Nexstar Shines Amid Market Selloff

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Nexstar Media Group reported excellent 4Q19 results and raised its guidance for 2020/2021 average annual free cash flow by 15%.  In a normal market this news would have been greeted by a sharp rise in the stock price, arguably up 5-10% or more.  Alas, Nexstar reported right into the teeth of the market sell-off on Tuesday morning and after an initial and short-lived pop, the shares sunk over -5% and fell a further -4% before reversing and regaining most of the initial losses on Thursday.

Nexstar has completed and integrated its acquisition of Tribune Media and is now the largest owner of local TV station across the county with many larger markets to go along with its historic focus on small and mid-sized cities.  Driven by huge gains in political advertising, even beyond the incredible spending by Michael Bloomberg, and a healthy market for traditional local TV advertising, Nexstar easily exceeded consensus estimates for 4Q19.  Even better for our bullish investment thesis, the company raised its 2020/2021 average free cash flow guidance by 15% from what it had issued just last August.  Political spending, greater merger synergies, stronger ad markets, a dose of typical Nexstar conservatism, and usual superior Nexstar management execution all contributed to the guidance increase.  The company is now calling for average annual free cash flow per share of $25.50 for the next two years.  Most of this free cash flow will be used to reduce debt associated with the Tribune acquisition but the company is already buying back shares a year ahead of schedule and just raised its dividend by over 20% for the fourth straight year.

As long-time media investors who have suffered on occasion in this year of cord cutting and streaming video (CBS and Comcast come to mind), we fully understand the risks facing Nexstar and local TV.  We have long thought, however, that the free cash flow at local TV stocks was vastly underappreciated and undervalued by investors.  Nexstar has been an excellent performing stock against the secular headwinds faced by traditional media and we believe that will continue for the next year or two on the back of the massive free cash flow.  Free cash flow represents 23% of the current stock price.  There are very few stocks with this cheap of a valuation on this metric and even fewer that are as well managed as Nexstar.  We see upside to $130-150 this year potentially to $170 in 2021 if the company meets its newly issued guidance.

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.

Activision Blizzard Outlines Plans for 2020

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Activision Blizzard (ATVI) slightly beat expectations for 4Q19 results, with typically conservative guidance for 2020 falling a bit below consensus estimates. Interestingly, Jefferies analyst Alex Giaimo noted that ATVI has beaten initial EPS guidance by 15% on average over the last 4 years. Alongside the results, ATVI also increased the dividend paid to shareholders by 11%, signaling confidence in the progress of ongoing restructuring initiatives. As a reminder, the restructuring is focused around efforts to expand key franchises exposure to mobile gaming, esports, digital advertising, and consumer products. Northlake expects the benefits of recent strategic changes to become more apparent in 2020 and beyond, now that the 2019 transition year is behind ATVI. 2020 EPS guidance of $2.35 may end up closer to $2.50-$2.70, implying a target price range of $50-$67.50 at 20x-25x with upside of $70-$80+ as investors begin to look to consensus 2021/2022 EPS of $2.83/$3.34 respectively.

Northlake already sees early evidence that restructuring efforts are paying off for ATVI. Proof of concept for the strategic shift toward prioritizing key franchises to expand audiences and increase engagement has been demonstrated by recent successes for Call of Duty (CoD) and World of Warcraft (WoW). Unit sales and in-game spending for the newest iteration of CoD have been strong, but more importantly the new free-to-play mobile version is now the largest platform for CoD after increasing the total franchise player base on all platforms from 40 million to 100 million players with more growth to come. Furthermore, ATVI just launched the CoD League (CDL) with 12 teams and several sponsors. The CDL should grow quickly given the massive global popularity of the franchise, the continued rise of esports viewership, and the ability to apply best practices learned from the ongoing success of the Overwatch League (OWL). Similarly, ATVI was also able to double the active player base for WoW in the second half of 2019 simply by releasing a remastered version of the original WoW Classic. Together, these successes show the blueprint for ATVI to maximize the value of key franchises; Northlake sees similar opportunities across the entire ATVI catalog.

Looking ahead, the major upcoming releases for ATVI in 2020 likely include Overwatch 2, WoW: Shadowlands, Diablo 4, and mobile title Diablo Immortal. Only Overwatch 2 has an announced release date (May 2020); the others are expected at some point this year along with potential unannounced titles that could help fill the gap left behind by the exit from the Destiny franchise. Overwatch 2 will aim to reengage lapsed players similar to the recent success of WoW: Classic while WoW: Shadowlands looks to build momentum for that franchise. Diablo Immortal will attempt to replicate the early success of CoD: Mobile and help grow the audience for the franchise overall around the same time as Diablo 4 launches for sale.

The rapid growth of digital advertising in the King segment also deserves a mention. ATVI elected to ramp the advertising business slowly and carefully to ensure they were making the right moves for the long term. After slow but steady progress, digital advertising has become a meaningful contributor with long-term upside. ATVI continues to grow the number of advertisers interested along with the types of ads and measurement tools. Additionally, the King segment could release new titles in 2020 to accelerate growth.

Northlake believes ATVI has shown early benefits of the recent restructuring, and expects similar successes in 2020 and beyond. As these benefits flow through to the bottom line, the stock should work toward $70+. The stock is still expensive compared to the overall market, but the potential growth should justify the higher valuation if ATVI can execute on the new strategy. Lastly, the upcoming new console cycle from Microsoft and Sony could prove to be beneficial to gaming stocks as it has in previous cycles.

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. Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.

ViacomCBS Outlines Post-Merger Strategies

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ViacomCBS (VIAC) reported more disappointing news with its 4Q19 earnings report and 2020 guidance.  The stock is now down about -40% since last summer when the company first lowered its outlook.  Investors had thought that management had given a conservative outlook back then but this appears to have not been the case.  Management credibility is now low contributing to the latest shellacking in the stock.  Northlake credibility on VIAC is also low but that said we still think it is too cheap to sell using any normal valuation metric.  The 2020 outlook finally seems to be de-risked even as longer term risks remain related to NFL rights, subscriber counts, and the rate card on affiliate fees.  Based on free cash flow compared to peers, we could see downside to the mid-$20s, or another 15-20%.  Should the company hit its 2020 guidance, we see upside of 25% to 40%.

VIAC’s problems are mostly twofold.  First, the company is dramatically increasing its spending on programming for its own networks (CBS, MTV, Nickelodeon), its new streaming network (CBS All Access), and to sell to other networks and streaming services (Netflix).  This is a large upfront investment of cash flow.  All media companies are upping their content spend.  A particular challenge for VIAC is that earning a return on increased investment at their traditional channels is increasingly difficult.  At the same time, the company’s efforts in streaming are modest.  VIAC currently has only 11 million paid streaming subscribers and 22 million ad-supported viewers, while competition from already established much larger players like Netflix and Hulu and new entrants aiming for greater scale like Disney+ and HBO Max make it seem likely to be challenging to earn a return in streaming.  VIAC expects paid subscribers to grow 45% to 16 million and ad-supported viewers to grow 36% to 30 million by the end of this year.  Selling to third parties is a high return business but not enough to drive financial success on content investment.

The second problem is that it appears the deterioration in Viacom’s cable channels has been much worse than expected.  This lowers the base for future growth even if the company’s strategies to invest in its business work.  Viacom’s networks are losing cable subscribers faster than expected and those it is keeping are bring in lower affiliate fees than expected.

The merger of Viacom and CBS was designed to address these problems by giving the company more scale from which to invest and by using CBS’s must have TV network and TV stations to protect Viacom’s cable networks.  Management’s newly articulated strategy and hopefully the end of estimate reductions are potential positives.  As we move through 2020, hitting numbers, resolving the future of the company’s NFL rights, selling assets, paying down debt, and buying back stock are all potential catalysts.  Management was very confident in its guidance and offered supporting detail in response to repeated questions from analysts.

Northlake has been wrong on CBS and now VIAC.  We think the stock is washed out or very close to it at $28 with much more upside than downside.

VIAC 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. 

Bad Luck Returns to MGM as CEO to Step Aside in 2020

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In our last blog post on MGM Resorts (MGM), we note that after a string of tough quarters brought about mostly due to things beyond MGM’s control, the story was moving in the right direction.  Bad luck has struck again and not just with hold in the casinos.  The coronavirus has shut down Macau and led to another leg down in the baccarat business on the Las Vegas Strip where MGM dominates.  The company was forced to pull their 2020 guidance which while explainable is still a disappointment given challenges the company has had forecasting its business over the past few years.  We have been very pleased with the company’s moves to sell assets, initial steps to simplify the corporate structure, and return of capital via buybacks and dividends.  Along with the 4Q19 report, the dividend was raised, a large new buyback authorization was put in place, and a Dutch auction tender for shares is underway to accelerate use of the new authorization.

While we are happy with the capital allocation and corporate restructuring, we are less positive on MGM exiting the latest report.  First, it appears the company lost market share and fell short of EBITDA targets in its Strip assets.  This is troubling given that margins should have been supported by the company’s 2020 profit improvement plans, which management says are going very well.  Second, and possibly related, the company’s long-time CEO, Jim Murren, unexpectedly announced he was stepping aside.  We have not been fans of Murren and the company has been the target of activist investors.  It may a good thing for him to move on.  The timing seems odd, however, as (1) the company remains in the middle of a major restructuring of its asset base, (2) is in the final year of its latest profit improvement plan, (3) is undergoing a major expansion in sports betting, and (4) faces a critical year in its bid to build a new integrated in Osaka, Japan.  The timing of Murren’s departure could be the sign of a deeper problem.  Or maybe not and it just makes sense to leave now with the biggest parts of corporate restructuring and asset sales complete and Japan needing clarity on long-term leadership.

In the near-term, MGM is offering to repurchase about 7% of its outstanding stock at a price between $29 and $34 in mid-March.  We suspect the price will be in top half of the range putting downside support in place for the shares.  We are revaluating our view on MGM and will use the Dutch auction period to decide if there is still sufficient upside to justify continuing to hold the shares.  It is worth noting that in our last post on MGM we mentioned a mid-$30s target, not that far above today’s levels.

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.

Disney DTC Efforts Ahead of Schedule

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Disney (DIS) is a difficult stock to value at the moment as the company is “all in” on the roll out of Disney+ and overall transition of its traditional media revenue sources to streaming.  The new streaming services are losing money now and likely will for another few years.  The traditional media businesses including ESPN and ABC produce high free cash flow but are barely growing and in danger of slow secular decline.  Theme parks and the film studio remain strong businesses worth a premium valuation.

Disney reported its December 2019 quarter (1Q20) earlier this week.  Northlake’s takeaway is positive with improved outlooks for streaming and theme parks offsetting continuing challenges for ESPN and ABC and a tough comparison at the film studio in 2020 after the massive 2019 that included the latest installments in the Avenger’s, Lion King, Star Wars, and Frozen franchises.  Key to the results was disclosure of 28.6 million paying subscribers for Disney+ at a better than expected monthly ARPU.  Subscribers and ARPU at ESPN+ and Hulu were also better than expected.  Management added comments noting that churn has also been manageable indicating that the wrap up of The Mandalorian did not lead to cancelled subscriptions as investors had feared.  There was also good news at domestic theme parks where attendance rebounded as new attractions opened.  Wall Street is giving Disney a pass on lost profits at the Hong Kong and Shanghai parks related to protests and the coronavirus.

When Disney held its analyst day for Disney+, management guided to 60-90 million subscribers in 2024 at which point the service would be profitable.  It now appears the low end of the range could be reached in late 2020 or 2021.  In March, Disney+ will roll out to a similar number of households in Europe as the service is already available.  The combination or more subscribers sooner, initially higher ARPU and lower churn than expected, and management comments that there is no change to the expected investment in the service strongly suggests profitability will be reached well ahead of 2024.  This is a major positive for DIS shares as it improves confidence in placing a big value on the projected revenue of the streaming services.

With theme parks performing well excluding the issues in Hong Kong and Shanghai and the film studio in good shape thanks to the Marvel, Star Wars, Pixar, and Disney franchises, the path is clear for DIS shares to resume their rally. Last quarter’s note on DIS indicated that we thought the shares could be comfortably valued at $150.  The good initial news on Disney+ and the other streaming services increases our confidence in the $150 value and argue for a meaningfully higher target to develop.

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 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.

Alphabet Discloses YouTube and Cloud Data

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Alphabet (GOOG/GOOGL) reported slightly disappointing 4Q19 results compared to elevated expectations that existed thanks to a +10% gain in the shares in January to all-time highs.  Looking more closely at the quarter, the headline miss in revenues was heavily concentrated in hardware sales, an area where Northlake has little concern.  Overall advertising revenues at search and YouTube were a touch light but nothing to worry about.  Facebook also fell a little short on advertising revenues in 4Q.  Both companies noted a slowdown in U.S. growth, which likely was caused by the shorter holiday selling season in 2020 vs. 2019, 22 days vs 27 days.  Alphabet still enjoyed +19% currency adjusted growth in search and newly disclosed YouTube revenues grew 26%.  While traders will quibble about 19% growth vs. expectations for 20% or YouTube absolute revenue dollars being a little smaller than expected, Northlake finds these growth rates to be very impressive.  In addition, newly disclosed information about Google Cloud reveals a $10B annual revenue rate growing at 53%.  The core part of cloud is growing even faster and management revealed a large number of $50 million and above cloud contracts, a good sign that that Google Cloud is competing well against Amazon and Microsoft.

The new disclosures breaking out revenue are a significant positive as YouTube and Google Cloud are deserving of premium valuations that we believe are not fully reflected in GOOG/GOOGL share prices.  Prior to this report, investors were left to guess and much was made of Alphabet’s limited disclosure as a headwind to higher valuation for GOOG/GOOGL.

Management was also was more forthcoming with comments about revenue guidance and capital allocation.  While no specific revenue guidance was provided, when discussing the new reporting segments, management used adjectives like “ample” and “substantial” and “enormous.”  We take these word choices as indicating that management sees no material slowing in overall revenue growth beyond the normal fluctuations that occur from quarter to quarter.

There were two important new positives related to capital allocation disclosure.  First, management gave specific guidance as the pace of the share buyback and the level will be higher and more consistent than expected during 2020.  The current authorization should be completely used by the end of 2020 setting up another large buyback as a positive catalyst later this year.  Second, regarding Other Bets, comments were offered that Verily (health care) had brought in outside investors and similar actions were being sought for more Other Bets.  Management described these actions as designed to both realize value for these investments and to help fund their future growth.

We believe the added disclosure across many areas is a significant tell for an expanded valuation for Alphabet shares coming in the first quarter after the company elevated a non-founder to the role of CEO.  Alphabet’s valuation on Northlake’s preferred Enterprise Value to EBITDA basis sits below the average stock in the S&P 500 despite the company’s sustained growth rate near 20% and many money-losing or low margin businesses that are surely worth tens of billions in market capitalization based on comparable stocks.  Added disclosure should help investors better understand the long-term growth drivers at Alphabet and result in a higher valuation for GOOG/GOOGL.  Using a conservative multiple of 12.5X vs. the S&P 500 average of 11X and giving just $80 billion in value for Other Bets, Google Cloud, and YouTube, we can see the shares reaching $1,525 over the next few quarters.  Looking further out to 2021, we can see GOOG/GOOGL rising to over $1,700.  Alphabet shares remain a core holding for Northlake.

GOOG/GOOGL 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.  GOOG/GOOGL 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 Growth Amid Increased Economic Uncertainty

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Northlake’s Style model shifted to a full growth recommendation after spending two months neutral on the growth vs. value themes.  The Market Cap model continues to recommend mid cap for the third consecutive month.  Client positions in the Russell 1000 Value (IWD) have been sold and the proceeds reinvested in the Russell 1000 Growth (IWF).  Current positions in the S&P 400 Mid Cap (MDY) will be maintained.  Clients with taxable accounts may continue to own a position in the S&P 500 Growth (SPYG) due to prior tax-related trades.

The shift to growth was driven primarily by recent stock market action where growth stocks outperformed value stocks by a considerable margin.  In January alone, certain growth indices produced returns more than 4% in excess of value indices.  This is an unusual occurrence even during the current multiyear stretch where growth has consistently been the best performing theme.  It may seem counter intuitive but momentum is usually a good near-term indicator in the stock market, so the big relative gains for growth recently are likely to be sustained.  Northlake’s models are designed to consider this momentum influence through the internal indicator factors that measure stock market trends and technical analysis.  The latest Style model reading shows a unanimous growth reading among the eight internal indicators.  There were also two external indicators that shifted from value to growth.  External indicators look at factors in the economy and interest rates.  Four of six indicators currently favor growth reflecting continued slow but steady economic growth.  Growth stocks outperform when the economy is not strong enough to boost the more cyclical industries that are considered value investments.

The Market Cap model saw several indicators shift in favor of small caps.  The single month reading actually has moved into small cap territory but the model uses a two month moving average in order to dampen volatility and improve the odds that recommendations prove to be at important turning points.  Small cap stocks have had a historically long stretch of lagging large cap stocks.  This is partially due to the dominance of technology and internet companies in the economy.  It is also linked to the slow growth in the U.S. and global economies.  Small caps are best either when economic growth is at least average or when growth has been very slow.  This is because smaller companies need a little economic boost or get too depressed when growth is very slow or negative.

MDY, IWF, and SPYG 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

 

Facebook on Track for Strong 2020

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Facebook (FB) delivered 4Q19 sales and earnings above consensus estimates, and reiterated guidance for 2020. The stock traded lower, reflecting an appetite for a larger upside surprise. Since last quarter, FB climbed midway into Northlake’s $200-$250 target range based on reaching 20x-25x $10+ EPS this year or next. After the earnings selloff, FB is back near the low end of that range. Northlake still expects $10 EPS soon, with substantial upside in the coming years.

The details of the quarter were solid, but concerns about slowing advertising growth were more pronounced than usual. Last quarter, FB warned investors that 4Q19 faced an unusually difficult comparison due to the timing of several successful product launches in 4Q18. While ad growth did slow more than usual, it wasn’t unexpected and the deceleration in 2020 should be less dramatic. In addition, Northlake expects upside from disciplined cost controls as FB executes on many priorities in 2020. FB management typically provides clear and conservative guidance, and has been able to overdeliver in recent quarters. Expenses have risen well under management projections even as spending has been heavy to combat privacy concerns.

FB still faces regulatory challenges on many fronts. Privacy laws in Europe and California limit ad targeting, leading to less pricing power. While there has been minor disruption so far, this challenge will persist and maybe get tougher. Since 2020 is an election year, FB will face more scrutiny on issues like free speech, fake news, and campaign interference. The company noted new goals to communicate principles more clearly and stand up for people to help build communities as part of addressing the ongoing issues.

The investments FB makes to maintain growth have been paying off. Different ad formats effectively monetize new ways that people share and interact. Areas like video, news, and dating will be incremental improvements for many users. FB is focused on improving payments across the suite of apps. New hardware platforms such as augmented reality and virtual reality (AR/VR) are starting to grow in popularity. The billions of people who use FB services remain entertained and engaged.

Given the consistent execution, above average growth, and relatively reasonable valuation, Northlake finds FB attractive near the low end of our expected $200-$250 range. Investments in addressing privacy and security are necessary for now, and innovations on software and new hardware platforms may start to contribute sooner than investors expect. Northlake sees an operating margin inflection and $10+ EPS coming in the near term, with potential for much larger gains on the horizon.

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.