August 17, 2018 - 2:24pm EST by
2018 2019
Price: 53.40 EPS 5.03 5.89
Shares Out. (in M): 386 P/E 10.6 9.1
Market Cap (in $M): 20,612 P/FCF 13.3 11.0
Net Debt (in $M): 9,202 EBIT 3,163 0
TEV ($): 29,814 TEV/EBIT 9.4 9.0

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Concerns surrounding a declining pay TV subscriber universe and negative ratings across many networks have driven significant multiple compression in the traditional media space.  While we do expect there ultimately to be winners and losers in the ongoing shift in video consumption habits, some misplaced concerns have created the opportunity to buy certain growing media companies at heavily discounted multiples.  CBS Corporation (CBS) is our favorite name in the space. While CBS is priced as though it were in secular decline, the company is actually a net beneficiary of the trends changing today’s media landscape, and as a result earnings should grow at a double-digit pace for the next several years.  Recent lawsuits between the CBS board and controlling shareholder National Amusements (NAI), along with CEO Les Moonves’s harassment scandal, have put some extra downward pressure on the stock. Meanwhile, the media space continues to consolidate. We believe CBS is likely to be acquired by a larger tech or media company in the next few years.  CBS has been written up several times on the VIC, and most are familiar with its business lines. We have arranged this write-up as an outline of the bear case points as we see them with our commentary on why they are wrong. We also include our basic model below.

Bear Point #1 – Cord cutting acceleration indicates that TV is in secular decline

Just as with most bear cases, including the incorrect ones, there is some truth to the view.  Let’s start with stating the problem: Pay TV is losing subscribers at an accelerating rate. Disney CEO Bob Iger raised the alarm on that company’s second quarter 2015 conference call saying,

“We're realists about the business and about the impact technology has had on how product is distributed, marketed, and consumed. We're also quite mindful of potential trends among younger audiences in particular, many of whom consume television in very different ways than the generations before them. Economics have also played a part in change, and both cost and value are under a consumer microscope.  All of this has and will continue to put pressure on the multi-channel ecosystem, which has seen a decline in overall households as well as growth in so-called skinny or cable-light packages. ESPN has experienced some modest sub losses, although those have been less than reported by one of the prominent research firms.”


These comments touch on several key factors at play here; we will unpack them below. Prior to Iger’s comments, it is important to note that the cable bundle had been slowly eroding for several years, as shown in the graphs above.  The large cable bundles that took off in the 1990s and eventually penetrated 90% of US households began losing subs in 2010. Initially this was due to what Iger refers to above as economics: pay TV became too expensive. The cable bundle, made up of broadcast networks – principally CBS, ABC, NBC and Fox – basic cable networks – AMC, FX, CNN, TBS for example – and premium cable networks – HBO and Showtime, costs on average $106 per month, up 44% since 2011 according to Leichtman Research Group.  According to Tivo, 85% of people who cut the cord do so because they viewed the service as too expensive.

Packaging an increasing number of channels, often with decreasing consumer value, into the bundle was a fantastic business for the cable/TV industry, which generated some $170 billion in revenue last year, roughly split evenly between advertising and subscriber fees.  Oversimplifying the dynamic, once the industry reached maturity, cable companies would add a new channel as a justification to increase fees. Distributors were forced to carry all channels, eventually leading to dozens of channels from several programmers. The average number of channels in the bundle more than doubled between 2005 and 2015; yet, customers only watched 17 channels on average throughout.  Distributors would in turn markup that content cost significantly for consumers. On the customer facing side, the cable industry has notoriously poor customer service. These businesses were often capitalized primarily with debt and managed for cash. Many markets were effectively monopolies, so customers were held hostage to some degree. Consumers were willing to consume content at an arbitrary on a twenty-year-old user interface, constantly interrupted with commercial breaks as long as there was no alternative.  The situation, marked by high profit margins, too many layers in the value chain, and complacent participants, was ripe for disruption by Silicon Valley.

Netflix was the first mover in the rise of Internet TV/streaming video on demand (SVOD).  After launching its streaming service in 2007, Netflix now has around 130 million subscribers globally.  Built around the consumer instead of the cable company, Netflix offers on demand viewing in an elegant, customized interface with no commercial breaks.  Which brings us to the second Iger point above: consumption of television in different ways. Once consumers experienced this alternative, they were hooked.  While most domestic Netflix subscribers also have a pay TV subscription (i.e, Netflix is a complement, not a substitute), Netflix and other OTT offerings have essentially stolen 20% share of total US viewing time.  That is to say, of the five hours of daily video viewing, digital is two of them. Much to the frustration of the traditional TV ecosystem, the majority of video viewed on SVOD is legacy media content.


For years, traditional media companies ignored the threat from Netflix.  Structural factors like long-term licensing contracts between content creators and distributors prevented obvious moves like making all Pay TV subscriber content available out of the house and on mobile (TV Anywhere) from happening quickly or being ubiquitous.  Pay TV only recently has started to respond with participation in SVOD and virtual MVPD services like Hulu, Direct TV Now and Sling, and by offering their distributed content through apps. These services offer smaller, more economical “skinny” bundles of the same content available in the linear feed as well as an increasing amount of exclusive content.  Others have decided to seek direct relationships with consumers. CBS falls into both categories, participating in virtual MVPD platforms, licensing content to essentially everyone in the ecosystem and offering its own branded OTT products – CBS All Access and Showtime OTT. Virtual MVPD platforms have grown to a high-single-digit percentage penetration of the ecosystem from a zero base in just a few years, with growth accelerating in recent quarters.


Without a doubt, these digital offerings are responsible for an acceleration of longstanding linear subscriber erosion trends; however, it is inaccurate to assume that all of those lost linear subscribers have left the ecosystem.  Many of the consumers who cut the cord pick up at least one of these digital offerings. In fact, the 50% of US households that subscribe to a streaming service, including Netflix, have an average of three digital video subscriptions.  Clearly these offerings are a substitute for linear TV on one level, but they are also complimentary on another. According to Horowitz research, 78% of OTT SVOD users are also MVPD subscribers. 75% say access to broadcast networks is a significant reason for having this mix.  In addition, Nielsen estimates that there are around 2 million viewers in skinny bundles that previously did not have a pay TV service. In other words, they are new to the ecosystem and are an offset to the traditional pay TV erosion. Once we look at those same subscriber trends including new vMVPD subscribers, the long-term erosion of 1-2% per year looks still very much intact.  Consistent with other industry data points, on Disney’s conference call last week, Bob Iger stated that subscriber trends are improving:

Although the erosion of the expanded basic bundle continues, the impressive growth of these vMVPDs has steadily slowed overall sub losses. To that end, we've seen noticeable improvement in the rate of sub loss in each of the last four quarters.


We also believe the installed pay TV base has varying degrees of willingness to drop out of the ecosystem.  Clearly, those consumers that saw limited value in their video subscription would be the first to drop out. Looking at the amount of time spent watching linear TV – 70% of primetime viewing is still watched live –  there is still a large percentage of the population that is unlikely to drop its cable subscription anytime soon. The rate of erosion is obviously a very important number to get a handle on as it is a driver for valuation multiples in the space.  Prior to subscriber losses accelerating in 2015, media companies often traded at premium multiples to the S&P 500. Discounts imply an accelerated shrinking subscriber base with little to no terminal value. Valuation discounts in the space have, in general, narrowed recently, mostly on consolidation news and speculation.  

One of the reasons we really like CBS is the fact that is has been able to grow subscribers and revenue/earnings while the overall pay TV universe continues to shrink.  In fact, the company reported accelerating subscriber growth in the March quarter and subscriber growth of 6% in the June quarter, marking its fourth sequential quarter of subscriber growth.  It’s outperformance of industry trends is a result of being well ahead of the game in launching and ramping CBS All Access and Showtime OTT. The company claims the two OTT offerings will have 8 million subs next year and 16 million by 2022.  While still subscale, especially at All Access, this is no small feat. CBS’s inclusion in a variety of third party OTT offerings speaks to the must-have nature of its content. One of the reasons we like CBS is that it does not carry the baggage of dozens of channels consumers wouldn’t widely pay for a-la-carte.  The most vulnerable segment of the ecosystem today is basic cable, an area where CBS has no significant presence.

Subscriber count is only one part of the fee revenue calculation; the other is dollars per sub.  CBS has the “must have” content in its network to provide pricing power with distributors and consumers.  Importantly, it makes more money on subs that drop a linear subscription and go with an SVOD subscription instead.  This is especially true in the case of CBS All Access, where 1/3 of its subs are paying $9.99 per month for a commercial-free version.  This compares to $2-3 per sub in the traditional ecosystem. All-in revenue per sub was up 30% y/y last quarter. Even at these higher rates, CBS is still underpaid, generating 12% of linear viewership but only receiving about 3% of available fees.  Some industry peers, in contrast, have struggled to justify their rate card and have not been included in SVOD offerings.




The current TV ecosystem is in flux, and the pay TV distribution model is being forced to change.  The good news is people are still watching a lot of TV, by some metrics, more than ever before. In fact, if you consider how people spend free time, it’s mostly watching TV.  The difference is they are watching less on an actual television and more on their phone and tablet.

To us, this is a distinction without a difference, especially for CBS, which is platform agnostic and relatively untethered to the existing model.  Our basic view is that the distribution portion of the TV value chain is being heavily disrupted, but content creation is still very valuable. CBS has been somewhat indifferent as to if, how or when the bundle breaks; CBS is well positioned in virtually any scenario.  As traditional distributors are being disintermediated by emerging OTT players, we will have truer price discovery for video content. This should benefit CBS. As long as CBS can offset linear erosion with SVOD gains, while getting some rate gains, the evolving ecosystem should at least be neutral for the company.  For the next few years, we see decent, low-risk growth in retrans and licensing fee revenue.

As traditional pay TV is replaced by OTT offerings, we might actually end up not too far from where we started.  The cable bundle, is actually a very good deal for the amount of quality content you get. For a family of four paying $100 per month for content, the cost for its primary entertainment is less than a dollar per day per person and includes an amazing amount of variety and options.  Almost every other form of entertainment is much more expensive. Even those offering “skinny bundles” have begun to let their belt out in an acknowledgement that a large portion of the market still wants a wide variety of channels. Consumers who want more than just a handful of channels will likely pay more trying to build their own bundle a-la-carte.