The CBS Content Machine Is Sitting on High-Potential Assets

(This is a highly-abbreviated version of a full SumZero report republished with the author's consent)

Contributor: Ryan J. Ross, CFA.
Firm: Formerly at American Century Investments. Mutual Fund.
Location: Kansas City, MO.

Recommendation: Long Shares of CBS (NYSE: CBS).
Timeframe: 1 to 2 Years
Recent Price: $31.65
Target Price: $44.00

Strategy: GARP

Quick Thesis:
Good long-term story, with several secular trends that should provide a nice tailwind for the next few years. CBS is adding additional non-ad revenue streams from retrans fees, reverse comp, and content licensing for streaming and syndication. They will also benefit from near-term catalysts, including a 2012 election year, a continued recovery of the advertising market, and favorable ad rate increases due to a dominant position as the #1 broadcast network. The stock is cheap and the company is buying back a ton of stock thanks to abundant free cash flow.

In addition to syndication deals, CBS has been controlling its content distribution and cashing in through non-exclusive streaming deals. Some of the notable deals are below:

Feb. 2011 – Netflix (Nasdaq: NFLX) agrees to 2-year deal (w/2-year option) to pay ~$200mm to stream shows such as Cheers, Frasier, Twilight Zone, Andy Griffith Show, and Star Trek. Contract allows CBS to ''put'' shows to Netflix for a fixed fee as they come off the air
July 2011 – Amazon (Nasdaq: AMZN) will pay ~$100mm for a 2-year agreement to stream CBS content
Sept./Oct. 2011 – two deals with Hulu; one for CW content and one for CBS content in Japan
Oct. 2011 – Netflix will pay $1bn over five years for rights to stream CW Network shows

KEY NOTE: CBS has yet to license content for current running shows for CBS or Showtime (i.e., its most valuable content!). Translation: they are signing $100mm+ deals for content that is 20, 30, 40 years old in some cases. The stuff that is really valuable is the current show lineup, which could produce a ton of money if/when they start to sign streaming deals for that.

While the non-ad revenue streams are highly incremental to earnings, advertising still accounts for ~60% of the company's sales. With that said, it's also good to note that the ad market is recovering nicely and has near-term catalysts. Recent mgmt. commentary that scatter market pricing +15% through Feb., and is significantly better than Q4. Auto advertising (#1 ad category) is strong, up high single digits. Fall upfront ads will likely be up double digits (after +13% last year); mgmt. is willing to sell 80%+. Obviously, 2012 is an election year, which is expected to be another record breaker, with $2.5bn-$3.5bn in political advertising on broadcast television. Mgmt. believes that they get 9%-10% of total ad dollars spent. Oh and by the way, the Super Bowl will be on CBS in 2013. CBS is expecting to get $4mm for a 30 second ad.

CBS generates a ton of cash and management is shareholder friendly. In 2011, the company generated ~$1.5bn in FCF, even after making $410mm in voluntary pension contributions. The dividend was increased 100% in 2011, but there is still plenty of room for further hikes. Overall, the company has returned $6.9bn in capital to shareholders through buybacks and dividends since CBS was spun off from Viacom (NYSE: VIA). They bought back $1bn in stock last year and have $2bn remaining under the current authorization (~9.2% shares outstanding)

The stock is cheap on a historical and absolute basis. It trades at 11.1X 2013 Street estimates. Historically CBS trades at 15X forward earnings; Considering this company should grow earnings 10%+ for next 4-5 years, the stock is attractive at current levels. DCF gets me to about $43 and I can easily see this trading in the mid-40's once there is a little bit more stable economic backdrop.

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