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December 01, 2008
December 2008 Model Updates
There are no changes to Northlake's Market Cap and Style models for December. I continue to own Small Cap (IWM/IJR) and Value (IWD/IVE) for personal and client funds . As a reminder, Northlake uses monthly models to rotate ETFs trying to capture excess return relative to the S&P 500 (SPY). The models are designed to look ahead six to twelve months and average holding periods are four to six months.
I was actually a bit surprised that the Market Cap model stayed at small cap. I had thought the significant weighting of technical indicators in the model would have shifted the model from a small cap to mid cap signal (the model works in steps and rarely will go from large to small or small to large without a stop at mid). However, the sharp drop in interest rates and a small bounce in advisory service sentiment off its low provided fresh signals favoring small caps and actually led to an ever stronger small cap signal this month. Of the ten underlying indicators measuring a variety of economic, interest rate, valuation, and technical factors, seven now favor small cap, with two recommending large cap and one neutral.
The Style model remained firmly in value mode for the third consecutive month. The only underlying factor which changed this month was insider activity which now favors growth over value. The Style model also uses a mix of economic, interest rate, valuation, and technical indicators. For December, six of the nine indicators favor value and three favor growth.
Recent performance of the Market Cap model has been poor. In November, the small cap signal was way off with IWM falling 11.7% vs. a loss of 7.2% for SPY. Since the small cap signal went in place on September 1st, IWM is down 35.9% vs. 30.2% for SPY.
The Style model has fared better with value outperforming growth but not providing incremental return to the S&P 500. Last month, value outperformed growth across all market caps. I am presently invested in Russell 1000 Value which fell 7.% last month, a little worse than the S&P 500 but ahead of the 8.4% drop in the Russell 1000 Growth (IWF). The value signals has been in place since October 1st during which IWD is down 23.2% vs. 24.7% drop in IWF. The S&P 500 is down 23.1%
Posted by Steve Birenberg at 03:47 PM in Models
November 28, 2008
Why You Should Own Time Warner
Time Warner (TWX) is one of the world's leading entertainment companies. The company owns AOL, 84% of Time Warner Cable (TWC) , Warner Brothers, HBO and a leading stable of cable networks including TNT, TBS and CNN. Time Warner also still owns its iconic magazine titles including Time, People and Sports Illustrated.
In early 2009, Time Warner will split off TWC, leaving TWX as a pure-play content company. Presently, TWC produces approximately half of EBITDA. After the split, the new TWX will get more than half its EBITDA from Cable Networks, with AOL and Filmed Entertainment (movie and TV production) generating another 20% each. The balance will be from magazine publishing. New TWX will have about $29 billion in sales and $6.4 billion in EBITDA. Debt will be $9 billion to $10 billion, less than 2 times EBITDA, leaving TWX with the best balance sheet in major media. Free cash flow will likely be $2 billion to $3 billion.
Adjusted for the TWC split, TWX is trading at less than 5 times 2009 EBITDA and about 7 times EPS. I am assuming that EBITDA will fall by 12% in 2009. This is below consensus, which is falling.
Short-Term Catalysts
Valuation-based ideas have not worked as the market crashed, but TWX is really cheap. In this case, cheap will matter because the split from TWC provides a catalyst to recognizing the value. TWC shares have outperformed TWX shares, making TWX shares cheaper post-split. Once the split is finalized, investors will look at New Time Warner and see a mix of assets that have low capital intensity and produce high free cash flow. The company will have a remarkably good balance sheet, making a material dividend or share buyback or an accretive acquisition a positive outcome.
Time Warner is also attractive at the operating level. AOL and Publishing are going to struggle in 2009, with double-digit declines in advertising. The film and TV businesses should be flattish in 2009; cable networks remain the best-performing media assets, and Time Warner's nets have been leading the industry for more than a year. About 70% of Time Warner's operating income should be down no worse than 5% in 2009, a good performance relative to media and many other consumer discretionary sectors.
Long-Term Drivers
Time Warner will have one of the most attractive asset mixes among diversified media companies after the TWC split. Both the growth and free cash flow profile will be attractive. Eventually, AOL will be resolved, either by turning it around or (more likely) by selling it. Any outcome for AOL wherein Time Warner reduces its exposure is bullish.
Time Warner will also benefit long term from the relatively poor management over the past decade. Time Warner's margins are below peers such as Disney (DIS) and News Corp. (NWS.A) , as is the consistency of its financial results at its film studios and cable networks. It seems backward, but the historically poor performance gives Time Warner more room to pull its financial results up to its peers, thus driving superior growth.
After the split, look for a big share buyback, material dividend, accretive acquisition or possibly a combination of all three. Depressed valuations across media dramatically reduce the risk that Time Warner uses its stellar balance sheet to make a dilutive acquisition.
What Could Go Wrong
The overwhelming risk for TWX shares is that advertising deteriorates further, driving 2009 financial results significantly below even the lowest estimates. Given negative sentiment toward AOL and Publishing, any accelerated decline in cable network advertising would be especially painful for TWX shares.
There is also a risk that the TWC spilt falls apart due to the current turmoil in the credit markets and the need for regulatory approval, which continues to drag out. Spending all of its cash on acquisitions as opposed to share buybacks or dividends would also be a disappointment.
My Position
I am long TWX for my clients and in my personal accounts. I started buying my position in early August at $14.87. My most recent trades came this week when I averaged down for some clients between $8 and $8.60.
The Bottom Line
The pending split of TWC and creation of new Time Warner is a positive catalyst. Time Warner will be left with two business generating 70% of profits that should hold together fairly well in 2009. The balance sheet will be very strong, providing plenty of options for enhancing shareholder value. Margins are below par and management is just beginning to implement strategies that have worked well for peers. For the short term or over the long haul, TWX looks like a winner.
Posted by Steve Birenberg at 09:13 AM in TWX
November 26, 2008
Why You Should Own Discovery Communications
Discovery Communications (DISCA) is one of the world's largest providers of cable networks, with projected 2008 revenue in excess of $3.4 billion. The company operates over 100 channels around the world in more than 170 countries reaching 1.5 billion subscribers. In the U.S., its best-known networks are Discovery Channel, TLC and Animal Planet.
DISCA is currently trading at $13.45. The 52-week high was $28.35 on Dec. 13, 2007. The 52-week low occurred on Oct. 24, 2008, at $10.02. The current market cap is $5.7 billion. Debt totals $3.9 billion. At year-end, cash should be over $300 million. DISCA should produce north of $500 million in free cash flow in 2009. Assuming flat 2009 EBITDA, net debt to EBITDA at Dec. 31, 2009, would be about 2.4 times, indicating the DISCA is not heavily leveraged. The debt currently consists of bank facilities, so some refinancing exists.
The consensus earnings-per-share estimate for 2008 is $1.09. For 2009 the estimate is $1.12. At $13.45, the price-to-earnings ratio for 2008 and 2009 is about 12.4. Media stocks commonly trade on EBITDA multiples. On the basis of my 2008 estimate, DISCA is trading at 7.1 times earnings. For 2009, the EBITDA multiple is 6.3 times. On both P/E and EBITDA, DISCA trades at a premium to the big four entertainment companies (Viacom (VIA.B) , Time Warner (TWX) , Disney (DIS) and News Corp. (NWS) ).
Why You Should Own DISCA for the Short Term
DISCA has the best earnings momentum among major media stocks. Recently reported third-quarter results were a significant positive surprise. DISCA raised its guidance for 2008. That is right, in the midst of all the gloom, DISCA just reported a good old-fashioned "beat and raise" quarter. As a result, analyst estimates for 2008 and 2009 have risen over the past 30 days. This relative strength in DISCA's earnings profile is the best reason to own the stock today.
DISCA shares have responded to its earnings performance. The stock is down about 20% since mid-September, easily outperforming the market and massively outperforming other media stocks, many of which are down 50% to 80%. The relative performance of the shares leaves the technical status of the stock in fairly strong position.
DISCA has less exposure to advertising than most other media stocks (40% of projected 2009 revenue) and affiliate fees, its largest revenue stream, representing 48% of revenue, will grow to contractual increases in both subscriber counts and monthly subscriber fees. In addition, DISCA's advertising revenue is somewhat insulated by a growing subscriber base internationally, solid ratings at its U.S. networks, and below-average pricing on its international advertising inventory.
Finally, in both the near term and long term, DISCA's operating income growth is being driven mostly by margin expansion at its international networks, which are significantly less profitable than its U.S. networks despite more synergies than any other cable network provider.
Why You Should Own DISCA for the Long-Term
DISCA's competitive advantage is its focus on nonfiction programming. Nonfiction programming provides the company with three distinct advantages. First, it looks great in high definition. Second, it is often narrated, allowing it to be easily used regardless of the spoken language of the viewer. Third, it is cheaper to develop and create.
Rising margins are driving DISCA's long-term financial performance. Margin expansion is coming mostly from abroad, where the 34% margin in 2008 pales next to the 53% margin for the company's U.S. networks. Because of the advantages of nonfiction programming, management should be able to increase margins steadily and independent of a weak advertising environment.
Margins should also benefit in the U.S. as certain channels are rebranded with the hope that ratings will improve. Planet Green, Investigation Discovery and the Oprah Winfrey Network are three examples of newly branded networks that offer upside, given that they are widely distributed (over 50 million households) but are producing no profits.
Finally, DISCA is an attractive acquisition for any of the major media companies. The dual revenue stream of subscriber fees and advertising make the cable network business attractive. Each of the big four entertainment companies would like to expand in cable networks. Several of these companies will be flush with cash when the credit markets normalize. Cable networks acquisitions historically have been at premium EBITDA multiples, providing upside of 50% to 100% if DISCA were to be sold in the near future.
What Could Go Wrong
DISCA trades at a premium to its peers and has had positive earnings momentum. A negative surprise would cause the stock to take a very hard hit. DISCA is also vulnerable to negative sentiment and further downgrades in advertising growth. The rebranding of channels could fail. Non-U.S. revenue is significant leaving the company's financial results vulnerable to currency fluctuations.
My Position
I am long DISCA for my clients and in my personal accounts. I started buying my position in mid-September at $16.50. My most recent trades came in mid-October, when I averaged down for selected clients between $11 and $12.
The Bottom Line
DISCA has positive earnings momentum and lower estimate risk than most other media stocks. Operating income growth is under a greater degree of management control, since it is driven by margins more than revenues. The stock acts well, indicating an underlying bid that would make DISCA shares a leader if media stocks come back into favor. A takeover bid provides downside support.
Posted by Steve Birenberg at 09:05 AM in DISCA
November 21, 2008
Latest Market Comments
The market has just been brutal. I have incorrectly thought the whole way down that stocks were reflecting a worse economic reality than was likely to occur. Obviously, this view has been proven wrong. I do believe that the market and the economic outlook are now in sync but that won't help until the economic outlook stabilizes. If we magically could declare that the economy will be "really terrible but we promise it won’t be worse than terrible" the market would stage a very big rally. It is the fear of unknown, which grows every day the market collapses, that is now driving the devastation in individual stocks.
There is a total lack of confidence in any forward looking estimate. Therefore, even when it is obvious that a company's business will not collapse the stock can be priced as though it will. For example, News Corp or CETV stocks are falling so rapidly that it suggests their revenues will collapse, down 50% or more. Yet, any realistic assessment of the likely demand for TV advertising or satellite TV subscriptions or subscriptions to the Wall Street Journal would show a worst case scenario where revenues fall 20%.
Maybe I am wrong and the downside is really as severe as the stock prices imply. One thing that makes it difficult for me is that I have an innate optimism. I have never believed doomsday scenarios. I just believe that things generally work out. The current market is telling me I am wrong.
There really seem to be just two things that can turn us hard upward. First, though it sounds stupid, we just need to go up. Investors are so scared and have been burned so badly with every buy since September that just a few days of upward momentum would remind us that you can in fact make money by buying. It may seem odd to those who don’t play in the market every day but what I am saying is that there will be many more buyers of a stock that has gotten destroyed at $20 or $30 or $40 than at $10. Right now, everyone is taking their signals from price. That needs to change.
Second, we need some good news. Either the macroeconomic outlook needs to stabilize or individual companies need to prove that the stock price is wrong compared to their ability to earn even in a severe global recession. I think lots of companies can do that. Just this week Dell and Hewlett Packard did that.
My optimism remains. This horrible period will pass. I know that Northlake's strategies and stock picking work. They worked in 2005, 2006, 2007, and until late September 2008. They will work again.
Posted by Steve Birenberg at 11:00 AM in Stock Market
Why You Should Own Dreamworks Animation
This will be the first in a new series of columns I will write titled "Why You Should Own..."
The first stock is Dreamworks Animation (DWA) . DWA is currently trading at $21, a new 52-week low. The 52-week high was $32.73 on Sept. 2. The market cap is $1.9 billion. At the end of 2008, DWA should have about $350 million in cash and less than $100 million in debt. DWA pays no dividend.
The consensus estimate for 2008 is $1.82. For 2009, the estimate is $1.67. At $21, the P-E on 2008 is 11.5. For 2009, the P-E is 12.6. The lower 2009 estimate is because there are minimal revenues from Shrek, DWA's most profitable franchise.
Why You Should Own DWA for the Short Term
DWA has very positive earnings momentum that should hold through at least the first half of '09. The fourth-quarter 2008 estimate has risen over the last 90 days. The momentum is being driven by success earlier this year from Kung Fu Panda. Panda grossed $215 million domestically and $416 million abroad, making it DWA's most successful film besides the Shrek series. Even with a $130 million production budget and another $100 million plus for marketing, the film is profitable before DVDs. The DVD just went on sale and immediately went to No. 1 on the charts.
DWA will also benefit in the near term from the successful release of Madagascar: Escape 2 Africa on Nov. 7. The film is on track to match Kung Fu Panda and exceed the original Madagascar. While the timing of revenue and expense recognition means that Madgascar 2 will not contribute greatly to EPS in the near term, the success is a great confidence boost for meeting or even beating 2009 estimates, something that very few companies can now offer.
DWA has two other near-term catalysts. First, on Dec. 10. the company will be holding its first- ever analyst meeting. DWA has lots of good things to say about the near term and long term, so the timing is good.
Second, Shrek the Musical debuts on Broadway in December. On its own, the musical will not be a big profit-driver, assuming it is successful. But if it is a success, it further diversifies DWA's revenue stream and builds a greater base of long-term earnings power.
Finally, and maybe most importantly for the near term, DWA is a major media stock that has zero advertising exposure. There is minimal cyclical or secular challenge to DWA's business model unlike almost every other media stock.
Why You Should Own DWA for the Long-Term
2009 has been a critical year for DWA. The massive worldwide success of Kung Fu Panda and the successful sequel to Madagascar has dramatically boosted the company's long-term earnings power and the consistency of its financial results. Along with Shrek, DWA now has three franchises that can spin sequels. Each new film in each franchise boosts profits from the library via the films, merchandising and TV rights. Three franchises make it easier for DWA to release two films per year, one sequel and one original. It also takes the pressure off every original to be a resounding success. Wall Street rewards consistent long-term earnings growth. DWA exits 2008 in its best shape ever.
What Could Go Wrong
DWA trades at a premium to other media stocks, which now generally have single-digit multiples on 2009 estimates. The shares have also held up very well compared to other major media stocks that are down 50%-90%. DWA is subject to disappointing box office for any of its films. In the near-term, weak holiday sales for the Kung Fu Panda DVD or poor international box office for Madagascar 2 (it has only opened in Russia so far) are a risk. In 2009, DWA will be releasing two original films. Originals are not as profitable as sequels and present greater odds for a disappointment. DWA is also planning on a boost from 3-D for its films in 2009 and beyond. So far, the rollout of 3-D theaters has severely lagged expectations.
My Position
DWA was purchased in early November at just under $27. I have not added to positions since that time.
The Bottom Line
DWA has positive earnings momentum, minimal estimate risk, the potential for upside earnings surprises, a debt-free balance sheet and identifiable catalysts. These all support near-term performance while the long-term outlook has greatly improved, thanks to the broader portfolio of hit movies and franchises that now exist in the company's library.
Posted by Steve Birenberg at 09:03 AM in DWA
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