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Morningstar | CBS Reports Weak 4Q; All Access Subscriber Growth Continues to Impress

CBS ended 2018 with a weak fourth quarter, missing consensus revenue and EBITDA expectations. While the miss was disappointing, we were impressed by the firm’s direct-to-consumer efforts as All Access and Showtime Now have garnered over 8 million subscribers. As a result, management has updated its 2022 target to 25 million combined subscribers, a substantial increase from the previous goal of 16 million. To reach this target, CBS is significantly expanding its slate of original content for both platforms with 11 original series on All Access, up from eight in 2018, and 30% more hours of original content on Showtime. We are maintaining our narrow moat rating for CBS but lowering our fair value estimate to $68 from $71, as we expect that margin expansion will be limited by the firm’s continued investment in content. We believe that CBS will be forced to increase its original content slate to compete within the increasingly crowded video streaming landscape.

Revenue grew 3% year over year to $4 billion as the growth at the cable networks and local broadcasting segments more than offset the weakness at the entertainment unit, which primarily includes the national CBS network and television studio. Entertainment revenue fell 1% year over year, as the ongoing strength in advertising (up 2%) and affiliate fee revenue (up 17%) was more than offset by weakness in licensing, due largely to the timing of sales. Retransmission and reverse compensation revenue hit $1.6 billion for the full year, with 70% of the subscriber base up for renewal over the next two years. Cable revenue improved by 8% versus a year ago as Showtime added both linear and Internet-based subscribers. Local media benefited from increased political ad spending, which drove 25% revenue growth. Adjusted operating margin expanded to 20.8% versus 19.4% a year ago as revenue growth in high-margin areas such as retrans and reverse comp more than offset the increased content spending at both CBS and Showtime.

While the search for a CEO continues at the board level, acting CEO Joe Ianniello did provide some interesting insights into the potential impact of the recent board overhaul. As a result of the recent battles between the Redstone family and the CBS board, over half of the directors were elected to the board in 2018. According to Ianniello, the senior management team has been working with the board to set out the priorities for the firm. Both sides appear to agree that investing in premium content is the best use of the firm’s capital. This shift in the firm’s capital allocation strategy appears to come at the expense of the buyback that Ianniello previously discussed pulling back on. Recall that the firm repurchased an average of $2.9 billion of shares annually from 2013 to 2016. Despite the repurchases decreasing substantially over the last two years ($1 billion in 2017 and $560 million in 2018), we think that some investors expected the repurchasing to reaccelerate as the Viacom and National Amusement battles have been settled. While Ianniello’s comments should squash the hopes for a return to $3 billion in annual repurchases, we do expect that the firm will continue to buy back stock in more limited amounts.