Update on VIACOm ($VIAC)

At the end of every year, I try to look back at some of the biggest mistakes to learn from them. Viacom ($VIAC) is certainly one of those. I have also received many requests on social media for an update on my thoughts and at times 280 characters can be a bit too restricting.

RECAP of $VIAC

​Back in 2020, I talked about VIAC being a more value centric way to participate in the excitement around streaming. VIAC’s stock surged and reached $100 on 3/22/2021 from $37 to start the year. In hindsight, much of the move in this name was driven by relentless buying by Archegos Capital Management, a ~$20B hedge fund. VIAC’s stock quickly retraced those moves as an extremely well-timed capital raise by VIAC and the high-profile liquidation of Archegos drove VIAC’s stock down to an intraday low of $40 on 3/26.

To us, this move lower created a very interesting buying opportunity which we talked about subsequently on air. But as of year end the stock is even lower at $30. So, what happened?

Fundamentally, VIAC rev expectations have been drifting up through 2021 driven by streaming revs that have also been going higher.  Given the losses in Viacom’s streaming business, this has driven EBITDA and EPS expectations lower which is natural as they gain scale in streaming.   As discussed later, streaming leader Netflix (NFLX) lost money for eight years before 2020 and should be cash flow breakeven in 2021. Obviously NFLX’s stock has done well over this time driven by subscriber growth, the most watched metric.  But obviously subscriber growth did not help VIAC’s stock price this year.  So what happened?

In our minds, there were two main driving forces after the Archegos meltdown that drove VIAC’s stock price even lower: 1) the leaders in the streaming space started missing their subscriber expectations and 2) treasury yields started to rise this year creating a greater focus on profits versus just growth.

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Driving Force 1:
​Subscriber Misses by Streaming Leaders

In 2021, NFLX missed both Q1 and Q2, Disney (DIS) missed Q3, and Roku (ROKU) missed Q3.  Traditional media company Discovery (DISCA), which is also pushing hard into streaming by merging with AT&T’s Time Warner division, missed their Q3 as well. When the leaders in a particular space miss, investors typically assume that the smaller players will suffer even more. If you believe that growth is slowing at the leaders like NFLX, DIS, or ROKU why wouldn’t growth at a smaller player like VIAC eventually slow as well especially when even their peer DISCA missed? Furthermore, there is less career risk as a portfolio manager for owning an industry leader like DIS or NFLX than VIAC if all of their stock prices decline. As a result, sentiment for VIAC soured as well as for the other players in the streaming space.

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Driving Force 2:
Rising Treasury Yields & focus on profits

As interest rates started to rise from 0.9% on the 10-year treasury to roughly 1.5% at year end, investors started to focus more on the profitability of companies in addition to their growth in all spaces. While streaming is a fast-growing business, it burns a lot of cash. For example, the free cash flow (FCF) of streaming leader NFLX was negative $3.3B in 2019. In fact, FCF was positive for the first time in nine years at $1.9B in 2020. But even that profit was due to an unsustainable decline in content production and a surge in subscribers both driven by Covid. In 2021, despite 214M subscribers as of Q3 and expected revs of $29.7B for the year, NFLX’s FCF is expected to be neutral as production expenses ramp back up and subscriber additions slow down. On a positive note, FCF is expected to be positive every year thereafter.

For VIAC, they have had upside to their subscriber expectations for the past nine months, but they have not disclosed their: 1) FCF losses from streaming; or 2) the timeline for these losses to peak or turn positive. Given streaming leader NFLX is just at FCF breakeven with 214M subs, investors are understandably nervous about VIAC which has 47M streaming subscribers with an additional 54M advertising supported streaming subscribers from Pluto TV. Additionally, EBITDA expectations have drifted lower in 2021 as VIAC has made the prudent business decision to invest more in streaming given the growth they are seeing in subscribers.

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Predictions looking forward

Q4 results for VIAC should breakout 1) their three separate divisions (Direct to Consumer, Studios, and Networks) and 2) their operating profits/losses for the first time. We believe the company will increase their subscriber forecasts for the long-term given the positive momentum in this business. We see VIAC both adding more streaming subscribers in Q4 than Q3 and in 2022 than in 2021. But we forecast that the losses in their streaming business will increase through 2022 as they invest to launch in Europe in the second half of 2022 with losses peaking at some point in 2023/24. We expect EBITDA/EPS expectations to be reduced as a result. Given the strength in their streaming business in contrast to others which disappointed such as NFLX, DIS, ROKU or DISCA, we believe this is a good investment for the long-term. Unfortunately, if the current sentiment persists, there is risk the stock may go lower in the short-term much like it did on Q3 results despite strong streaming rev growth of 62% y/y.

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Conclusion

I am an investor that likes stocks with growth at a reasonable price. VIAC trades at 8x CY22 PE despite their streaming revenues up 62% y/y. This is incredibly cheap compared to streaming leaders NFLX (46x PE; revs up 16% y/y in CQ3), DIS (~34x PE; streaming revs up 38% y/y in CQ3), and ROKU (~121x PE; revs up 51% y/y in CQ3.) These streaming leaders are all growing their streaming revenues slower than VIAC yet fetch much higher multiples. In addition to VIAC's asymmetric growth vs. valuation profile, VIAC’s $1.1B in streaming revs in their September quarter grew to 16% of overall company revenues. NFLX is trading at 10x trailing sales. VIAC should do close to $5B in streaming revs this year, so it does not seem unreasonable to assume $50B is a reasonable valuation for this business alone. However, all of VIAC has a market cap of only $21B with ~$10B of net debt assuming current announced deals close.

From a subscriber perspective, NFLX had 214M subscribers at the end of Q3:2021 with a market cap of $267B.  A valuation of ~$1,250 per subscriber. VIAC now has 47M streaming subscribers with 54M ad supported streaming subscribers from Pluto TV with a market cap of $21B. Just the value of the pure streaming subscribers for VIAC is $59B on this metric.

While we have admitted our mistake and cut our position in VIAC  to take a tax loss for 2021, upcoming Q4 results and the outlook for streaming losses hopefully sets a bottom for the stock and sets the name up for a good rest of 2022. Investors may want to go to the sidelines until guidance is given on Q4 results or sentiment reverses for the company.

Today VIAC is viewed as a melting media ice cube and streaming loser. We believe VIAC will slowly become recognized as a contender along with NFLX and DIS in the streaming wars. VIAC has one of the broadest offerings of all the streaming services with sports, movies, news, unscripted, adult, and kid content. This should lead to a higher multiple much like we saw with DIS when their streaming business really took off. We believe the stock is still significantly undervalued long-term based on their streaming momentum. Time will tell.

Best wishes for your investments in the New Year.