Disney Outlines Expectations for 2017 and Beyond

/0 Comments/in /by

Disney (DIS) reported FY2016 results with sales and earnings modestly below expectations. While the results were slightly underwhelming, investors were more focused on the outlook for 2017 and beyond. Although DIS faces difficult comparisons next year, due largely to year ago strength in Frozen consumer products and Star Wars: Episode VII box office receipts, we believe the long-term growth outlook is still very promising. Using 2017 EPS estimates, DIS is trading at a slight discount to the S&P 500 instead of the premium multiple investors typically award the stock. Given the de-risked estimates and discounted multiple, we believe the shares can move back toward $110 with limited downside from current levels.

Arguably the largest concern for DIS investors recently has been the implications for affiliate fee and advertising revenues tied to the recent decline in ESPN subscribers. On the earnings call, CEO Bob Iger commented that DIS has “taken a more bullish position on the future of ESPN’s sub base.” Two important factors are likely involved in this improved outlook. First, DIS now has deals in place with Sony, Dish Network, Hulu, and AT&T/DirecTV for broadcast and cable networks like ESPN to be included in new skinny bundles. The new distribution deals should help stem subscriber losses if consumers leave traditional cable bundles for the new offerings, and could even add new subscribers who never had cable in the first place. Second, DIS recently purchased a 33% stake in Major League Baseball’s BAMTech, with the option to acquire majority ownership in the coming years. This investment is likely tied to ESPN’s plans to launch a direct-to-consumer OTT network in the near future, further increasing the potential subscriber base. Separately, BAMTech already delivers digital content for several other companies, and could eventually help DIS to create dedicated OTT networks for its other brands including Disney, ABC, Pixar, Marvel, and Star Wars.

While investors worry about ESPN subscribers and revenues, DIS also expects cable programming expenses to increase 8% in 2017, largely driven by the step-up in NBA deal. ESPN now has NBA rights locked up through the 2024-25 season, and has long-term deals in place with the NFL, NCAA Football, NCAA Basketball, and MLB. We believe high-quality sports rights are a worthwhile investment that provides valuable ad inventory at a time when advertisers are struggling to find large audiences watching live TV. Rising costs and the threat of falling sales understandably worry investors. However, we believe that the exclusive sports rights and increasing distribution options will allow ESPN to continue to grow long-term.

The parks and resorts segment is benefitting from a better than expected opening at Shanghai Disneyland. The new park is already pulling visitors from across China, with 50% of attendance coming from outside of Shanghai. Even better, the park is expected to operate at close to break-even profitability by the end of 2017, much faster than originally planned. Due to the early success, DIS is already expanding Shanghai Disneyland to include “Toy Story Land”. The resorts in Orlando and California are each getting their own “Star Wars Land” expansions. DIS believes they have pricing power at their parks due to demand-oriented flexible pricing and new ticket packages.

Finally, and most importantly, DIS continues to leverage their world-class brands and franchises starting with the Studio division. Success at the box office leads to years of success in consumer products and parks. For example, Frozen merchandise is still selling so well 3 years after the film’s release that it creates difficult growth comparisons into 2017! Key upcoming films in the next two years include 4 titles from Marvel, 3 animated pictures from Pixar and Disney, and 2 Star Wars films including Episode VIII. The upcoming film slate and powerful business model is more than enough reason for us to believe that growth will continue across the entire Disney business for years to come.

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 not currently held as a 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.

On Track But Not Much Fresh News at Liberty Media and Liberty Sirius

/0 Comments/in /by

Liberty Media and Liberty Sirius reported earnings and held their annual analyst meetings last week.  We attended the analyst meeting, one of our favorite events of the year given Liberty’s broad reach into the world of media and communications that is a focus of our investment strategy,

The big news at Liberty Media has been the acquisition of the Formula One auto racing series.  Announced a few months ago, the acquisition has been very well received by investors with LMCA/LMCK shares trading up nearly 40%.  Partially what has happened is that Liberty Media shifted from a collection of assets with an uncertain future to an operating company.  Sports rights have gained value as TV viewing has fragmented and Formula One is unusual given its massive global popularity and the ability for a company to own the entire series.  You can’t buy the entire NFL or NBA.  Liberty Media used its quarterly earnings and analyst meeting to outline its plans for Formula One.  The company sees a lot of upside given its experience developing media properties and its view that Formula One’s economics have not been maximized.  Liberty Media will change its name to Formula One next spring following closing of the second phase of the acquisition.  Northlake plans to hold LMCA/LMCK shares in most cases and sees upside to the mid-$30s over the next year.

Liberty Sirius (LSXMA/LSXMK) is a tracking stock that holds a 65% controlling interest in Sirius XM Satellite Radio (SIRI).  LSXM’s earnings report came after SIRI had already reported another set of strong results.  Subscriber growth, operating cash flow, and free cash flow all at least matched Wall Street estimates.  SIRI shares have rebounded about 4% since the report and since LSXM has no other assets besides SIRI it has gone up in value similarly.  There are two things at SIRI that investors are keeping their eye on.  First, the company is increasingly focused on the used car market.  There are tens of millions of cars driving around with second or third owners that had a Sirius radio installed at the factory when new.  Management seems to be having success reaching used car buyers.  This will be more important with new car sales appearing to be a plateau, albeit still at a high level.  Second, SIRI is rolling out 360L, which effectively makes the Sirius product two way rather than just a downstream beam.  Enhanced products and services could follow but maybe more importantly, the company will gain a much better understanding of its subscribers which could reduce churn.  Large subscription businesses face a big challenge with churn, much of it just being natural — someone sells their car, a cable customer moves, etc.  One other item of interest at LSXM is when LSXM and SIRI will combine.  LSXM trade around a 15% discount to SIRI, which seems crazy to us but a path to narrowing this discount in the short-term is hard to discern.  We think SIRI can move toward $5.00, up about 15%, with a similar rise in LSXMA and LSXMK.  Should the discount on the LSXMs narrow, they will receive an added boost to their return.

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.

Growth Begins to Accelerate at Liberty Global

/0 Comments/in /by

As we hoped, Liberty Global (LBTYK) reported a modest improvement in its revenue and EBITDA growth rates for 3Q16.  Revenue adjusted for foreign exchange, merger activity, and other one-time items grew 2% and EBITDA gained 3%.  EBITDA excluding the Netherlands (soon to be part of a joint venture) grew a more impressive 5%.  A variety of factors have depressed LBTYK’s growth over the past 18 months but we believe that 3Q16 marked the start of an acceleration to management’s stated goal of 7-9% over the next several years.  Investors remain somewhat skeptical but we are willing to be patient as we have had great success in our career with the management of LBTYK.  IF growth rates accelerate from here over the next several quarters, we think LBTYK can rise to the upper $30s, providing a return of near 30%.

Reinvigorated growth is being driven by the companies buildout of new cable plant in the UK, German, and selected other markets.  So far, the results in the UK are quite good with penetration of new homes passed of 29%.  The company is well on pace to reach its 40% penetration goal.  LBTYK is able to finance the expensive buildout of new neighborhoods by using the cash flow of the new subscribers to fund borrowings.  Presently, this pressures free cash flow as capital spending and interest expenses are elevated.  However, as the buildout matures, free cash flow should rise rapidly to benefit shareholders.

Growth is also being supported by the company’s cost containment and efficiency drive, Liberty Go.  LBTYK is a diverse business, operating cable and wireless service business in Western and Central Europe.  Each market has unique characteristics and in many cases languages.  After years of mergers and acquisitions to expand the company’s geographic reach, it was inevitable that inefficiencies crept in.  Management is no focused on gaining efficiencies to drive cost saves and enhance revenue opportunities.  3Q16 results suggest early success.

Management reiterated the low end of the 4-5% EBTDA growth guidance for 2016 during the conference call.  This should lead to another quarter of higher growth in 4Q, something we expect to build investor confidence in LBYTK.  Admittedly, it is has been a long period of underperformance for LBTYK shares, down around -20% this year.  We think the payoff may be at hand, however.

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.

Activision Blizzard Reports a Solid Quarter

/0 Comments/in /by

Activision Blizzard (ATVI) reported good quarterly results that beat investor expectations, while raising guidance for the fourth quarter. The stock reacted with a mild selloff, as the increased fourth quarter guidance did not quite meet Street expectations. Aside from the slightly conservative fourth quarter guidance, ATVI appears to be on track to benefit from several secular tailwinds, including the growth of higher-margin full-game digital downloads, rising popularity of mobile gaming and related digital advertising driven by the recent acquisition of King Digital (KING), and the increasing viewership and participation in professional e-sports. In total, we believe that solid execution from ATVI will continue to drive the shares higher into the upper-$40’s.

Player engagement remains incredibly strong, with more than 500 million monthly active players across the company’s various games playing more than 10 billion hours in the third quarter alone. Recent game launches such as Overwatch and World of Warcraft: Legion have been well received. Destiny remains very popular, and ATVI plans to build on that success with expansion packs and another full-game release.

Investors and gamers are anticipating the release of the newest installment in the Call of Duty franchise, subtitled Infinite Warfare. Importantly, ATVI and analysts are already assuming conservative unit sales figures for the game, partially offset by a higher average sales price than previous versions due the availability of better bonus content. This year, gamers can purchase the “Legacy Edition” of Infinite Warfare, which includes a remastered version of the massively successful Call of Duty: Modern Warfare for an extra $20.

ATVI is progressing on integrating the recent KING acquisition. Over the last three months, ATVI has been testing digital ads in KING’s mobile games. Although company guidance does not account for any benefit from the sales of mobile game ads, this is a significant growth opportunity. During the third quarter conference call, ATVI announced that they now expect mobile ads to begin to contribute to earnings in FY17. We believe that mobile ads will contribute substantially to ATVI earnings in FY18 and beyond.

ATVI has been a big winner for Northlake, and we expect it to continue to move higher as the company executes on its plans and benefits from the several secular tailwinds discussed above. In the near-term, we expect the shares to move towards the upper-$40’s, with more potential long-term upside driven by growth in digital ads and e-sports.

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.

MGM Resorts Reports Outstanding Quarter

/0 Comments/in /by

MGM Resorts (MGM) reported its best quarter in a strong run of growth for the company and upside surprises to Wall Street estimates.  When Northlake bought MGM for clients earlier this year, our investment thesis was based on strong management, unappreciated strength in Las Vegas, upside at soon to open regional gaming properties in the U.S., consistently strong management execution, and an attractive sum of the parts valuation.  Following the 3Q16 report, each aspect of the investment thesis remains firmly in place.  We are sticking with MGM and see upside to the mid-$30s looking out to the end of 2017.  Catalysts to achieve this target include opening of the new casinos in Washington DC and Springfield, MA, further stability and modest improvement in Macau, continued strength in Las Vegas, additional upside from the company’s Profit Growth Plan, and further portfolio restructuring to realize shareholder value.

Even adjusting for a couple of favorable one-time items, MGM’s 3Q16 results were very good. On a same store basis, revenues at the domestic casinos and resorts rose 7%.  Gaming volumes were good but the big upside came from an 11% increase in REVPAR in Las Vegas.  The excellent revenue trends drove margin expansion which received a further kick from the company’s Profit Growth Plan.  This plan, a combination of revenue initiatives and cost savings, has met its goal of $400 million well ahead of schedule.  Management was unwilling to up its target but spoke confidently of further improvements ahead.  All financial metrics reported by MGM easily exceeded Wall Street estimates

It is too early for management to provide guidance for 2017 but there was a discussion of group trends looking good for 2017 and optimism that REVPAR gains can be in the mid-single digits next year.  These general comments should be well received.  2017 also will see the opening or first full year of results at new resorts in Macau, Washing DC, and Springfield.  New openings can be tricky given pre-opening costs and needed management and marketing resources.  We are confident that the excellent and detail-oriented MGM team is up to the task.

As long as Northlake remains comfortable with the outlook for Las Vegas, stability or slight growth in Macau, and reasonable domestic regional gaming trends, the unique drivers of the MGM story should shine.  In 2017, we could see the company find more ways to realize value from its portfolio of assets as D.C. at least is sold to sister company MGM Properties with MGM retaining the operating profit after paying rent to to MGP.  Actions like this plus continued growth at all existing properties can drive MGM shares to our mid-$30s target price over the next year.

MGM 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.  MGM 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.

Another Good Quarter at CBS

/0 Comments/in /by

CBS reported another solid quarter, supporting our view that it is among the best positioned traditional media companies in a challenging landscape as viewers use different devices to watch TV and new entrants like Netflix offer alternative viewing options.  With the exception of Time Warner, which is being bought by AT&T, CBS has been the best performing entertainment stock over the past year, up more than 15%. Viacom, Fox, Disney, and Discovery Communications, all companies where like CBS the primary business is TV networks, are each down between -10% and -25%. We think CBS can continue to outperform its peers and see some signs that stock performance for the group could improve.

The strength at CBS comes from its narrow focus with most of the revenue and operating profits coming from broadcast TV and the premium pay channel Showtime.  The company is not burdened by a large portfolio of cable networks that are struggling with cord cutting, cord shaving, skinny bundles, and viewer fragmentation leading to weak ratings.  The CBS broadcast network has must have programming that supports its inclusion in any bundle of channels that viewers may choose and any device and through any distribution mechanism.  Big time sports like the NFL and still relatively highly rated entertainment programming leave CBS as a must by for advertisers seeking the reach advantage of TV.  Having of the industry’s most successful programmers, Les Moonves, as its CEO also supports the outlook for the company.

These competitive advantages were evident in the most recent quarter where revenues grew 4%, operating cash flow grew 5%, and EPS grew 19%.CBS has been astute at using its free cash flow, balance sheet strength, and divestitures to dramatically reduce its shares outstanding and support EPS growth.  The company announced further good news on the capital allocation front with its third quarter results.  The share buyback of $500 million per quarter will be supplemented with a $1 billion buyback in the fourth quarter as CBS completes the divestiture of its Radio business.

One major uncertainty hanging over CBS is whether it will merge with Viacom.  Both companies are controlled by Sumner Redstone and his family.  We are neutral on the merger possibility, balancing CBS strong management against the struggling business fundamentals at Viacom.

CBS estimates are rising due to better than expected operating performance and greater share buybacks.  There also looks to be somewhat better sentiment toward TV networks owners as new OTT services like Hulu and DirecTV now allow affiliate and retransmission fess to stabilize (or in CBS case accelerate).  We think the shares can work toward $60-65 as confidence grows in the stability of CBS business amid technological change.  A P-E of just 14X 2017 estimates would target the low $60s and still leave the shares at a meaningful discount to the market.

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.

Facebook Strong As Ever But Investors Fret About Deceleration

/0 Comments/in /by

Facebook reported another strong quarter with revenue growing 56% and operating income up 73%.  Both figures exceed Wall Street estimates despite high expectations.  As it has consistently since going public, management provided cautious commentary on revenue and operating expense growth looking ahead.  Comments about revenue growth slowing next year and “aggressive investment” were almost verbatim from the last quarterly report and closely parallel repeated comments back to 2013.

Unfortunately, in a very nervous market that has already witnessed many good earnings reports meeting aggressive selling (most notably for Facebook was a selloff in Google after posting strong earnings), Facebook shares sold off as investors focused on the cautious commentary.  Northlake expects Facebook to again exceed its own guidance and views the pullback as an opportunity.  We do believe that a recovery in the shares could be prolonged because they are already so widely held and Wall Street has a tendency to penalize stocks in the near term when revenues and earnings growth is decelerating.  Even when it slows from 59% to 35%!

Current consensus estimates for Facebook call for EPS of over $5.00 in 2017.  We think that will prove conservative.  Given the growth rate and the company’s dominant competitive position in advertising, we find the share a bargain at only 23X 2017 and under 20X 2018.  Northlake is staying the course on Facebook and would look to add to positions on further material weakness.

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.

Back to Neutral on Growth vs. Value

/0 Comments/in /by

Northlake’s Style model moved back to a neutral reading between growth and value for November.  As is often the case when a trend change may be under way, the model signals can be volatile from month to month.  In this case, after a long stretch favoring growth stretching back most of the past several years, the Style model appears to be transitioning toward value.  This makes sense given that interest rates and inflation may have bottomed at the same time that global economic growth risks have moderated.  What we used to think of as a normal economy would favor value over growth so when you read about the Federal Reserve wanting to normalize monetary policy that could also be read as a signal suggesting value stocks may be poised for outperformance.  Thus, the model appears to waffling between value and neutral until stronger evidence confirms a shift to value.

As a result of November’s neutral signal from the style model, one half of client positions in the Russell 1000 Value (IWD) have been sold and proceeds reinvested in the Russell 1000 Growth (IWF).  There is no change to the mid cap recommendation from the Market Cap model, so client positions in the S&P 400 Mid Cap (MDY) will be held for at least another month.

The shift back to neutral from value in the Style model was driven by internal technical and trend indicators.  Two breadth indicators are showing that growth stocks may be poised for improved relative performance in the near-term.  The interplay of internal technical/trend indicators and external economic and interest rate indicators is a key part of the models.  The internal indicators are shorter term in nature and designed to help the timeliness of the model recommendations against the longer term data series that dominate the external indicators.

Last month, the shift from neutral to value proved beneficial as value outperformed growth in September. The mid cap signal for October was mixed.  Small caps had a horrible month so mid cap was better than small cap but large caps still did best even though they fell during September.

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.