ViacomCBS Is a Rare Value

In a sector where undervalued opportunities are few and far between, ViacomCBS VIAC stands out, trading 30% below our $61 fair value estimate. We believe the company is poised to capitalize on the trend toward increased consumer adoption of streaming services with its relaunch of Paramount+ in March and the success of its other streaming platforms like Pluto. The flagship service offers not only a strong on-demand library from the company’s deep library but also access to CBS and its wealth of sports rights, including the NFL and March Madness, which helped to drive streaming growth over the first four months of 2021. With the recent renewal of Sunday afternoon NFL rights, ViacomCBS now controls two of its most important sports rights into the next decade.

Like larger peers Netflix NFLX and Disney+ DIS, Paramount+ and Pluto should both benefit from international expansion. While the rebranded flagship Paramount+ service launched in 23 international markets in March, including 18 in Latin America, it has yet to launch in most of Europe, the largest non-U.S. market for Netflix, or India, the biggest international market for Disney+. Given the opportunity internationally and the relatively low guidance of 65 million-75 million subscribers by 2024, we think it’s likely that Viacom management will raise its outlook in the next two years, similar to the increase that Disney management made in December 2020.

In order to support its streaming growth, we project that ViacomCBS will continue to invest in content creation for the linear networks, theatrical slate, and streaming platforms. Additionally, we expect that the company will probably exceed its minimal target of $5 billion in streaming content spending as it ramps up local language content to better compete with Disney+ and Netflix around the world. This spending will help to drive subscription revenue as well as ad revenue for the lower-priced ad-supported tier and Pluto.

Sustainable Competitive Advantage Results in Narrow Moat

Our guiding premise in media is that the value of video content continues to increase even as the distribution markets mutate. Despite changes in distribution, pay-television penetration remains at around 70% of U.S. households. Even without a pay-TV subscription, most cord-cutters still consume video content and many use antennas to capture signals, providing content creators with an additional avenue to generate revenue from these viewers. While over-the-top providers like Netflix and Amazon Prime AMZN are creating their own content, both services require deep libraries to gain and retain subscribers. Given the ongoing demand for content, we believe content creation is not a zero-sum game, as high-quality content will always find an outlet.

ViacomCBS’ competitive advantage lies in the CBS broadcast network, a valuable portfolio of cable networks with worldwide carriage, production studios, and a now deeper content library. The company owns one of the four major national broadcast networks and affiliated TV stations in 16 markets. While network ratings have declined over the past two decades, the broadcast networks are the only outlet to reach almost all 120 million households in the United States. Network ratings still outpace cable ratings and provide advertisers with one of the only remaining methods for reaching a large number of consumers. The network also provides an outlet for CBS Studios, which has generated multiple hit programs on an annual basis. CBS Studios currently produces or coproduces 80% of the prime-time slate on CBS, with 40% fully produced in house. The strong ratings at CBS offer a virtuous cycle in which the creators of the network’s hit shows have an incentive to launch new shows with the network and the ratings attract other creators to the platform.

CBS also has a strong portfolio of sport rights, including NFL, college football, and college basketball. Live sports is one of the few programming categories to remain largely immune to DVR/time-shifted viewing, and it continues to draw males aged 18-49, a key advertising demographic. We believe the combination of highly rated original programming and exclusive sports rights will allow CBS to continue to increase its revenue from retransmission fees and reverse compensation.

A new entrant would encounter two major hurdles to launching a new cable channel with widespread distribution in the U.S. or abroad. First, it is very expensive to create new high-quality content. While some of Viacom’s channels may air lower-quality original programming than peers, the company spends more than $3 billion per year on content creation.

Second, building an audience even by investing in content has become harder than ever, as demonstrated by the struggles of Apple TV+ AAPL and Quibi, among a host of other over-the-top platforms. One of the issues that online services face is the wide-open nature of the Internet and the difficulty in standing out among the vast array of choices, In contrast, the walled garden of pay TV provides a safer arena to launch a new platform, and a larger player like Viacom can use its established, well-known channels to advertise its new ones. While it is harder to gain carriage for a brand-new network, as most distributors have enough channels, Viacom can rebrand one of its existing channels in order to quickly gain carriage, as the company did with Paramount Network, which formerly operated as Spike. As a result, the company owns more than 310 channels across 180 countries, broadcasting in 46 languages with over 4.4 billion cumulative subscribers.

Viacom operates two channels with extremely strong brands: Nickelodeon and MTV. Nickelodeon recently regained its position as the top domestic cable channel for young children and now reaches over 600 million cumulative households worldwide. While MTV does not generate cash flows as strong as Nickelodeon’s, the brand retains a strong appeal internationally, with 987 million cumulative subscribers worldwide. The company also owns other solid brands, including VH1, Comedy Central, and BET.

Advertising Still Important

The new business models proliferating throughout the media sector could diminish ViacomCBS’ revenue growth or profitability. Viewership of the company’s programs could fall below expectations and advertisers could pull back on their spending, both of which could drag on advertising sales growth. As more than 40% of revenue comes from advertising, ViacomCBS remains vulnerable to an economic slowdown. Licensing historical content to online players like Netflix and other video-on-demand providers could have long-term negative implications for ViacomCBS’ audience ratings.

While CBS had shed some of its less core business like billboards and radio, the new management team appears to be much more aggressive in monetizing noncore assets. CBS had been very aggressive in returning capital to shareholders via stock repurchases, but we expect that the combined company will invest more aggressively in creating content and in revitalizing the cable networks and Paramount studio, along with paying down the debt load. Additional capital will be used to fund the dividend, which was maintained at CBS but was cut in half at Viacom in 2016.