Positioned for Success at CBS

/0 Comments/in /by

Two years ago, in August 2015, Disney (DIS) set off the angst that has troubled traditional media stocks since by admitting to larger than expected subscriber losses at ESPN.  We refer to August 2015 as the Media Meltdown.  This May, another round of media companies created a smaller, mirror image decline in media stocks, this time triggered by greater than expected subscriber losses for cable and satellite companies that deliver subscribers to the companies that own TV networks.  This time the subscriber losses were occurring as ratings for most TV networks were in sharp decline.

During this period of cord cutting, cord shaving, and cord nevering, CBS Corporation (CBS) has navigated the landscape particularly well.  Its latest quarterly earnings exceeded expectations across the board even as its peers mostly stumbled.  CBS has the advantage of owning only one major TV network.  This advantage is further pressed because it is a broadcast network.  After decades of losing ground to cable networks (ESPN, CNN, TNT, Food Network, MTV, HGTV, etc.), broadcast networks are now in a relatively stronger competitive position, none more so than CBS.

CBS was early to see the importance of direct to consumer over the top offerings and established CBS All Access and Showtime as OTT services a few years ago.  Perhaps the most important takeaway from CBS’s latest earnings report was that both services are well ahead of 2020 subscriber goals of 4 million each.  Suddenly, CBS is positioned with a must have broadcast network on every major cable, satellite, and OTT service with a well-established direct to consumer flanker strategy.  Disney’s recent announcement of OTT services for its ESPN, Disney, and Pixar branded content supports the importance of a direct to consumer strategy.  CBS is well ahead of the curve.

CBS has also done a good job of reducing its reliance on advertising revenue.  Led by CEO Les Moonves, the latest earnings report showed advertising is down to 40% of revenue from over 70% a few years ago.  Smart divestitures of the company’s billboard and radio businesses have helped but more importantly for the future, CBS has shifted heavily toward subscription revenue via retransmission fees it receives from cable, satellite, and OTT distributors and its own network affiliates.  This revenue source, which barely existed ten years ago should be over $2.5 billion per year by 2020 while growing at 15-20% for the next several years.  CBS also has a thriving subscription at Showtime, which has emerged as a strong premium network, second only to HBO and the aforementioned All Access OTT service.  All Access will soon supplement its network and local TV content and massive library of older TV shows with new series like an updated Star Trek and spin-offs from popular series like The Good Wife.

With a long history of analyzing and investing in the media industry, Northlake understands well the challenges the industry is facing from the shift in viewing habits of American households.  We have acknowledged these secular challenges by diversifying our individual stock portfolio into other industries such as video games and internet media and even looked abroad.  Even as we revaluate holdings in Disney and Liberty Global and other media-linked investments, we remain fully committed to CBS.  With earnings looking to be over $5 in 2018 and the divestiture of the radio assets (and accompanying share buyback) scheduled for yearend, we think the shares are cheap at 13X earnings, a large discount to the average stock at 18X.  Just reaching 14X would get the shares to $70 and a more realistic target is 15X, which equates to our year ahead target of $75.

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 Restoring Management Credibility

/0 Comments/in /by

Liberty Global (LBTYK) showed progress in 2Q17 after a disappointing 1Q that was accompanied by lowered 2017 guidance and a major reset and management change related to its UK buildout known as Project Lightning.  2Q17 was mixed for LBYTK with rebased revenues a bit below reduced expectations, new subscriber additions below expectations, and operating cash flows slightly ahead of estimates after adjusting for favorable one-time items.  Rebased revenue growth of 1.6% and adjusted rebased OCF growth of about 4.5% are below full year guidance but are a step in the right direction after the weak 1Q17.  Management affirmed all 2017 guidance for revenue, OCF, free cash flow, and subscriber additions and noted the big acceleration would come in 4Q17.  Back end loaded guidance is always a risk but we believe street expectations are already assuming a slight miss in 2017.  As noted in prior LBTYK updates, we have been too patient with this stock over the last few years as we are overly influenced by our long successful history with this management team and outsized potential upside of 50%+ if the story comes together.  2Q17 was far from perfect but there were enough positives – led by general stabilization in key performance metrics – that we going to remain patient.

Items we are monitoring include (1) UK growth still looks anemic even with the benefit of new homes coming online from Project Lightning, (2) Germany should have a big uptick in 2H17 as 2Q17 saw focus on the switch-off of analog signals at the expense of growth initiatives, (3) cost controls accelerated and provided a nice boost to OCF against weak revenue in 2Q and should leverage OCF growth if the top line improves as guided, and (4) capital allocation and M&A could emerge again as upside given what see at both LBTYK and Vodafone (VOD), the likeliest merger or asset sale/swap partner for LBTYK.

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.

No Surprises From Liberty Media’s Second Quarter

/0 Comments/in , , /by

Another fairly quiet quarter is in the books at Liberty Media which controls tracking stocks in Formula One (FWONA/K) and Liberty Sirius (LSXMA/K).  LSXM controls nearly 70% of SIRI and SIRI had already reported strong second quarter results so there was very little discussion on that front.  FWON was the primary subject although there were many questions regarding recent takeover rumors about Charter Communications (CHTR) which is owned by a separate Liberty Media company in which Northlake clients are not presently invested.  The CHTR takeover rumors do support our long-standing investment in Comcast (CMCSA) as they justify the good outlook for the cable industry even as cord cutting, cord shaving, and cord nevering has accelerated in 2017.  Cable is well protected from disruption in its video business as the provider of the leading broadband internet network – you need great internet service to take advantage of internet-delivered over the top video.

Results at FWON were largely in line with estimates, showing very modest growth.  Approximately 1/3rd of the Formula One (F1) racing season was completed as of 2Q17.  While it is too soon for Liberty’s vision for enhancing F1 to be implemented, there are some positive signs with race sponsorship up modestly, TV ratings and attendance up vs. last season, and positive steps to reduce leverage and interest costs on the balance sheet.  F1 has great potential as a global sports business that has been undernourished and undermanaged.  We expect Liberty to boost the prospects of FWON over the next several years as it brings its expertise in media and sports media to company operations.

FWON shares are currently valued similarly to other trophy sports assets that trade publicly like the Atlanta Braves (via Liberty controlled BATRA/K), Manchester United (MANU), and the New York Knicks (via MSG).  The next leg up in FWON shares may be a ways off as it will take Liberty time to make significant changes to the F1 racing competition and business.  However, we think it is worth the wait even if at some point there is a little profit taking among less patient investors.

We still see modest upside in SIRI that will boost LSXMK but are closely watching the economy and auto sales that could trip up the growth story.  LSXMK trades at more than a 15% discount to the value of the SIRI shares it owns, providing some support over the next six to twelve months.

FWONA, FWONK, 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.  FWONK is net long position in the Entermedia Funds.  LSXMK is held as an arbitraged long position against a short in SIRI 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 Strong Second Quarter Results

/0 Comments/in /by

Activision Blizzard (ATVI) reported strong second quarter results with sales and profits substantially higher than expected. While guidance for the third quarter and full year were raised from previous levels, it appears investors expected a larger increase. ATVI has typically provided conservative guidance in the past, and this appears to be the case again this quarter. The stock reacted with a mild decline.

Strength in the second quarter was driven by the ongoing shift to digital sources of revenue. Despite not releasing any major games in the quarter, ATVI collected highly profitable in-game revenues of nearly $1 billion from existing titles. This is a testament to the strength of ATVI’s strategy of increasing player engagement by offering digital add-on content across a large library of strong franchises. ATVI is also able to leverage their library by releasing remastered versions of popular games, as demonstrated by the successful re-launch of Crash Bandicoot in the second quarter.

King, ATVI’s large, recent acquisition in mobile gaming, was the weakest segment in the quarter, with profits below expectations as monthly average users declined from both the previous year and previous quarter. We remain excited about the mobile advertising opportunity in the King segment. Engagement remains strong with players spending an average of 35 minutes per day in mobile games, more than the average time spent in either Snapchat or Instagram. In the short term, ATVI announced a partnership with Facebook (FB) to deliver display ads into mobile games. This buys ATVI time to continue the push towards delivering premium video ads on mobile devices. Northlake believes King is right to focus on protecting the user experience while testing various ad formats instead of rushing to monetize games as quickly as possible. King continues to see success from launching live operations and new features in existing games, as demonstrated by bookings per paying user rising for the 8th quarter in a row to a new record.

ATVI made good progress towards the upcoming third quarter launch of the Overwatch League. So far, 7 teams for the new e-sports league have been purchased for $20 million each. ATVI is pleased with the quality of the new team owners, which include several owners of traditional sports teams. Revenue from team sales will be recognized over several periods and marketing expenses to launch the league will likely offset any benefit in the near term. However, we believe the Overwatch League will likely make material contributions over time. ATVI noted that there are currently 30 million Overwatch players, providing a large potential e-sports audience even if no one from the general public becomes interested.

Looking forward to the second half of 2017, ATVI will release major titles including Destiny 2 and Call of Duty: World War II. Both games are receiving positive attention leading up to the release dates and are expected to sell very well. However, as seen in the reaction to the recent quarter, elevated expectations can create downside risk if either title does not perform well. The upcoming release of a remastered version of Starcraft should also contribute, similar to the second quarter contribution from Crash Bandicoot.

In summary, ATVI continues to benefit from secular tailwinds as revenue increasingly comes from highly profitable digital sources like add-on content, full game downloads, and mobile game ads. Investor expectations have recently surpassed the typically conservative guidance from ATVI, but Northlake expects further upside as sales and profit margins expand. Additionally, untapped opportunities in e-sports, TV and film, and consumer products should drive earnings estimates even higher. As investors begin to evaluate ATVI on 2018 earnings of $2.50 or above, using the current 2017 P-E multiple of 29 could push shares toward $73.

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. 

Disney Announces New Media Network Strategy

/0 Comments/in /by

Disney (DIS) reported a mixed quarter that was completely overshadowed by its announcement of a new strategy for its media networks.  The shares are trading lower, which in Northlake’s opinion is logical.  Making major investments into digital, over the top distribution of its sports rights and Disney and Pixar content is going to be expensive with an uncertain outcome.  However, as suggested by another very tough quarter for Media Networks/ESPN, the company probably has little choice.  Fortunately, for long-term investors, DIS is in great shape at its Theme Parks and Filmed Entertainment segments.  These divisions can support a premium valuation for the shares as clarity on the new products and services emerges ahead of their launches (sports in 2018 and Disney/Pixar in 2019).  One other positive in the near-term could be a new cycle of affiliate negotiations between ESPN and its traditional cable and satellite distributors.  ESPN should be able to boost its per subscriber fees from current levels and stabilize subscriber losses without incurring any additional costs since expensive sports rights are locked in under deals that extend into next decade.  Therefore, Northlake is sticking with DIS at least until we can better evaluate the financial on long-term growth implications of the dramatic shift in corporate strategy.

Looking back at 3Q17, Theme Parks performed very well, while Media Networks, Consumer Products and Filmed Entertainment underperformed expectations.  We can dismiss the film studio underperformance given it was mostly due to tough comparisons and the upcoming film slate is outstanding through 2018 with two Star Wars, two Avengers, and two Pixar films.  Media Networks saw a steep year-over-year drop in profits as higher NBA rights costs converged with weak ESPN ratings, fewer NBA playoff games, and still material and larger than expected subscriber losses.  While see ESPN pressures easing in 2018 as new affiliate deals are struck, the weak quarter clearly explains the new OTT strategy.  Consumer Products weakness is a little surprising suggesting that the Frozen benefit has finally worn off and Star Wars and Avengers are not as consumer friendly.  EPS surprised to the upside but that was driven by non-operating items.

Building from its $1.5 billion deal to take control of BAMTech, DIS announced two new OTT services –Sports and Kids – to be launched in 2018 and 2019, respectively.   Management did not reveal many details about the new strategy and there are many unanswered questions.  ESPN will launch a new OTT product available to non-cable/satellite subscribers in early 2018.  The new service will offer thousands of games and live sports including MLB, NHL, tennis, and college sports.  ESPN buys rights to entire sports yet the TV networks can only show one game at a time.  Think about college football when Ohio State-Michigan may be on ESPN while ESPN is televising other games in the Big Ten and SEC.  The secondary games can be sold along with a lot of other sports content in the new OTT service.  Current cable and satellite subscribers with access to ESPN will be able to authenticate themselves and watch the televised games in addition.

The consumer OTT service will feature Disney and Pixar content after DIS takes back its rights to those brands from Netflix beginning in 2019.  As of now, Marvel and Lucasfilm (Star Wars) are not included in the new service.  DIS’s goal is to create a family friendly OTT service selling millions of subscriptions.

Each of these services is designed to be a growth vehicle and position DIS to sustain growth as the traditional TV ecosystem fragments due to cord cutting, cord shaving and cord nevering.  TV delivery is changing rapidly and due its kids and sports focus, DIS, perhaps more than any other company, needs to find a way to have a direct link to consumers.

The strategy has a lot of unknowns and risks.  Will DIS have to invest more heavily in content production and sports rights?  Management seems to think so.  Will the new apps work well and appeal to users?  Too soon to tell but we have experienced some frustration with current ESPN digital apps.  What will the new subscriptions cost?  Will an aggressive OTT strategy only service to accelerate this still very large and very profitable traditional TV business?

As noted at the beginning of this note, we are willing to give DIS time and learn more given there are some other positives supporting the shares over the next several quarters.  Near $100, DIS shares look reasonably valued based on current 2018 earnings.  However, the earnings level and P-E ratio for DIS shares is uncertain.  This balances out to a HOLD for now.

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. 

Nexstar Media Group Increases Free Cash Flow Guidance

/0 Comments/in , /by

Our timing on adding Sinclair Broadcast Group (SBGI) to Northlake’s portfolio proved poor.  Over the past few weeks, we sold SBGI at a loss and reinvested in Nexstar Media Group (NXST).  Like SBGI, NXST owns local TV stations around the country, generally in small to mid-size markets.  The bull case is also similar:  extraordinarily high free cash flow used to pay down debt, buy back shares, and increase dividends over the next few years at the same time as the FCC is relaxing ownership restriction on local TV stations.

Acquisitions of stations are very accretive to NXST and create immediate shareholder value.  While these factors create a great outlook for SBGI, we are able to get the same thing at NXST without the distraction of a major acquisition awaiting approval and the subsequent competitive response and complaints.  In fact, early this year, NXST closed on the transformative acquisition of Media General and based on 2Q17 results reported this morning, the upside in the new Nexstar is emerging right on schedule.

One other factor that favors NXST is what we know the management team very well (having first invested in 2013 via the Entermedia hedge fund) and find them to among the very best operators of any company we follow.  This was also evident in today’s earnings report when the company showed 2Q and early 3Q revenue trends ahead of most all other TV related businesses and attributed the results to new managers at many of its TV stations that were installed after completion of the Media General merger.  Furthermore, NXST has performed well on all its synergy targets for the merger, realizing 90% of the goal after just six months.

NXST raised its 2017/1018 average free cash flow guidance reflecting interesting savings on refinancing the term loan it incurred to finance the Media General acquisition.  Based on current shares outstanding, that equates to $12.40, a figure that will likely be higher solely due to future share repurchases.  The company has aggressively bought shares this year and publicly states its plans to buy more and notes how it is the best thing it can do to create value for shareholders.

With the stock at $63, the free cash flow yield is 20% ($12.50 divided into $63).  Most stocks we follow have free cash flow yields of 5-10%.  Local TV has always traded cheaply due to concerns it will go the way of newspapers in the internet age.  However, 20% is the high end of the normal range at a time when for the first time in a decade the industry has friends at the FCC.  Consolidation is the path to saving local TV and it is also the path to shareholder riches as expansion of geographic reach and especially in-market acquisitions (buying a second TV station where you already own one).

We expect a September ruling from the FCC to relax ownership rules to be the next major catalyst for NXST shares.  Debt pay down, share repurchases, future accretive acquisitions, a likely increase in Media General synergy targets, and big political ad spending for the 2018 mid-terms set up a series of positive catalysts for the shares between now and the end of 2018.  If NXST shares traded at a 15% free cash flow yield, they would rise to $83, a level we still view as a conservative target.

NXST 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.  NXST 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.

*************************************

Since we spend a lot of time writing about quarterly earnings and the subsequent conference calls, we thought you might enjoy reading our unedited notes from this morning’s NXST call.  You will learn a lot more about this new investment and also get a sense for what goes on during these calls:

NXST 2Q17 Call Notes (Transcribed from AIM): 8/8/17

Management Script:

-just going over press release type commentary on NXST so far.  Brief comments on ad mkt are positive but very big picture.

-since they are not doing pro forma comps for MEG it is hard to get a good read as company has more than doubled in size since 2Q16

-but as usual tone seems better than others

-giving some comp pro forma now.  Good expense controls.  Went too fast on revs and did not catch it.

-NXST about to start Q&A.  They remain confident.  Let’s see what the street is worried about.

Q&A:

Q: why are your ad comments more bullish?

A: lots of new station GM’s having a big impact when previously undermanaged by MEG.  Unlikely it would be geography or affiliation mix.  July local up MSD.  Natl flat.  Beneficiary of slight improvement in economy. Exceeding budget in august but tricky due to Olympics.

Q: visibility on net retrans?

A: very little unknowns thru end of 18 and into 19.  Vast majority affiliation agreements done.  High $% of retrans done.  CAGR low DD net retrans thru 19.  Higher in 17 and 19. Lower in 18 due to deal timing.  Only a few MEG NBCs up on affiliation between now and end of next year.

Q: impact of weak network primetime rating?

A: -10% would be -1% impact on NXST advertising.  Half of ad rev from local news.  Key is 10pm lead into to local news.

Q: would nets object if they made a big acq a la FOX/Ion?

A: never been an issue.  Feel like relationships with networks are excellent.  Always been able to do business even with tough negotiations.

Q: is July so strong compared to peers?

A: new mgmt impact.  mgmt really matters at local level.

Q: on Fox/Ion?

A: same reporter who wrote about Fox/Blackstone.  Does not think it would work long term.  Head of Ion wandering vineyards in Tuscany last week.  Would basically be Ion giving up to become FOX surrogate.  Fox has definitely looked so kernel of truth.  NXST has looked at Ion as well.

Q: transformative M&A?

A: if they present themselves and bear return on our own stock.  Three times a day they discuss capital allocation and most accretive is what wins.

Q: why not buy back even more stock given visibility thru 18?

A: for right now important to pay down debt against a non-political year.  Opportunistic toward buyback.  In 18 when political returns EBITDA goes up so that provides deleverage.  But we can walk and chew gum at the same time.

Q: auto 2Q/3Q?

A: down a couple % in 2Q.  Five of top 10 up.  Other 5 down but none worse than -3%.  Ford and Chevy down.  Others good.  Dealer spending down a couple %.  3Q…not seeing departure adjusted for Olympics.  2q/3q better than 1q.

Q: sub numbers?

A: YTD absolute loss is less than 50 bps across footprint.  Before OTT in most markets. Not sure when OTT will ever be material in our markets.  Mostly top 50 markets.  Maybe rev in 4Q and 2018 but not material.

Q: all MEG digital biz profitable?

A: done restructuring.

F/U: What is outlook?  Katz/SSP?

A: like improved credit profile at SSP.  Shut some MEG digital biz in 2Q, will impact revs. Station website biz very strong.  Other biz all growing with positive EBITDA. OTT deals worst case equal to current net retrans incl Fox.

Q: private equity interest in space?

A: has been increased activity but no deals.  Had some calls and taken some meetings.  Would consider private equity as partner in a larger deal.  Seen thesis of taking NXST private, math works. No synergies for private equity in bidding against actual operators like NXST.  But they will leverage to 6X and push up multiples.

-take retrans growth out several years on gross basis and digital at LDD and NXST is 60/40 non TV advertising

-old JSA rules coupled with end of 8 voice and 2 of top 4 taken together create most opportunity.

-OTA local ad rev is 14% across entire 210 markets.  Stupid to think of it as its own markets.  Think FCC and DOJ agree but FCC ahead of DOJ.

Q: ATSC JV?

A: calls with other broadcasters who might want to join.  Hiring CEO for venture. Repack will jump start investment in 3.0.  That has to be done first before monetization.  That being investment at local level to upgrade to 3.0. Other side of 39 months…material rev 5 years away.  Want to manage your expectations but it is real. Over time spectrum revs could equal retrans rev!  Notes that is his opinion not universally held view.

An Unexpected Positive Surprise for Apple

/0 Comments/in /by

We have grown accustomed to lower volatility from Apple’s earnings and its stock price post-reporting.  Well, what do you know?  Apple (AAPL) reported better than expected 3Q17 results and the shares are responding favorably in initial trading, up about 5%.  Guidance for the September quarter, a key focus point for investors, was better than expected as well, especially regarding revenue.  Northlake finds the Apple results reassuring but the magnitude of the initial rise in the shares strikes as more about bearish positioning among investors heading into the print rather than fundamental upside.  The story still revolves around the success of the new iPhones that will begin to ship in late September.  The setup for the “super cycle” is in place with a massive installed base of 2-3 year old iPhones and the potential that the new phones, at least the high end model, have significant changes from the iPhone 6, 6s, and 7 models.  Whether demand comes though or upgrade cycles continue to lengthen will determine how well the phones sell.  Wall Street expectations are high for the new iPhones creating balanced risk-reward tradeoff for AAPL shares until we finally see the new iPhones in September.  We are comfortable sitting tight with AAPL shares and see the potential for the stock to work toward $180-200 by yearend as we believe the new iPhones will sell well.

The just reported 3Q17 had a several positives.  iPads had their first growth quarter in several years and Mac sales were strong following a refresh of many models in June.  Sales in Mainland China grew for the first time in almost two years. Services and Other Product revenues surprised to the upside and represented 22% of revenue, an all-time high.  These product lines, services in particular, have high profit margins and are critical to sustain Apple’s overall profitability and growth given that the iPhone business has matured with growth aligned almost exclusively with major upgrade cycles.

The other big positive coming out of the report relates to September quarter guidance.  Investors have been concerned that the new iPhones could be delayed due to reports of manufacturing issues.  Revenue guidance is above street estimates and working backwards it appears that unit volumes for iPhones are the reason.  Apparently, Apple is confident in its normal shipment schedule for new iPhones that begins in September and leads to full availability in the critical holiday season.

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.

Style Model Moves to Neutral on Growth vs. Value

/0 Comments/in /by

Northlake’s Style model flipped to neutral for August after spending three months on growth.  The Market Cap model remains on large cap for the third consecutive month.  To align client portfolios invested in the models with the neutral signal, one half of positions in the Russell 1000 Growth (IWF) were sold and the proceeds were invested in the Russell 1000 Value (IWD).  The large cap signal from the Market Cap model continues to be implemented by investment in the S&P 500 (SPY).

Three indicators in the Style model shifted from growth to value for August triggering the change in the model’s recommendation to neutral.  Over the last few days, we thought the Style model might shift given unusual volatility in growth stocks, specifically leading internet stocks, during June and July.  Volatility can move the internal indicators that measure trend and market technicals.  In fact, two of the Style model’s eight internal indicators moved from growth to value.  Growth had been favored for the last several months based on almost unanimous alignment favoring growth.  The message from the new neutral signal is a combination of a loss of momentum for growth stocks and somewhat firmer economic indicators.  We are somewhat skeptical but should economic activity finally breakout to the upside, value stocks would be expected to take over leadership from growth stocks.

The Market Cap model is comfortably in large cap territory with all eight external indicators favoring large cap for the second consecutive month.  Slow but steady growth in GDP favors large cap. The recent weakening in the dollar is a big boost as well, since larger companies do more business overseas.  The internal indicators are split between small and large cap reflecting the rotation in market leadership between these two sectors over the last six months.

The growth signal that just closed worked pretty well.  For the three months that the growth signal was in place, IWF gained 4.8% against a gain of 3.6% for the S&P 500 and 2.2% for the Russell 1000 Value (IWD).

SPY, IWF, and IWD are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov. 

Continuous Improvement Underway at MGM Resorts

/0 Comments/in /by

MGM Resorts (MGM) reported strong 2Q17 results with better than expected profitability. Management executed well against long term plans to continuously improve profit margins, overcoming a self-imposed headwind from lower hotel room revenue and a slightly unlucky quarter at the casino tables. The investment thesis remains on track with several catalysts expected to drive shares higher in coming quarters, such as asset sales, new resort openings, debt reduction, and increased capital return to shareholders.

2Q17 shed light on part of MGM’s strategy to improve overall resort profitability. Instead of focusing solely on maximizing revenue per available room (RevPAR), MGM is taking a more holistic approach by encouraging a shift to more profitable revenue streams such as restaurants and other non-gaming spending. Since MGM is in the early stages of this new approach, investors were surprised to see weaker than expected RevPAR growth. However, the new strategy allowed MGM to deliver better than expected overall profits, validating the new strategy.

MGM has two resorts under construction; MGM Cotai is expected to open later this year, while MGM Springfield is slated to open in mid to late 2018. As each project nears completion, capital expenditures will sharply decline and MGM will allocate capital toward paying down debt, increasing dividends, and share repurchases. Another potential use of excess capital could be building a resort in Japan, but there are legislative and competitive hurdles to clear before that becomes reality.

The recently opened MGM National Harbor near Washington D.C. and recently acquired Borgata in Atlantic City both continue to perform well. Management stated that discussions with MGM Growth Properties (MGP) about a transaction for National Harbor’s real estate will likely begin soon now that the resort has been operating for a few quarters. Additionally, MGM is exploring other non-core asset sales such as their stake in CityCenter.

Looking forward, we expect the upcoming Mayweather-McGregor fight and the start of the inaugural season for the Las Vegas Golden Knights National Hockey League team will contribute to a strong back half of 2017. The opening of MGM Cotai, continued growth in profits and margins, and asset transactions described above should help push MGM toward the upper-$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.