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SuperModels Recent articles: • How Buffett tripped over the dollar, 6/15/2005 • Can Google grow like Dell and Cisco?, 6/8/2005 • The rising stars in RFID technology, 6/1/2005 More... | SuperModels Two Viacoms will be better than one Breakup fever is spreading, and Viacom's planned split into two parts shows why. The move should substantially raise the company's market value. By Jon D. Markman Virtually every week lately, Monday morning headlines have been topped by a new industrial, financial, media or retail merger. You have to wonder why. Most of the major mergers of the past few years have not worked out well, particularly among media companies, and they show few signs of improvement except in cases where they are being reversed. While synergy among disparate corporate assets was the mantra of the past half-decade, the most logical course over the next couple of years is a sort of fundamental disintegration. Much like the coming deconvergence of the socialist dream of a European Union will lead to stronger individual economies, a deconglomeration of U.S. big business will lead to an improvement in focus, capital formation and shareholder wealth. Bigger mousetraps, but no better Companies laying merger plans now would do well to study the path of media giant Viacom
Now, at least, there are signs that the boards of both companies are set to do the right thing and try to get small, and breakup fever is spreading. The most recent indication is the spin-out and going-private announcement of troubled cable-media-sports conglomerate Cablevision Systems Viacom and Comcast Putting aside the Byzantine world of financial services for now, lets focus in on the prospects of a broken-up Viacom. And along the way, lets contrast it with its mirror-opposite, the cable services kingdom amassed by Comcast The owner of such great brands as CBS, MTV, Infinity Broadcasting and Nickelodeon, Viacom announced that it would split itself into two parts early next year via a tax-free spinoff. Each segment was oriented toward distinct investor types, with all the slow-growing broadcast television, radio and publishing assets going into one new company, called CBS Corp., and all the fast-growing cable networks and film-studio assets going into a new Viacom entity. The former will get two-thirds of its revenue and about half of its earnings from TV, with the rest equally split between billboards and radio. The latter will get about 75% of its revenue and 90% of its earnings from cable, and the rest from films, according to estimates from analyst Jeffrey Logsdon of Harris Nesbitt. Although each will continue to be chaired by billionaire entrepreneur Sumner Redstone, there is little doubt that this will lead to a higher valuation for each new public company, as investment managers who specialize in each group will find it much easier to assess their individual prospects. In its press release, the company said the split would allow it to become more nimble and focused -- a clear repudiation of Redstones prior strategy -- and would use their already prodigious cash flow both for significant share repurchases and acquisitions. Related news and commentary on MSN Money Broadcast television and radio both generate a ton of cash flow via advertising revenue, and they dont require a lot of capital expenditures except for content. Advertising has certainly been lackluster of late, and high-quality programming is growing more expensive. But Viacom has already proven in the past that it has the ability to compete strongly and smartly for each. The group will be headed by veteran CBS executive Les Moonves. The companys Paramount TV production business will remain with CBS, giving it the ability to reduce costs of programming by developing in-house shows. How should the parts be valued? Thats much more voodoo than science, but Logsdon proposes that if you place a price-to-earnings multiple of 14 to 20 on the new Viacom entity and a 9 to 13 multiple on CBS, you can foresee a blended multiple of 12 to 16. Apply that against expected enterprise value minus debt, and you get a potential new valuation of around $43 to $60 a share, or 28% to 80% more than the current price around $33.50. The bottom line is that Viacom hasnt done its shareholders any favors in the past five years by pushing a bunch of great media operations under one roof. It also hasnt gotten much of a break, either, as poor advertising, lackluster films and poor decision-making at CBS News have all hurt results. And it badly suffers from a lack of recurring revenue, as it must eat what its advertising sales people kill each quarter. But the company appears to have a good plan to restructure intelligently, and should be at least modestly rewarded for the effort. Viacom and Comcast side by side Now, its interesting to compare the new version of Viacom and CBS with Comcast. On the one hand, you have a more focused, high-margin provider of content; on the other, a more diffuse, low-margin distributor of that content. Which is better? I recently became a fan of the Philadelphia cable-television goliath after subscribing to its high-definition, video on-demand and digital television service. It provides a tight set of digital media services for a reasonable amount of money, and wraps it with good marketing. Since 1998, its monthly revenue per subscriber has risen to more than $77 from $42, and millions of digital services subscribers are now paying $100-plus per month. And it has recently entered the highly competitive world of voice telephony. Comcast has grown in a much different manner than Viacom. By buying up minor and major cable operations around the country, it has become bigger without adding a lot of noise to its corporate structure. It is all hardware and carrier services, along with some minor distractions like passive investments on programming and sports marketing. Over the last three years, its shares have risen 27% while Viacoms have fallen 22%. Now the two are at an interesting crossroads. To get bigger from here, Comcast needs to continue to invest a lot of its cash flow and debt capital in digital telephony and cable infrastructure. It must keep paying and paying and paying to provide the wires and switches that will make its imperial dream a reality. As a result, its return on invested capital, which has averaged a paltry 1.7% since 1986, according to Rochdale Research, will only worsen. Meanwhile, its cable broadband services, while a strong point today, will remain under siege both by telephone companies spending on dragging fiber-optic lines from central offices to homes, as well as by the coming wireless broadband technology known as WiMAX. Rochdale -- which believes that a strong return on invested capital, in the double-digit area, is the single most important signature of a thriving business with the potential for a lift in shareholder value -- suggests that Comcast is in real danger of becoming an undifferentiated distributor of content provided by others. And commodity products are typically purchased by consumers primarily on the basis of price. In this context, Viacoms move to deepen its commitment to content -- which requires an order of magnitude less capital commitment -- through its breakup, and become better valued for that effort, makes a lot of sense. Consider Viacom a buy around here in the $29-$33.50 area over the summer, and look for prices north of $45 in the next 18 months. And be on the lookout for other conglomerates to get this religion, and move in the same direction. Fine Print To learn more about Viacom, visit its Web site. Showing that it continues to look for growth opportunities at all demographics, Viacom recently announced the purchase of Neopets.com, a site that my 10-year-old daughter and her friends adore for some reason. To learn more about Rochdale Research, read here Thanks for the ton of e-mail received last week on both sides of the Warren Buffett and dollar debate. Despite my view that he might turn out to be wrong on the dollar -- though the verdict is still out, and will be for some time -- I was probably overly harsh in the language that I used for dramatic effect. No disrespect was intended to Buffett, who is clearly one of the greats of his generation. Also, I will humbly note for the record that I have been wrong virtually every time that I have written skeptically on his point of view. Two weeks ago, I wrote about Google, and now there is word that the company is preparing a PayPal-type service to compete with eBay. One wonders if the search-engine company might not be spreading itself too thin if it tries to leverage its name in the direction of financial services. That is usually how good companies get off track, as they begin to think they can conquer all adjacent business domains at once. Jon D. Markman is publisher of StockTactics Advisor, an independent weekly investment newsletter, as well as senior strategist and portfolio manager at Greenbook Investment Management. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jon.markman@gmail.com; put COMMENT in the subject line. At the time of publication, Jon Markman did not hold a position in any of the equities mentioned in this column. | ||||||||||||||||||
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