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May 24, 2007

Central European Media Enterprises Pulls Back On Czech News

Central European Media Enterprises (CETV) shares have pulled back this week amid news out of the Czech Republic concerning the awarding of new digital television licenses. The licensing process has been full of fits and starts with the government initially awarding six new national licenses but failing to provide licenses for the two national analog stations including CETV's TV Nova which is far and away the number one station in the Czech Republic. Following objections from Nova and the #2 station, TV Prima owned by Modern Times Group, the government threw out the awards.

Without warning, earlier this week the government announced that the six licenses originally awarded would be granted and that Nova and Prima would receive their licenses for free. The new licenses would be provisional with a five year term. Analog services would be turned off in 2009 when the switch to digital went nationwide. The government also gave interested parties just 48 hours to respond compared to the constitutionally mandated 13 days.

This news has plusses and minuses for CETV. On the downside, the six new national digital stations would be on the air several years sooner than expected. When the initial awards were thrown out, it was presumed that the whole process would be restarted and no new national stations would launch before 2012. Another problem for Nova would be the analog signal going dark in 2009. Short of the government handing out new digital set top boxes there is no way that all the TV households in the Czech Republic would be able to watch TV on the new digital channels. The combination of new national competitors and loss of reach clearly would be a negative for the long-term growth of CETV's largest asset. This is partially offset by the granting of a free license for the digital Nova, which could be broadcasting from day one of the digital era without any new programming investments unlike the new competitors which would have to spend huge sums on programming and infrastructure with no established audience.

Based on my discussions with management of CETV and other large shareholders, I don’t see how the latest moves by the government will pass constitutional muster with the same Czech courts that already threw out the first awards. Besides Nova and Prima, there are other parties upset with the ruling including those who were passed over when the initial licenses were rewarded....

I long ago learned not to try to predict government or legal outcomes, especially in far away lands. However, the latest moves by the government seem blatantly incorrect and likely to be adjusted. Furthermore, the outlook for TV Nova through 2007 and 2008, a reasonable investment time horizon, is extremely strong as ratings are near all-time highs, cost cutting has been steep since CETV gained control in 2004, and Nova's efforts to restructure the TV ad sales market in the Czech Republic and raise advertising rates for the first time since 1999 are clearly working.

I think the reaction in CETV shares has set up an excellent buying opportunity. CETV is trading at 13 times 2007 estimated EBITDA and 11 times 2008 estimated EBITDA. Given 41% growth this year and 30% next year, I find these multiples significantly too low. In its heyday, Univision traded at 15-18 times EBITDA. CETV's growth is at a premium to Univision and given the open-ended growth for TV advertising in Central and Eastern Europe, I think that CETV should be valued at least at 15 times EBITDA. At 15 times, CETV would trade at $96 this year and $121 next year.

Accepting the risk that the shares are sensitive to trends for emerging market stocks (even through the revenue and cash flow growth is not), I think the latest pullback is an excellent buying opportunity. I've added CETV to new client accounts on this pullback and the stock continues to be one of my largest positions for clients and the largest in my personal accounts.

Posted by Steve Birenberg at May 24, 2007 08:36 AM in CETV