

LMCA. LMCK, LSXMA, and LSXMK 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, LSXMA, and LSXMK 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 Blizzard Gets Back on Track

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Activision Blizzard (ATVI) bounced back from a disappointing end to 2015 with a strong beat on sales and earnings in the first quarter of 2016. ATVI also increased guidance for 2016. Based on the first quarter and management commentary on the conference call, we believe analyst estimates could be revised higher throughout the year as ATVI executes on its plan, leading the stock to rise to the low-$40’s.

The successful quarter was driven by continuing strength in its key franchises, especially Call of Duty, World of Warcraft, and Destiny. ATVI has benefitted from a focus on keeping users playing and paying with add-on downloadable content between major franchise upgrade cycles. The quarterly results also demonstrated progress on the integration of recently-acquired King Digital Entertainment as ATVI moves to unlock significant upside in mobile gaming and advertising.

Looking forward, ATVI has some exciting product launches coming soon that should continue to drive strong results. Overwatch, a new Blizzard franchise with a creative twist on the first-person shooter genre, will launch on May 24th, 2016. Expectations are high for Overwatch, with some believing the launch could rival the massively successful launch of Destiny last year or Diablo III in 2012. More importantly, ATVI sees Overwatch as a key franchise going forward with long-term potential to grow the user base and create eSports offerings. Excitement is also starting to build for the releases of the World of Warcraft: Legion expansion at the end of the summer and the next iteration of Call of Duty: Infinite Warfare in the winter.

In summary, we believe that conservative guidance, solid execution, and several underappreciated opportunities to drive long-term growth and profitability leave ATVI shares well-positioned to climb into the low-$40’s. Long-term opportunities in advertising, eSports, video content production, and the shift to digital video game downloads each contribute extra optionality for the shares to outperform.

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.

Despite a Wall of Worry, Comcast Continues to Perform

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Comcast (CMCSA) reported another good quarter, seemingly a habit for the company.  Against a lot of noise and negative headline regarding cord cutting, cord shaving, anti-cable regulation, and technological change, the company continues to execute superbly.

The latest quarterly results were issued almost simultaneously with the acquisition of DreamWorks Animation (DWA).  CMCSA paid a steep price for DWA but the acquisition is strategic more so than financial.  Furthermore, CMCSA has an enterprise value approaching $200 billion, making the expenditure of $3.8 billion a low-risk move.  Capturing DWA’s intellectual property (Shrek, How to Train Your Dragon, Kung Fu Panda) and relations hips in China offer upside to CMCSA’s TV networks, theme parks, and film studio.

Getting back to earnings, consolidated revenues grew 5.3% and operating cash flow rose 6.9%.  At the cable business, revenues were up 6.7% driven by 269,000 new customer relationships and a 4% increase in revenue per subscriber.  Broadband is the major driver with revenues up 7.6% and 438,000 new subscribers.  The much maligned cable TV business saw 3.9% revenue growth and 53,000 new subscribers.  You read that right.  Despite all the talk about cord cutting, CMCSA has been adding cable TV subscribers.  Heavy investment in the network and the X1 set top box and software is allowing CMCSA to gain market share, particularly from satellite.  Skinny bundles, which can hurt NBC Universal, provide a more balanced impact on the cable TV business.

An old adage on Wall Street is that bull markets climb a wall of worry.  This is less applicable to individual stocks but does still apply. CMCSA faces many worries but so far they are not impacting the company, which is thriving, rather than reeling.  We find the combination of steady, moderate growth in financial metrics, unusually strong balance street metrics, shareholder friendly capital allocation, smart strategic thinking, and excellent operational execution very attractive.  On a sum of the parts basis using peer comparisons, the shares belong in upper $60s.

CMCSA 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.  CMCSA 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.

Lots of Bruises on Apple

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Apple (AAPL) reported a disappointing quarter and issued guidance for the June quarter that was below expectations.  Missing the quarter on revenue and EPS is highly unusual for Apple.  There have been times in the past where guidance was considered disappointing but missing against consensus expectations on revenue and EPS is unusual.  Shipments of iPhones came in OK so the problem was in gross margins and average selling prices for iPhones.  Both of these issues have long been major fodder for Apple bears who believe that the company is over earning against a commodity product.  Guidance does not necessarily support the bears, however, as the lowered expectations appear designed to clear inventory of the mediocre selling iPhone6 and 6s ahead of the iPhone7 launch this fall.

The quarterly report and guidance suggest that the bottoming in Apple’s growth will now be pushed out the June quarter.  Northlake had expected the March quarter to mark the bottom allowing the shares to begin to rally into the iPhone7 cycle.  This no longer appears the case.  Furthermore, there are doubts about how strong the iPhone7 cycle will be given weaker than expected demand for the 6 and 6s.  Part of the issue is that U.S. telos are extending the upgrade cycle on smartphones with pricing and promotion strategies.  There also could be resistance to the latest phones now that software, which is upgradeable via download, rather than hardware, is driving consumer perceptions.

Northlake is less positive on Apple than it has been in some time.  The challenge the stock faces is that even a good iPhone7 cycle will only drive only modest, single digit growth in operating income.  Given what looks like a mature global smartphone market, it is hard to see the valuation on AAPL shares move much higher.  New estimates have the company earnings $8 this year and less than $9 next year.  Financial strength remains unrivaled providing support for the shares with buybacks and dividend increases.  AAPL increased its shareholder friendly capital allocation program as expected when it reported.

In our last update on AAPL, we noted that the shares could rise to $120, if growth resumed as we expected.  With growth now on hold for longer than we had expected, we believe upside is limited.  Support should exist in the mid $80s at 10X 2016/17 earnings.  We plan to hold AAPL for now but may look trim oversized positions as we have been doing occasionally over the past several months.

AAPL 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.  AAPL 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.

Facebook Momentum Continues Unabated

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In our initial blog post on Facebook (FB), we noted that the shares could reach $140 based on $4.00 in EPS power in 2017.  After another blowout quarter in 1Q16, 2017 estimates now average over $4.50.  Our confidence in the $140 price target has risen and that level may prove conservative.

FB reported revenue growth of 52% for 1Q16, a phenomenal result given quarterly revenue is over $5 billion.  This was better than even the bulls expected.  Concern had risen form a few analysts that 1Q would miss estimates and those worries increased when Google fell short when it reported a week earlier.  FB continued to execute very well with operating margins also exceeding consensus expectations.  EPS soared to 77 cents vs. consensus of 62 cents as the tax rate came in lower than expected.  Normally, a lower tax rate would indicate poor quality earnings but management had been telegraphing a lower rate and indicated on the conference call that it was here to stay.

Growth in 1Q16 continued to be driven by the core Facebook Newsfeed which is getting a big boost from video.  We continue to see the Newsfeed as similar to broadcast TV networks in that the reach is just massive leading advertisers to buy it almost regardless of activity levels.  Activity levels look good, however, with average daily and monthly users continuing to grow on a global basis.  As we had hoped, Instagram is beginning to contribute meaningfully as well.  Instagram should grow from hundreds of millions to billions in revenue helping to support growth as the law of large numbers leads to moderation in Newsfeed growth.  Much time on the conference call was spent on Messenger which management is wisely trying to get right and grow users before worrying about monetization.  WhatsApp remains behind Messenger on the monetization curve but could be another big product in a few years.

FB also announced an effective 3:1 split by issuing non-voting shares.  This is similar to what Google did a couple of years ago. For FB, the issuance of non-voting shares is happening because Mark Zuckerberg has committed to giving most of his FB stock to charity.  The issuance of non-voting shares will allow him to give those shares away and hold his super voting shares that give him control.  Zuckerberg is dong a fantastic job, so we are very happy to see him maintain control.

FB shares are being held back by rotation form growth to value stocks as concerns about global economic growth, collapsing oil prices, and dollar strength abate.  Northlake is focused on the long-term and remains confident that FB shares will meet our target over the next 12 months.

FB 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.  FB 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.

ClubCorp Results Continue to Affirm Bull Case

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ClubCorp (MYCC) reported another solid quarter further putting to bed the bear case that has led the stock to decline by more than 30% in 2016.  The concerns have revolved around the Texas economy, membership trends, lack of margin expansion and return on recent acquisitions, high debt levels, and declining participation in golf.  Each of these items saw positive news in the 1Q16 report.  We were especially encouraged by improved top line growth with same club membership trends accelerating to low sing digit gains and food and beverage up high single digits.  Better revenue growth allowed margins to expand.  It appears the completion of upgrades at many recently acquired clubs has allowed activity at these clubs to improve such that the upside related to these acquisitions is being realized.  This is exactly what we had in mind when we invested in MYCC.

For the second quarter, trends in Texas look good.  Texas accounts for about 30% of MYCC’s clubs and revenues and concerns about the Texas economy due to weak oil prices have fed the bear case on the shares.  Houston, which is 8% of the company, actually returned to growth in 1Q16, while Dallas, continues to be among the fastest growing cities for MYCC, even better than places like Atlanta, Florida, and Southern California.  Oil prices have rebounded and employment trends, wages, and housing prices in Texas are firming.

Skeptics still abound on MYCC but that is where Northlake sees opportunity.  Poor weather last spring creates an easy comparison for MYCC in 2Q16.  Management guidance for 2016 looks low after the strong 1Q.  One more solid quarter should improve sentiment on the shares, which remain very cheap at 7.5X EBITDA.  A conservative target is 8X the conservative management guidance, which would get the shares back to $15.  As confidence in MYCC’s growth profile returns and investors look to 2017, an 8X multiple can get the shares to $18-20.

MYCC 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.  MYCC 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.

Mid Cap Favored for May

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Northlake’s Market Cap model shifted to mid cap from large cap for May.  As a result, client holdings in the S&P 500 that are linked to the model will be sold and proceeds reinvested in the S&P 400 Mid Cap (MDY).  There is no change to the neutral reading from the Style model, so client positions dedicated to this model will remain evenly split between growth (IWF) and value (IWD).

The change to mid cap in the Market Cap model is driven mostly by the 2-month smoothing process that determines the final reading.  Last month, the April only reading was already at mid cap driven by the internal trend and technical indicators.  Another indicator in this group flipped to small cap for May, while all the rest of the indicators in both the internal and external groups remained unchanged.  This was enough to slightly strength the mid cap reading for May and move the 2-month average into mid cap territory.  The new signal is not particularly strong as the external indicators continue to favor large cap reflecting the weaker data on the U.S economy as confirmed by the low reading for 1Q16 GDP growth reported last week.  The models purposefully combine internal and external indicators to maintain a balance between what the data is saying and what the market action is saying.  Stocks are a leading indicator, so trend is important to consider side-by-side with the data.

The Style model saw two internal indicators move from value to growth but this was not enough to shift the recommendation from the neutral reading.

During the time the large cap reading was in place, the Market Cap model would have been better off in small or mid cap but there was nothing lost on a relative basis to the benchmark S&P 500.  The Style model would have been best positioned in a pure value reading last month.  The stock market rally off the February low continues to be led by energy, commodity, and cyclical stocks.  This is happening because those sectors were severely depressed early in the year as fears of global recession ran rampant.  Mostly due to weakness in the dollar, those worries have dissipated and allowed these sectors to rebound sharply.  The neutral reading has not been ideal these past few months but it has allowed for partial capture of significant gains for value stocks.

MDY, IWD, 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.