MGM Resorts Setup Improves into 2019

/0 Comments/in /by

MGM Resorts (MGM) reported better than expected 3Q18 results driven by the company’s Las Vegas properties. The beat was at least partially due to a significant reset of expectations following a new approach to guidance by management after overpromising in 2017 and 2018 and a pessimistic outlook from analysts after a sudden slowdown in Las Vegas Strip fundamentals.  Normally, this could be viewed as spin from management but MGM shares are very sensitive to Strip performance and even bearish analyst admit there is a lot of value in the stock.  Thus, conservative guidance is helpful amid uncertainty over whether the 3Q18 slowdown on the Strip is just tough comparisons or the start of a cyclical downturn.

MGM has faced a lot of headwinds this year that should reverse in 2019.  First, the tragic shooting on 10/1/17 at Mandalay Bay has hurt performance at this important property and the impact has lingered longer than expected.  On a year over year basis, the comp eases beginning in 4Q18.  MGM is also completing a large project to rebrand its Monte Carlo property as Park MGM.  This project has taken longer and proven more disruptive than expected but should be completed by year end.  The reversal of headwinds at these two properties can drive low single digit growth in EBITDA and REVPAR for the entire corporation in 2019.  MGM should also benefit with a better event calendar in 2019, especially during the third quarter.  Events held in 3Q18 were down 20% vs an unusually strong 2017.  Analysts can already see a pickup in events in 4Q18 and early 2019 that should gain further momentum vs. the easy comp in 3Q19.

Backing out MGM’s large stakes in publicly MGM Properties and MGM China, leaves the core Las Vegas Strip and regional casino business trading at less than 8X EBITDA.  This is a large discount to other Strip operators and regional casinos on a relative basis historically.  MGM owns trophy assets like Bellagio and MGM including the real estate.  REITS focused on gaming properties trade at 12-15X EBITDA indicating further hidden value at MGM.

With business momentum improving, management showing discipline on balance sheet improvement, capital allocation favoring shareholders, and easy comps on operating fundamentals, Northlake likes the setup for MGM and sees potential for the stock to move back to the low to mid-$30s.  The primary risks are a slowdown in US economic growth and large, complex acquisition.

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.

Cheap Valuation Meets Uncertain Future at Facebook

/0 Comments/in /by

Facebook (FB) reported mixed 3Q18 results relative to expectations.  Revenues fell slightly short of estimates but operating and income and EPS beat consensus as the ramp in expenses to combat the many privacy issues the company is facing was slower than expected.  Management provided initial expense guidance for 2019 of up 40-50% indicating the 3Q18 positive surprise on expenses was likely timing related.

User metrics are equally important given overriding concern that all of the controversy surrounding FB will drive users and, ultimately, advertisers off the platform.  On this front, FB still saw about 8% user growth driven entirely by emerging markets.  North America saw flat growth on a year over basis and Europe had a slight decline related to recently new privacy regulations requiring users to opt in to FB data sharing.  One positive user metric showed stable engagement looking at daily vs monthly active users.

This set of results served to initially lead to a rally in FB shares after months of significant declines.  However, the stock is probing new 2018 lows today after a series of articles in the New York Times reignited controversy about how the company acted and what it said as the controversy that began with Russian election interference intensified.

After years of steady growth that was relative easy to forecast and model, FB has become difficult to analyze from a financial and strategic perspective.  The company is in transition as the main Facebook product shifts from being text based to stories.  Furthermore, FB is now more reliant on initial efforts to monetize the massively used but thus far ad-free Messenger and WhatsApp services.  On the financial side, it is not yet clear if advertisers will leave the platform or reduce their spending and with fresh controversies breaking, it is hard to gauge the level of operating expense required to fix the problems.

Following the report, earning estimates for 2019 fell about 8%, primarily on higher operating expense assumptions.  Currents consensus of $7.53 for 2019 is pretty close to Northlake’s initial simple model developed in July when the company’s 2Q18 earnings call dramatically lowered guidance-based on slower revenue growth and much higher expense growth.

We take comfort in the fact the street has finally moved its 2019 outlook in line with our more cautious view.  We believe estimates should stabilize now.  With the stock at less than 19 times 2019 estimates, we are willing to wait out the answer to the big questions surrounding user growth and advertiser loyalty.  The company’s platforms including Facebook, Instagram, Messenger, and WhatsApp still have massive reach and industry leading targeting capabilities.  It is up to management, damaged credibility and all, to directly address and fix the privacy issues.  Balancing out this likelihood vs. the cheap P-E ratio tells Northlake to sit tight for now.

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. 

 

New Leadership Offers Its Vision for CBS

/0 Comments/in /by

CBS continued its pattern of reporting modest growth against the tide of change in the TV business.  3Q18 revenues grew 3% with EPS advancing 11%.  Operating income grew only 1% as the company continues to benefits at the EPS from large share buybacks and the reduction in corporate tax rates.

CBS shares have stalled the past couple of years due fears about cord cutting, weak TV ratings, and the prospect that critical sports rights will get much more expensive in the future as tech companies like Google, Amazon, and Facebook make bids.  EPS growth has been fine but like in 3Q18, operating income has not grown much.  This has left investors asking how the company can grow in the future given the challenges and the limits to financial engineering.  In addition, ongoing speculation about CBS being forced to combine with Viacom (the two companies have the same controlling shareholder) has muddied the future growth strategy.

These questions faced renewed importance following the forced departure of the company’s long-time well-regarded CEO Les Moonves under a cloud related to sexual harassment allegations.  Mr. Moonves long serving #2, Joe Ianniello is now interim CEO at CBS as the Board considers him and others for the permanent job.  Joe is also well thought of by us and the street.

3Q18 marked Joe’s first opportunity to handle investors by himself and present his vision for the future of CBS.  The company announced (1) a third OTT service based on in its Entertainment Tonight brand, (2) expansion of current OTT product All Access to Australia, (3) new deals to take its digital news network, CBSN, to virtual MVPDs like Hulu, and (4) noted it is building on its strength as a TV producer with 76 series in production, up 17% from a year ago.

These initiatives were well received by investors and the shares have been stable near 2018 highs, albeit down a few percent for 2018.  With estimated EPS of $5.25 and almost $6.00 in 2018 and 2019, respectively, at $57 CBS shares are inexpensive.  This is cheap enough for Northlake to hold but until we see signs that the strategic initiatives are improving operating income growth, we do not expect a major upward move.

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. 

Election Cycle Powers Nexstar to Beat and Raise

/0 Comments/in /by

Powered by the intense election fight, political ad sales drove Nexstar Media Group (NXST) to better than expected 3Q18 earnings.  Management raised guidance for the year based on the political ad spending.  Importantly, management also noted that after accounting for the displacement of core non-political advertising, traditional ad spending has modestly strengthened and is approaching flat in the fourth quarter and early 2019.

NXST and its peer local TV broadcasters offer massive free cash flow that creates optionality to shareholder value creation via dividend increases, share buybacks, debt pay down, and accretive M&A as the industry continues to rapidly consolidate.  Against this bullish valuation argument, bears point to poor TV ratings, weak non-political ad sales, loss of subscribers as households cut the cord, and a shift in industry economics in favor the major TV networks (ABC, CBS, FOX, NBC) that supply the bulk of programming seen on local TV stations.

We have followed this industry for a long-time and believe and NXST is the industry leader with the best management on an operating and strategic basis.  We have great confidence that shareholder friendly actions are coming as the company makes decisions about using its free cash flow.

We expect NXST is looking at several large broadcasters that are currently for sale, including Tribune and Cox.  Either of these acquisitions is highly accretive to free cash flow.  There will be some worry about adding a lot of debt to the balance sheet but we believe a large transaction is doable.  Management is disciplined about M&A and has publicly declared many times that they know how cheap their own stock is and the high hurdle rate it creates for any other use of free cash flow.

NXST shares have held up well in the current market correction.  We see upside to the mid $90s for an additional gain of 15-20% assuming the economy holds together, which is our current view.  We base this target on average 2018/19 free cash flow per share of $13.40 with further growth in 2019/20 to nearly $14.00.  Using a 15% free cash flow yield gets us to $89-93.  We believe the company deserves credit for the likelihood of a big acquisition that could bump the free cash flow estimates up another 20%.  Given strong management, free cash flow, and valuation, Northlake maintains will continue to be an investor in NXST.

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.

Apple Hits a Sour Spot, Long-Term Intact

/0 Comments/in /by

Apple (AAPL) reported decent September quarter results with revenues and EPS slightly ahead of estimates.  iPhone shipments came in about 1% under street estimates but were offset by better than expected average selling prices.  Services, which had been surprising to the upside and driving an improved growth narrative for AAPL, saw revenue come in about 2% lower than expected.

The small misses in iPhone units and services revenue were immediately troublesome for AAPL shares but the real story that has led to sharp downside in the shares since the report was weaker than expected guidance and the company’s announcement that it would no longer report unit volumes for its products.  Investors always view less disclosure as a sign of weakness – the company has something to hide – and when combined with the somewhat soft December quarter guidance that conclusion was easy to draw.

Management’s cautious commentary was reinforced in recent days when a leading supplier of critical components for the Face ID module slashed its December quarter revenue guidance.  The scale of the reduction suggests demand for the new lineup of iPhones may be below even the cautious guidance provided by management.

This comes as a surprise to us and most investors as the steady demand since the introduction of Face ID in 2017 suggested the large installed base of older iPhones, iPhone 7 and below, would begin to transition with the broader lineup of Face ID enabled phones introduced this year.  On the conference call, management suggested weakness in emerging markets, in particular China and India, is the primary culprit.  China is a very important market for AAPL.

AAPL’s change in disclosure appears designed to focus investors on the idea that the company represents a massive ecosystem of users, mostly iPhone but all iPad and Mac that now use a more or less common operating system and purchase products and services.  This makes the company look more like Google or Facebook or Netflix and less like a hardware company given the very high margins on incremental hardware sales and especially services – downloaded apps, Apple Music, Apple Pay, iCloud storage.

Northlake has long subscribed to this view of AAPL, so while disappointed in the recent stock price action and surprised by thus far slow demand for the new iPhone lineup, we remain confident in the long-term investment thesis.  AAPL shares are not expensive at just over 14 times 2019 earnings estimates without giving the company credit for it still hefty net cash balance of over $27 per share and prodigious production of free cash flow.  Northlake maintains its positive outlook for AAPL shares and plans to continue to hold.

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. 

Comcast in Strong Position As It Looks for Blue Sky in Europe

/0 Comments/in /by

Comcast (CMCSA) still has to convince us and a lot of investors of the wisdom of its acquisition of Sky Plc, Europe’s largest satellite TV provider.  Fortunately, the company’s domestic cable business and NBC Universal content operations are performing well giving the company some breathing room.  Management can point to a strong record on acquisitions that have worked financially and strategically, including major diversification moves akin to the takeover of Sky.  We remain moderately skeptical, however, given the premium price paid for Sky, almost 2X current valuation of CMCSA shares on an EBITDA basis, and the fact the company is using most of its balance sheet capacity to finance the transaction.  Sky is less than 20% of Comcast so we are willing to trust management.  For now.

Looking back at the quarter, despite all the press and hand wringing about cord cutting, Comcast reported Adjust EBITDA growth of almost 8%in its cable business, the highest growth rate in six years.  Cash flow grew even stronger as the company continues to wind down a period of heavy investment in its cable network.  You may hate your cable company but it is continually pumping billions into its broadband network to increase the speed and reliability of your internet and cable TV.  Cord cutting hurts but the company is getting better at keeping customers in bundles as it rolls out its own skinny TV packages and demand for the industry’s leading broadband internet packages remains strong.

NBC Universal, which should get a boost from selling its content to Sky, saw broad based growth across its portfolio of cable and broadcast TV networks.  Film held back results against a tough comparison to a year ago.  The movie business is naturally lumpy depending on the timing of releases.

Prior to Sky, Comcast has the best balance sheet in media, leveraged at just 2X.  Sky will take that to 3.5X.  We would have preferred more dividends and share repurchases and a lower leverage level, given the suddenly tricky economic and stock market environment.  Comcast feels otherwise and investing for one of the likely few spots available alongside Disney and Netflix to become a global media powerhouse — and survivor — was deemed more important.  As long as we have confidence in the cable business, we will give CMCSA shares the benefit of the doubt.

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.

Disney Steady Ahead of Major 2019/20 Transition

/0 Comments/in /by

Disney (DIS) reported a strong 4Q18 as it wrapped a good fiscal year financially and an eventful one strategically.  For the year, revenue grew 8%, the best rate of growth since 2015.Opeting income grew 6% but adjusting for losses at recently acquired BAM TECH and ongoing losses at Hulu, growth would have been several percentage points higher.

These strong results came amid several years of fear about the outlook for ESPN as skinny bundles and cord cutting led to declining subscribers as the company is locked into massive, fixed, long-term sports rights contracts.  The company should be able to pass through rising sports rights on a per subscriber basis as it has renegotiates deals with various cable and satellite distributors in 2019.  Theme Parks and the Film Studio continue to perform incredibly well.

DIS shares have been among the market’s better performers recently, hovering very 2018 and all-time highs.  The outlook from here is trickier, however, as the company is about to close on its acquisition of assets from 21st Century Fox and launch its direct to consumer Disney Plus service.  Each of these items is dilutive to EPS and the level of investment at Disney Plus is still unclear.

If one assumes that Disney Plus (a streaming service composed of the family brands Marvel, Star Wars, Disney, and Pixar) can quickly attain tens of millions of subscribers, it is fair to ignore the heavy upfront investment and look at just core Disney, or Disney as it stands today.  On that basis, 2019 should be a decent year despite incredibly difficult comps at the film studio.  On this basis, DIS shares look like they could have additional upside of 10-20%.  However, dilution could be heavy, driving EPS from over $7 in the just completed year to near $6 in 2019 and 2020.  If Disney Plus gets off to a slow start, the shares likely have similar downside.

At Northlake, we believe investors will give DIS the benefit of the doubt for the time being given the power of the company’s brands and management’s history of execution.  We also think that during a difficult market environment, it pays to stick with best companies and stocks that have been showing relative strength.  A tougher decision on the outlook for DIS shares is coming as we move through 2019.  For now, Northlake is sitting tight and comfortably long.

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. 

Large Cap and Neutral Signals Remain Intact for November

/0 Comments/in /by

For the third month in a row, there were no changes to the signals provided by Northlake’s thematic models. Northlake’s Market Cap model remained on a large cap signal for November, and the Style model remained neutral between growth and value. Current client positions in the S&P 500 (SPY) will continue to be held for large cap exposure, while Style exposure will remain evenly split between the Russell 1000 Growth (IWF) and the Russell 1000 Value (IWD).

The underlying indicators of the Market Cap model moved more strongly in favor of large caps. In fact, all but one of the sixteen indicators now recommend a large cap signal. The strong signal reflects recent concerns about economic data and recent stock price action. Large caps are less risky than small caps, and perhaps investors are reducing risk after a volatile October.

The underlying indicators of the Style model are as close to neutral as possible. Exactly half of the indicators are signaling growth and half are on value. Furthermore, the groups of internal indicators and external indicators are each evenly split between growth and value. Last month, the internal indicators slightly favored growth while the external indicators recommended value. October was a challenging month for many high-flying growth stocks, which helps explain why the internal indicators shifted back toward value. Despite the rough stock performance in October, many growth stocks reported solid earnings and guidance. This is reflected in the external indicators shifting back toward growth. The Style model’s ongoing neutral signal is a microcosm of the debate surrounding whether value can finally begin to outperform growth as we move into the tenth year of the current bull market.

SPY, 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