Growth Expectations Reset at MGM Resorts

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MGM Resorts (MGM) reported disappointing fourth quarter results. The miss was partially self-inflicted; previous guidance from MGM warned about a difficult year-over-year fourth quarter comparison but neglected to mention the potential impact from a shift in the timing of Jewish holidays. A related timing shift by one large convention group impacted fourth quarter EBITDA by nearly $20m, or about half of the overall EBITDA miss. Additionally, operating margin flow-through was below expectations after continually surprising to the upside for several quarters. While it is understandable that the stock pulled back in response to the report, Northlake’s long-term thesis remains intact. Sales and profit margins should continue to grow at least throughout 2017, albeit at a slower pace than investors were previously expecting. Northlake believes MGM can trade into the mid-$30’s despite the reduced growth expectations and will continue to hold the stock.

Positives from the quarter include continued progress on the Profit Growth Plan (PGP) and the initiation of paying a quarterly dividend to shareholders. MGM expects to achieve the full $400m run-rate of incremental cash flow from the PGP in the first half of 2017, earlier than the initially targeted end of 2017. MGM also signaled that the PGP will provide further benefits beyond the initial $400m, although the extent of those incremental benefits may be less than some investors initially expected. The initiation of the dividend reflects an inflection point of free cash flow generation and debt reduction for MGM, as well as an ongoing commitment to return capital to shareholders. Even with a comparable yield to many lodging and gaming peers, MGM has left themselves room to balance between growing the dividend, continuing to reduce debt, and reinvesting in growing the business. Additional capital will likely be returned to shareholders after subsidiaries including City Center and MGM China transfer cash back to the parent company.

MGM has delayed the opening of their new resort in Cotai until sometime in 2017 while they work with the government to finalize project details. The delay has created additional expenses and uncertainty, but an upcoming board meeting in March should provide more detail for investors.

MGM’s 2017 outlook for Las Vegas appears solid. Despite another difficult comparison in the third quarter, RevPAR and profit margins are expected to grow each quarter throughout the year. Leisure and business travel should remain strong as consumers continue to spend on experiences instead of products. MGM already has 90% of its convention business booked for the year, and is increasingly focused on driving total group spend on food, beverages, and gaming.

The recently acquired Borgata and the newly opened National Harbor are both performing well so far. MGM said that National Harbor has been capacity constrained on the weekends, implying strong consumer interest. MGM plans to roll out a new regional marketing campaign once National Harbor is included in the M Life rewards program, which should help boost both properties traffic in the coming quarters.

In summary, the disappointing quarter from MGM led the stock to pullback as growth expectations were reset. The combination of poorly anticipated and communicated guidance from MGM along with a stretch of surprisingly strong quarters allowed investors’ expectations to run ahead of the actual results. However, even after this reset, Northlake believes the fundamentals are still on track and continues to hold MGM with a target price in the mid-$30’s.

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.

CBS Long-Term Story Very Much Intact

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CBS reported mixed results for 4Q16 in a quarter where that was widely expected due to difficult comparisons.  The company showed three fewer Thursday night NFL games and lost 9 hours of primetime to election coverage.  This led to revenues and operating income declining by -2%; ignoring the discontinued radio operations that are being sold.  EPS grew by 2% to $1.11 thanks to CBS’s shareholder friendly capital allocation of modest debt leverage and aggressive share repurchases.

2017 is a challenging year for CBS to grow given the CBS Network broadcasted the 2016 Super Bowl and received a lot of political ad dollars at its local TV stations.  Comparisons get easier in the second half of 2017 when the TV network and stations will not have to compete with Olympics coverage on NBC and no network primetime is lost to election coverage.  A slow growth year is with revenues probably no better than breakeven.  EPS should still grow nicely, rising as much as 10% toward $4.50 per share boosted by share repurchases, including the upcoming exchange offer related to the sale of the radio assets.

The story at CBS is not about near-term earnings, however.  Rather the company remains arguably the best positioned media company to deal with the challenges of cord cutting skinny bundles, and internet-delivered OTT video services.  CBS has a rapidly growing revenue stream of retransmission payments received from cable and satellite companies and some of the new OTT services like Hulu and DirectTV Now.  These revenues are projected to grow by 25% this year and approximately double by 2020.  The company has also had success with its own OTT services including CBS All Access and Showtime.  Each has gained about 1.5 million subscribers is less than one year and both are ahead of schedule to meet the 2020 target for a total of 8 million subscribers.  As one of the largest producers of TV shows, including most of those shown on Showtime and CBS, the company also benefits from a robust secondary market for TV shows in the era of Peak TV.  Overseas demand is especially vibrant for the broadcast-friendly fare that CBS typically produces.  Finally, with only one broadcast network and one pay network, CBS is unlikely to face the same level of subscriber losses or damage to its economics that many other entertainment companies have while trying to protect a multitude networks against cord cutting and cord shaving.  CBS does have relatively high exposure to advertising at 45% of revenues but this has moved down from around 70% as CBS has strategically restructured its asset portfolio.

We think CBS shares could reach a 15 P-E on 2018 estimates by late this year, equating to an upside target of $75.  That is still a nice gain from current trading levels near $65 after the stock rose 35% in 2015.  In Northlake’s eyes the Tiffany Network retains its shine.

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.

 

Liberty Global Growth Acceleration Affirmed

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Liberty Global (LBTYK) reported solid 4Q16 results, affirming the acceleration in the company’s growth rate that is critical to our investment thesis.  Using the company’s methodology that ignores foreign exchange fluctuations, M&A, and the new joint venture with Vodafone in the Netherlands, rebased revenues grew 3.3% and operating cash flow grew 7.5%.  Revenues were slightly ahead of expectations, while operating cash flow greatly exceeded Wall Street estimates.  Management guided to 6-7% operating cash flow in 2017 and 7-8% growth beyond that with 2018 potentially exceeding 8%.  This guidance is comfortably ahead of investor expectations.  Finally, the Board unexpectedly boosted the share buyback by $1 billion to $3 billion for 2017.

All of this should add up to good news for LBTYK shares although after an initial 5% move higher, the stock sits unchanged as we write this note.  There seems to be some concern that subscriber counts and revenue fell short of estimates in the U.K, the company’s largest market.  With LBTYK aggressively building out its cable network to hundreds of thousands of new homes in the UK, some worry has crept in that the build-out is not going to be as much of a growth driver as expected.  We accept management’s explanation that a second price increase in 2016 led to increased churn that overshadowed continued excellent returns on the build-out.

We have waited patiently for over a year for LBTYK to show accelerated growth with a strong belief that value in the shares could once again approach $50.  Now that the reported numbers support our view and management’s consistent commentary and promises, we see LBTYK shares continuing their recovery.  Already up 17% this year, we think in a reasonable market environment, the stock can see $38-$40 over the next six months.

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.

Relief Rally Pushes Activision Blizzard to Record High

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Activision Blizzard (ATVI) reported strong sales and profits with FY17 guidance modestly below Street expectations. It appears the conservative guidance was better than most investors expected, as ATVI rallied almost 19% to a new record high of $47.64. ATVI remains on track to benefit from several secular tailwinds, including the growth of higher-margin full-game digital downloads with add-on content, rising popularity of mobile gaming and related digital advertising after integrating the company’s acquisition of King Digital (KING), and growing engagement with e-sports.

Strength in the fourth quarter was driven by ATVI’s increasingly diversified portfolio of major franchises including Overwatch, World of Warcraft, and Destiny, offsetting the underperformance of Call of Duty: Infinite Warfare. Measuring units sold of each new game is becoming less relevant to ATVI’s success as add-on content downloads and micro-transactions become larger contributors to earnings.

Looking forward, we see untapped potential from the KING acquisition, e-sports, consumer products, and other new media initiatives. KING continues to test digital advertising, and is developing new content using ATVI’s existing intellectual property. Mobile game ads should be a positive contributor to FY17 earnings, and should contribute materially to FY18 earnings. E-sports continues to grow in popularity, and ATVI is well positioned to benefit from the trend. ATVI is also undertaking new initiatives in consumer products and TV/film that should boost growth further.

In summary, ATVI continues to be a big winner for Northlake. Although the recent surge post-earnings might limit the immediate upside, we believe the move higher is fully justified. With the conservative FY17 guidance announcement leading to a relief rally, we expect the next major catalysts to be related to the launches of Destiny 2 and the next Call of Duty title later in the year. We believe that ATVI can continue to move higher as these catalysts near and into the mid-$50’s as investors look towards strong earnings growth potential in FY18.

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.

Puts and Takes But No Significant Change for Core Holding Disney

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Disney (DIS) reported its second consecutive quarter of lower year over year revenue, operating income, and earnings growth as it faces difficult comps from the massive success of Star Wars: The Force Awakens and a big step up in programming expenses due to the new NBA rights contract that went into effect this season.  While there were gives and takes across the company’s operating segments, little was surprising.  A down year in FY17 followed by resumed growth in FY 18 has been widely and carefully telegraphed by management.  Northlake still sees DIS as a core holding but expects stock performance to lag until we get closer to FY 18 (begins 10/1/17) and investors have more confidence in the resumption of growth.  Once that happens we can see DIS shares trading toward $130 or 20x current estimates.  DIS’s quality, unique business model, and strong balance sheet support a premium multiple despite legitimate concerns on growth for ESPN as the cable TV audience fragments to small channel bundles and OTT services.

Looking more carefully at the segments, media networks saw slightly weaker than expected performance from ESPN, while the ABC network appeared better.  The film studio faced impossible comparisons and saw revenue -7% and operating income -17%.  Nevertheless, DIS’s remarkable success at the box office continued in the quarter with Doctor Strange, Moana, and Rogue One: A Star Wars Story.  Theme parks provided the best news, outperforming expectations for revenue and especially operating income.  Operating margins at theme parks reached an all-time record with cost controls especially impressive.  Encouragingly, the international parks performed well in Paris and Hong Kong, and Shanghai appears on track to meet expectations in its first year.  Consumer Products, which is closely tied to the studio, had a tough quarter, with revenue and operating income declining over -20%.  Management still forecast that Consumer Products would grow this year thanks to new movies in the Cars and Spiderman franchises.  Cars has been a mammoth success in consumer products in the past.

Finally, there was a lot of discussion on the call about DIS’s investment in BAMTech, which is leading provider of OTT platform services for Major League Baseball as well as other companies such as HBO.  Investors seem to have growing confidence in BAMTech as a standalone asset that could prove very valuable and also its ability to allow DIS to go direct-to-consumer new OTT services featuring Disney and ESPN content.  BAMTech is improving investor sentiment toward DIS’s long-term growth.

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. 

Steady As She Goes at Blue Chip Comcast

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Comcast (CMCSA) reported another steady growth quarter with revenues up 9%, operating cash flow up 8%, EPS up 10%, and free cash flow up 64%.  Despite emerging completion form internet delivered skinny bundles such as DirecTV Now and Sling, the core cable business remains healthy.  During the fourth quarter, cable revenues rose 7% led by high speed internet.  Video revenue grew and despite all the cord cutting talk, CMCSA added 80,000 video subscribers.  For the year, CMCSA added 161,000 subscribers, the biggest gain in 9 years.  Business services remain a driver with revenue of 15% in the quarter.  Advertising is another growth vehicle, offering double digit gains, particularly in political years.

NBC Universal also continues to have healthy growth led by theme parks, filmed entertainment, and the NBC broadcast network.  Cable networks are also growing despite fears about skinny bundles, albeit growth rates have settled into the low to mid-single digits.

CMCSA shares reacted well the 4Q16 results, rising to another all-time high.  Investors seem comfortable with the company’s outlook for steady growth.  2017 could grow a little slower than 2016 as the company faces higher programming costs and tough comparisons in filmed entertainment and political advertising.  CMCSA will also enter the wireless business in 2017 with a controlled rollout that is likely to slow profit growth by about 1%.  Growth should pick up to high single digits again in 2018.  2017 will still see above average growth for a large cap U.S. company and Northlake expects CMCSA to again use its strong balance sheet and free cash flow to increase the dividend and fund large share buybacks.

CMCSA is a beneficiary of the Trump Administration primarily as the FCC now has a deregulatory bent.  The reclassification of broadband as a Title II service will likely be overturned removing a major overhang from the possibility of government regulated broadband rates.  Easier M&A oversight could also help CMCSA as it decides on its future path in the wireless industry, looks to maintain strength at its local broadcast TV stations, and possibly even expands its cable footprint slightly.  Tax reform should also help CMCSA as the company is wholly domestic and an underleveraged full taxpayer.

CMCSA has emerged as blue chip company over the last few years, even improving its damaged reputation with heavy investments in customer service and innovation.  The company’s X1 platform is best in class and provides excellent competitive positioning in the rapidly evolving and highly competitive cable TV and broadband industries.

Northlake still sees upside for CMCSA shares to the mid-$80s based upon continued steady growth and a sum of the parts valuation that implies the core cable business is still trading for less than 8x EBITDA.  To us, this suggests that there is still too much concern over the changing delivery technologies and competition.  By now, CMCSA has proven they can thrive despite the challenges.

CMCSK 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.  CMCSK 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 But Facebook Range Bound for Near-Term

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Facebook (FB) reported another strong set of earnings, again beating the high bar set by Wall Street estimates.  Revenues grew 51% ahead of expectations in the high 40% range.  Mobile ad growth continues to lead the way, up 61%, and now accounting for 84% of total revenue.  Profitability also exceeded expectations with GAAP margins of 52% about 400 basis points ahead of the street.  As a result, EPS came in at $1.41 versus the consensus estimate of $1.31.  Underlying usage metrics support FB’s strong growth.  Monthly and daily active users and time spent on the site all grew nicely on a year over basis.  Ad pricing also looks firm.

FB shares are trading around flat following the report as investors remain concerned about revenue growth being at peak levels and a modestly higher guide for expenses to growth 47-57% in 2017.  Given that revenue growth has been north of 50% for the past year, the “material” slowdown projected by management is acceptable.  Growth should still be in the 30-40%, an extraordinary level for a company of FB’s size, and a growth rate that far exceeds any comparable advertising driven company.  Growth will be shifting toward video usage and it is not clear how FB will be able to monetize the massively growing viewing of videos on its site.  This will give investors a little heartburn until later in 2017.  Northlake is less concerned on revenues as we see FB much like a better version of broadcast TV networks.  Similarly, the reach is unrivaled but with the added benefit of specific targeting.  Broadcast TV CPMs have risen steadily against falling ratings.  FB should have no problem raising ad pricing given its reach, targeting, and still growing user base.

Investors are a little more concerned about FB’s expense guidance which also included higher than expected capital spending.  The company has consistently guided expenses conservatively and easily produced much better than implied profit margins.  2017 expense guidance seems hard to reach when looked at on absolute basis, so we expect the company to see expenses grow at the low end of guidance.

All together, we now see FB earning between $5.50 and $6.00 in 2017, up from $5.00-$5.25 at the time of our last quarterly review.  We see FB shares as range bound for a few months until there is greater clarity on the 2017 outlook and upside vs. guidance.  We believe that will occur at which point the shares can move above $150 as investors look forward to 2018 earnings of over $7.00.

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.

Good Quarter vs Low Expectations Clears Deck for Apple Until iPhone 8

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Apple reported a good holiday quarter relative to muted expectations.  The company got back on a growth track, albeit modest, after three straight quarters of declining revenue and iPhone shipments.  With revenues up 3%, EPS up 2%, and iPhone shipments up 5%, Apple is no longer the growth stock we once knew.  But it does not have to be with reasonable valuation of 12x estimated 2018 EPS that ignores $30 per share in net cash.  With repatriation a real possibility, crediting Apple’s valuation for some of the cash held abroad seems warranted.  Northlake remains long Apple, seeing upside to $150-180 over the next year depending on the strength of iPhone 8 cycle.

Apple shares responded well to the earnings report, especially getting a boost from guidance for the March quarter.  Guidance was slightly below Wall Street expectations but above what many investors had feared.  Under Tim Cook, Apple has mostly reported in close approximation to its guidance, so putting the holiday season and March quarter to bed is leading investors to look ahead to what sets up as a very strong iPhone upgrade cycle. The upcoming iPhone 8 is presumed to be the first major upgrade in form factor in three cycles and upgrade rates have slowed considerably over the last few years.  As a result, the installed base of potential upgrades is massive and Apple may give buyers a reason to upgrade with new features.  This is the main leg of the bull case for Apple over the next year.

Northlake’s current view is that the iPhone 8 cycle may represent the last big up move for Apple shares unless new higher growth, high margin opportunities develop on a large scale.  Perhaps the best opportunity is the services business, which received a great deal of attention on the company’s quarterly conference call.  Now at a run rate of $7 billion quarterly at high margin, services such as the App Store, ApplePay, iCloud, and Apple Music have the potential to be a differentiator for Apple investors.  For perspective, iPads produced $5.5 billion in revenue in the just completed seasonally strong holiday quarter.  iPhones are still Apple’s dominant source of revenue with sales of $54.4 billion.  Services grew 20% last quarter adjusted for one-time items.  Management seems very confident that this level of growth can continue for several years as it reiterated its forecast for a doubling of services revenue in four years.  If this occurs, services will be big enough to matter and will also bring a higher multiple business into the Apple valuation story.

Beyond services and the usual dissection of revenues, margins, and inventories, the two most interesting discussion points on the conference call were China and India.  China improved in the December quarter but still saw declining revenue for the fourth straight quarter.  Management noted that adjusting for currency weakness and poor results in Hong Kong, mainland China actually grew.  They also pointed to positive data on switchers and new to Apple users as a sign of brand strength.  China historically has done well when major upgrades came to the iPhone, potentially setting up a big return to growth against much easier comparisons that begin in the current quarter.

Comments on India were brief but management is confident that Apple is finally breaking through there with a full strategy including manufacturing and retail stores.  India is starting from almost nothing and if it could grow to just ¼ the size of China could add materially to Apple’s earnings potential.

The bottom line is that the pressure is off Apple until iPhone 8 cycle is imminent.  Low valuation and the prospect for positive financial momentum and repatriation should allow the shares to continue to work higher.  We expect weak June quarter guidance given the immensity of the iPhone 8 publicity but April is when Apple updates its capital allocation policy and a big dividend increase and another massive share buyback should be well received by investors.

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.

 

Small Caps and Value for Feb as Market Consolidates

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There are no changes to Northlake’s model signals for February.  For the second consecutive month, the Market Cap model favors small caps and the Style model favors small cap value.  As a result, client positions in the Russell 2000 (IWM) and the Russell 2000 Value (IWN) will be maintained at least through February.

The Market Cap model saw a little deterioration in the strength of its small cap signal this month compared to last month.  This occurred because two internal indicators that measure stock market trends and trading action moved from small cap to large cap reflecting large cap outperformance during January.  The internal indicators are designed to be more short-term-oriented to offset the economic and interest rate based external indicators where data inputs move more slowly.  The external indicators remain on firm footing for small caps for February.

The Style model still likes value and the small cap signal form the Market cap model pushes the model signal to small cap value.  Similar to February’s Market Cap signal, the Style model saw modest shift toward growth in its internal indicators as growth stocks made a comeback in January, reversing a portion of their lagging performance since the election.  One external indicator also shifted from value to growth.  However, the overall model remains firmly in value territory with 9 of the 14 combined indicators recommending value.

The current model recommendations are consistent with our view that the Trump Trade favoring reflation, value, small caps, and regulated industries will remain in place for at least the first half of 2017.  We remain cognizant of the risks of President Trump’s personality and management style and are ready to shift our sanguine outlook in response to fresh datapoints.  We also remain concerned about long-term implications of massive tax cuts unaccompanied by spending discipline, changes in international trade policy, and foreign policy adventurism. For now, despite risks and volatility being elevated, we prefer to be reactive rather than proactive given our concerns are longer term in nature.

IWM and IWN 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.