No, the picture below does not depict a tidal wave, but rather a simplification of the rise and fall of Netflix (NFLX). Once the darling of Wall Street analysts, Netflix is now destined for MBA case study books in what not to do in business. Management's errors are now well known, but the downside still remains uncertain. WedBush calls the business "[b]roken" and the Street tends to agree, rating the stock nearer to a "sell" than a "buy".
Source: Bloomberg
In light of this fiasco and despite the recent rise, one should consider what makes a strong media company. Comcast (CMCSA) and Viacom (VIA) are two giants in this industry. They have reduced risk and increased upside through diversification, sustainable global expansion, and a consumer-centric business model.
From a multiples perspective, Viacom is the cheapest of the three. It trades at a respective 12.7x and 9.1x past and forward earnings. Comcast and Netflix trade at a respective 17.7x and 18.3x past earnings - the latter of which will have earnings so low in 2012 that analyzing its forward PE becomes meaningless. Viacom also offers the highest dividend yield at 2.2% and is, to most analysts, the most undervalued investment.
Several factors are pointing in the right direction for Viacom. First, it knows how to draw in crowds. Mission Impossible 4 is #1 at the box office, with a worldwide total of $145 million up until Thursday. The Adventures of Tintan is off to a much slower start, but has had stellar results in Europe, resulting in a worldwide total of $247.1M up until Thursday. While Nickelodeon has had ratings problems of late (ie. iCarly), MTV, Comedy Central, and BET have all improved in this area. Expect great results with the debut of I Just Want My Packs Back and the new season of Jersey Shore.
Second, management is committed to returning free cash flow to shareholders. As I noted earlier, Viacom has a noteworthy dividend yield. It also has a noteworthy buyback program: $10B, 40% of market cap. In 2012, $3B will be returned to shareholders.
Third, based on earnings potential, the firm has favorable risk/reward. Consensus estimates for Viacom's EPS are that it will grow by 13.5% to $4.29 in 2012 and then by 18.2% and 18.5% more in the following two years. Assuming the multiple holds steady at 12.5x and a conservative 2013 EPS of $5.02, the rough intrinsic value of the stock is $62.75, implying 38.6% upside.
Comcast is similarly an attractive value play. At the third quarter earnings call, Comcast CEO Brian Roberts, noted solid results:
"I'm pleased to report another quarter of strong performance across key financial, operating and product areas. Our primary focus has been on great operational execution and on extending our industry leadership.
Let's begin with Cable, which really had an outstanding quarter, making this the fourth consecutive quarter of improving customer metrics. Our combined video, voice and data customer additions increased 13%. In addition to customer growth in high-Speed Internet and voice, we saw a continuing improvement in video, where we reduced our customer losses by 110,000 over last year's third quarter.
High-speed Internet was, once again, the largest contributor to Cable's revenue growth. Every quarter this year, we've added more high-speed Internet customers than in the same quarter of 2010, and we continue to take share as we expand the differentiation between our high-speed service and DSL".
Comcast has a majority stake in Universal Studios and will also be building a Harry Potter park in Hollywood. "The Wizarding World of Harry Potter" in Orlando, Florida at Disney World was a tremendous hit that I do not anticipate any meaningful disappointment in the Hollywood effort. I am further optimistic about the cross-marketing deals the company has planned with Verizon (VZ), AT&T, and Time Warner Cable (TWX). This will reduce vulnerability during a challenging economy.
Consensus estimates for Comcast's EPS are that it will grow by 18.9% to $1.51 and then by 23.2% and 17.7% more in the following two years. Assuming a multiple of 17x and a conservative 2012 EPS of $1.81, the rough intrinsic value of the stock is $30.77, implying 29.1% upside.
A few months ago, many would have taken very seriously the thought that Netflix could be the Viacom and Comcast of movie rentals. Now, investors are starting to appreciate the level of competition it faces. Verizon is launching a streaming service in 2012 and will extend the service beyond its FiOS customers. Google (GOOG), Amazon's (AMZN) PRIME, Hulu, Apple (AAPL), and especially Time Warners's HBO GO will make the market for content even more competitive. Eight hundred million dollars and $1.7B worth of content costs is possible in 2011 and 2012, respectively. Netflix CEO Reed Hastings nevertheless argues that Netflix is well positioned in streaming and has strong liquidity - the $400M raise was to cushion the firm from a crisis, should one arise. The movie company rose 11.4% amidst better than anticipated revenue from online viewing, which logged in 2 billion hours over the last three months. I view that the reaction to this news was overdone and that the weak fundamentals will continue to show poor sustainability.
Consensus estimates for Netflix's EPS predict much volatility: An estimated 38.5% growth to $4.10 in 2011, 95.9% decline in 2012, 1952.9% growth in 2013. Assuming a multiple of 19x and a 2013 EPS of $3.41, the rough intrinsic value of the stock is $64.79, implying downside.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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