ViacomCBS Corp. (NGS: VIAC). ViacomCBS is slowly recovering from the economic effects of COVID-19, particularly from the severe impact on its advertising business. As professional sports resume and the primetime season gets under way, we agree with management that advertising should continue to recover; however, the immediate future is uncertain. We also do not expect much from the theatrical side of the business in 2020. The pronounced shift in consumer behavior toward home-based entertainment (as traditional revenue streams like Adverting and Theatrical slowly recover or remain moribund) has spurred management to double down on the company’s own streaming options. This is exemplified by its move to rebrand and relaunch its primary streaming subscription service, CBS All Access.
In the face of the pandemic, the company has refinanced near-term debt and improved liquidity in recent quarters through a large new debt offering and asset sales. This was simply prudent on the part of management given the uncertain macroeconomic climate. Viacom’s credit ratings remain investment-grade, though this could change rapidly. S&P already gives the company a negative outlook.
ViacomCBS is the result of the merger of CBS and Viacom in an all-stock deal on December 4, 2019. While CBS may have gotten Viacom on the cheap, it will now be saddled with Viacom’s unevenly performing basic cable channels as the two companies look to reintegrate after a 14-year separation. The old CBS had a unique asset in its flagship CBS television network, and had made good strides both in premium cable with Showtime and in video streaming with its CBS All Access and other streaming services. ViacomCBS CEO Bob Bakish has begun to execute his plan to leverage the combined assets of the two companies, particularly in digital video streaming with the recent expansion of the CBS All Access video streaming service. Even after COVID-19 recedes, it remains unclear if ViacomCBS will be able to overcome the powerful forces of cord-cutting and the rise of digital distribution. In addition, even with the merger, ViacomCBS may not have the scale to compete with industry giants like Disney or new entrants like Apple, and may need to acquire or be acquired by another industry player to achieve the necessary scale. We think that ViacomCBS should partner, or perhaps merge with, a digital technology firm rather than continue to aggregate traditional Hollywood content/distribution assets.
Revenue declined 9% year-over-year to $6.12 billion. Advertising revenue declined by $145 million or 6%; however, it improved sequentially from the 2Q decline of $711 million as the television ad market slowly recovered. Affiliate revenue rose $216 million or 10%, also improving from the 2Q trough.
The positive inflection in Affiliate revenue was driven by growth in subscription streaming, higher reverse compensation and retransmission fees, and expanded cable distribution. Content Licensing fell a disappointing $607 million or 33%. Though we know that Content With content production just beginning to get back to normal following the COVID-19 hiatus, Content Licensing is likely to suffer long-term effects from the pandemic. Theatrical revenue fell $88 million or 94% in 3Q; no surprise given the continued closure of, and/or restricted audience regulations for, movie theaters around the world.
Operating income declined 7% to $959 million. Management’s favored metric, adjusted OIBDA, declined 12% to $1.1 billion in 2Q20. Adjusted diluted EPS from continuing operations fell 18% to $0.91 from $1.10 in 3Q19. GAAP diluted EPS fell 2% to $0.99 from $1.10.
Naveen Chopra became the company’s new CFO on August 10. Mr. Chopra previously served for eight years as CFO of Amazon’s Devices and Services business. Before that, he was the CFO of streaming music service Pandora.
EARNINGS & GROWTH ANALYSIS
Management expects 4Q Affiliate revenue growth to be in line with the 10% growth seen in 3Q. It also looks for continued sequential improvement in Advertising revenue.
Viacom and CBS completed their merger just a few months before the COVID-19 lockdown. Management had many plans for the merged Viacom CBS. However, the severe economic impact of COVID-19 from initial stay-at-home restrictions to the longer-lasting shift in consumer behavior toward home-based activities significantly impacted ViacomCBS’ advertising business. In addition to the impact of general economic malaise, certain industry verticals, including travel, lodging, food service, entertainment, and retail essentially crashed with the onset of the pandemic. However, as noted in the company’s 3Q results, advertising has begun to recover with the resumption of sporting events and the new prime-time television season – though these positives will also mean a return to higher operating costs.
With movie theaters remaining closed or severely restricted in many markets worldwide, ViacomCBS has continued to delay large franchise theatrical releases to 2021. Even when movie theaters reopen (if they reopen), social distancing requirements – or consumers simply staying away – could impact box office receipts for some time. Still, the company’s Theatrical business accounts for only about 3% of total revenue.
The pronounced shift in consumer behavior toward home-based entertainment as traditional revenue streams like Adverting and Theatrical recover slowly or remain moribund has spurred management to double down on the company’s own streaming options. This is exemplified by its move to rebrand and relaunch its primary streaming subscription service, CBS All Access. CBS All Access will be rebranded as Paramount+ and expanded globally. CBS was one of the first content producers to jump into direct-to-consumer video streaming and the service has been successful, though still dwarfed by leading video streaming services Netflix, Hulu and the extraordinarily successful Disney+. Management expects domestic pay streaming subscribers to reach 18 million by the end of 2020. The expansion of CBS All Access includes the use of content from Viacom’s stable of cable channels, including MTV, Comedy Central, Nickelodeon, and Paramount. All Access is also expanding its slate of originally produced content and sports programming. Finally, CBS All Access is introducing a new user interface that includes enhanced personalization and discovery features. The launch of Paramount + should take place in early 2021.
We cannot forgot the momentum at the company’s other streaming platforms, Showtime OTT and Pluto TV. In 3Q20, Pluto TV, the company’s advertising-supported streaming service, grew monthly active users 57% year-over-year to 28.4 million and global MAU’s to 36 million. The company has continued to roll out Pluto TV in international markets, including in Europe and Latin America. Management reiterated its forecast of 30 million Pluto TV monthly active users by the end of 2020.
Management remains intent on selling its headquarters building in New York and well as the Simon & Schuster book publishing business, as both are deemed noncore assets. These assets were first put on the block in March, though we think COVID-19 has obviously affected the market for New York City commercial real estate if not for book publishing. The company is reportedly looking for a price of $1.2 billion for Simon & Schuster. The publishing segment was just 3% of total revenue and 2% of total EBITDA in 2019. Publishing has been a stepchild for many years as the company has focused on its core video entertainment assets.
FINANCIAL STRENGTH & DIVIDEND
Free cash flow has benefited from a positive swing in working capital due to the hiatus in content production earlier in 2020. As content production continues to ramp back up, management expects the working capital benefit to reverse in the coming quarters, acting as a headwind to free cash flow accretion. Outlooks are stable to negative.
Management intends to devote excess cash after dividend payments to debt reduction. However, the company is also selling its Manhattan headquarters building and Simon & Schuster publishing business, which could generate excess cash for share repurchases.
MANAGEMENT & RISKS
With the ViacomCBS merger come the usual integration risks – perhaps mitigated by the similarity of the two businesses and the fact that they were previously part of the same company, Viacom, before being separated in 2005.
The advertising market’s extreme sensitivity to the economic cycle is a major risk for ViacomCBS. Advertising still accounts for 40% of revenue. In addition, the company faces regulatory risk on a number of fronts, including indecency and media-ownership regulations.
Add to this the fact that sports broadcast rights for almost all the major leagues are wrapped up in long-term network agreements, a critical issue since sports are generally not DVR-time-shifted; this makes the advertising more valuable to networks like CBS in its contracts with the NFL, the NCAA, and the PGA, among others. In a ‘if you can’t beat’em, join’em’ strategy, VIAC is relaunching its own streaming video service in January.
ViacomCBS is a worldwide media entertainment company. Remerged in December 2019 from sister companies Viacom and CBS, the company produces and distributes television and cable programming over its networks, including the flagship CBS broadcast network; a stable of basic cable channels, including MTV Networks, VH1, Nickelodeon, Country Music Television, Comedy Central and BET; a network of locally owned and affiliated CBS broadcast television stations and various digital streaming video platforms including CBS All Access and Pluto TV. ViacomCBS also produces and distributes theatrical films through its Paramount Pictures studio and partners with Time Warner in the CW network. The company’s businesses and trademarks also include the CBS and CW television networks, the Showtime cable network, CBS Television Distribution, and Paramount Pictures.
On November 13 at midday, HOLD-rated VIAC traded at $31.26, up $0.23.