Sunday, 30 August 2015

52 Week Lows as a Source for New Ideas

Over the past month, I've started making a list of stocks hitting new 52 week lows on the major exchanges (Toronto, New York, and Nasdaq).  I've drawn inspiration from reading about Paul Sonkin's approach to finding worthwhile candidates.

Sonkin sounds fascinating, and is profiled briefly in a short chapter at the end of Bruce Greenwald's book, Value Investing, From Graham to Buffett and Beyond.

Sonkin's approach, similar to the other investors profiled, is to find under-followed micro-cap companies trading at $.50 on the $1.  Greenwald gives an example of one company Sonkin found which had net cash (total cash + securities less total liabilities) sufficient to effectively reduce the quoted PE down to 5 from 20 once the net cash was excluded.

Sonkin screens the 52 week lows daily, and determines candidates for further research by screening for high after tax EBIT/EV (he refers to this as his after tax cap rate).

I've started integrating this approach into my own screening, and the difficulties I'm having are as follows:

1) Not many candidates have net cash (about as close to a Graham Net-Net is you'll find today)
2) If a candidate does have net cash and is making 52 week lows, there's usually a good reason as to why,
3) Not many candidates have after tax cap rates (EBIT/EV) in excess of 10%, and if they do, see 2) above,
4) I'm not finding a ton of micro-caps

So what have I found that appears interesting?

Its no secret that legacy media/content companies have been making 52 week lows for some time. Part of the paradigm shift is symptomatic of concern regarding cord cutting (i.e., consumers getting rid of cable altogether and gradually migrating to online delivery via medium like Netflix, YouTube, or Hulu).  I suppose the fear is that, as legacy media/content companies derive most of their revenue from either payment for content by cable networks based on ratings, and/or from related advertising, as cable audiences gradually recede over time so too will these companies' collective revenues and profits.

The punishment in terms of loss of capitalization afflicted on these companies throughout 2015 has been severe.  Case in point, Scripps Networks is down almost 40% from its 2014 high, Viacom is down 56%, and Discovery Communications is down 44%, all while Netflix is up 167% over the comparative period.

I look at this ongoing disparity as a clue for further research.  The contrarian in me tells me that when Wall Street is all in on a theme like Netflix to the detriment of a group like legacy media/content companies, it's probably a smart bet to buy legacy media/content companies.  If greater than 50% of the 39 analysts (yes, you read that right, 39) have a strong buy or buy rating on a company which is technically insolvent (more on this later), it gets me thinking along the lines of, which of the beaten down legacy content/media companies are worthwhile candidates?

I began by researching Viacom, Scripps, and Discovery.  Viacom seems like the granddaddy of all things legacy media.  The company's bread and butter network is MTV which, at one point in time, was significantly pervasive in terms of reach.  Circa 1990, MTV was the captive medium for content delivery.  Circa 2015, not so much.  While MTV is still dominant, it no longer has the reach and captivity it once had.  And therein lies the problem.

Bloomberg penned a recent article outlining the issues the company is facing.  The original link to the article is here:

According to Bloomberg:  "while CBS is thriving, Viacom, which includes 23 major and minor cable-TV networks in the U.S. and Paramount Pictures studio, is in trouble.  This season, according to Nielsen, the TV industry’s chief measurement agency, ratings have declined by double digits at Viacom’s most popular cable networks, including Comedy Central, BET, VH1, Nickelodeon, Spike, and TV Land. At MTV, the company’s flagship network, prime-time ratings are down 21.7 percent from last season and 25 percent in the 18- to 34-year-old demographic the network targets.

While Viacom is still profitable—last year it earned $2.4 billion in net income on $13.8 billion of revenue—the ratings collapse is alarming because the company is one of the least diversified of the U.S. media conglomerates. Its fortunes are heavily dependent on TV ratings, which help determine how much money it collects from advertisers and how much cable, satellite, and online distributors pay to carry Viacom programming."

So, in a nutshell, ratings and viewership are down, which has led to concerns regarding how pervasive and/or how much viewer captivity Viacom's networks have going forward, and one only need to look at price performance over the last year or two to observe the slow motion implosion first hand.

This is where the concepts under-pinning value investing become difficult, especially in real time. While undoubtedly cheap based on a variety of measures, is Viacom cheap because of a permanent deterioriation in the sustainability of its business model (i.e., in the words of Buffet, is Viacom a cigar butt offering one last puff)? Further, has the current cheapness based on diminution of its networks resulted in the investing public now over-looking the value of its other assets (filmed entertainment, film libraries, etc.)?  Guess what?  I have no clue.  But, perhaps a comparative analysis across 5 different media / content companies can help narrow the search down.

I performed the following comparative analysis across Scripps Networks, Discovery, Viacom, Netflix and CBS in order to examine the relative valuations among them:

Market Cap6,83511,27716,40450,11122,236
Net (cash) / debt2,57118,7612,228-6039,690
Revenue (ttm)2,7046,43513,4716,11213,767
EPS (ttm)4.321.64.260.442.35
P/E (ttm)12.3116.949.60267.3419.49
PE (09 low)125.0015.005.6617.008.00
P/E prem/disc to 09 low9.85%112.96%169.67%1572.59%243.56%
EBITDA (ttm)1,6482,2738,2403,4752,562
EBIT (ttm)1,0272,0263,2213482,663
EV / EBITDA (ttm)5.7113.222.2614.2512.46
EV / EBITDA (09 low)7.846.662.303.305.30
EV / EBITDA prem/disc to 09 low72.80%198.43%98.31%431.72%235.12%
EV / EBIT9.1614.835.78142.2611.99
EV / Sales3.484.671.388.102.32
Yield %1.67%0.00%3.40%0.00%1.31%
EBIT Margin37.98%31.48%23.91%5.69%19.34%
EBITDA Margin60.95%35.32%61.17%56.86%18.61%
10 year rev g0.00%30.60%12.40%28.20%3.10%
10 year earnings g0.00%0.00%20.30%17.50%0.00%
5 year rev g15.20%18.30%6.60%23.90%5.20%
5 year earnings g17.80%20.922.00%-0.40%43.80%
Current ratio10.481.441.311.741.51
Int coverage8.566.145.602.817.34

While Viacom certainly looks cheap on the basis of EV/EBITDA, EV/EBIT, Price/sales, and EV/sales, I'm actually more interested in Scripps Networks.  Why?

1) Customer captivity: when I think of Scripps, I think of the captivity (and possible sustainability) inherent in offerings like the Food Network, the DIY Network, and HGTV, compared to MTV.  (Caveat - this is a very cursory analysis as Viacom also runs the Comedy Network, BET, Nickelodeon, Spike, and CMT, all of which could have greater captivity than I'm assuming is the case)
2) Scripps appears to have a higher EBIT margin vs. Viacom, Discovery, Netflix, and CBS
3) Scripps appears to have a similar EBITDA margin vs. Viacom and Netflix, but well ahead of Discovery and CBS
4) Scripps appears to have the highest interest coverage out of all five comparables
5) On an overall basis, Scripps has the lowest Enterprise Value.  At $9.4B, I wonder if Scripps could be a possible acquisition target

(Note, I'm ignoring the 2009 trough PE because it's nonsensical, this was right after the Scripps spin-off from E.W. Scripps back in 2008, and earnings included all sorts of post spin-off expenses)

Circling back to Viacom, at 2.26 x EV/EBITDA, I'm certainly not discounting its viability as a worthwhile candidate, as it's actually trading lower now than it was at its 2009 trough lows on an EV/EBITDA basis.  

The joke in the bunch is Netflix.  It had $6B in revenue last fiscal year, and has an EV of 5.5x Scripps, and 2.6x Viacom's (not counting the $5.7B or so of off balance sheet content liabilities).  For the same dollar amount of revenue as Discovery, investors are paying 8x Netflix's revenues on the promise of future growth and profitability.

Using Netflix's June 30, 2015 quarterly balance sheet, strip away the $2.5B of capitalized content libary assets included in current assets and current assets drops to $3.1B vs. $5.6B as reported.  More importantly, the current ratio drops from 1.74 to .96.  I'm not going to attempt to estimate the future cost of assuming the off balance sheet future content liabilities of $5.7B, as I have no idea whether Netflix is going to issue debt or equity in order to finance the future obligation.  They had -543M in free cash flow in the rolling twelve months through June 30, 2015, and they have cumulatively had -760M of free cash flow since December 2012.  My guess is that either a debt or equity issuance must be done in order to finance the ongoing cost of content production.

Back to Scripps:

I performed the following EPV analysis on Scripps in order to get an idea of potential EPV ranges under a no growth scenario:

EBIT %36.83%35.30%35.05%21.60%33.61%39.41%42.81%39.62%37.85%37.22%37.98%36.12%
Avg EBIT362478520560557680748833914962977
Add special charges0087311849391127144129120
EBIT before special charges3694675926466028359781,0411,1021,1211,09711.51%
Special charges as % of sales0.00%0.00%6.04%20.05%5.45%4.94%4.39%5.50%5.69%4.84%4.44%6.82%
Deduct avg special charges-52-52-52-52-52-52-52-52-52-52-52
EBIT after avg special charges3174155405945507839269891,0501,0691,04512.66%
SG&A as % of sales13.87%15.95%12.98%11.22%9.34%29.47%27.41%28.39%1.15%28.71%27.92%18.76%
R&D as % of sales0.00%0.00%0.00%0.00%0.00%0.00%0.00%0.00%0.00%0.00%0.00%0.00%
Add back 25% of SG&A35534744361391421647191189
Add back 25% of R&D00000000000
Adjusted EBIT3524685876385869221,0681,1531,0571,2601,23313.37%
Tax rate30.00%30.00%30.00%30.00%30.00%30.00%30.00%30.00%30.00%30.00%30.00%
EBIT AT246327411446410645748807740882863
+ Dep'n233293344100448526562131125136125
Adj EBIT AT4505806824717681,1161,2568757929649427.67%
NI per F/S59192-12611638552957585068372776129.14%
$ Diff39138880835538358768125109237181
% Diff86.90%66.92%118.48%75.38%49.88%52.61%54.21%2.85%13.77%24.60%19.24%
Cost of capital rates:EPVAdj for Debt & Excess CashAdj EPVO/S sharesEPV / shareBVPS / shareExcess EPVCurrent pricePrice / EPVPrem/Discount vs EPV
Upper bound - VC15%6,282.13-23003,982.13129.930.6610.762.8553.181.7373.48%
Arbitrary 2 <10% - 12 %>10.00%9,423.20-23007,123.20129.954.8410.765.1053.180.97-3.02%
Per GF9.48%9,940.08-23007,640.08129.958.8210.765.4753.180.90-9.58%
Arbitrary 17.50%12,564.26-230010,264.26129.979.0210.767.3453.180.67-32.70%
LT equity return; 2014 - 19285.05%18,676.43-230016,376.43129.9126.0710.7611.7253.180.42-57.82%
Combined NI & Div growth3.94%23,927.82-230021,627.82129.9166.5010.7615.4753.180.32-68.06%
Adj BetaRfRisk Premium%D%EAT Int cost

Under cost of capital rates between 7.5% and 10%, my EPV analysis produces a theoretical discount to EPV ranging from 33%, using a 7.5% WACC, to 3% using a 10% WACC.

If long term WACC is somewhere between 7.5% and 10%, I can take some theoretical comfort that Scripps offers a margin of safety of somewhere between $.67 on the $1 to $.97 on the $1 under a no growth scenario.

Next, I performed the following Balance Sheet Reproduction Cost analysis to test whether Scripps had a possible franchise:

AssetsAs reportedAdjustmentReproduction cost
Deferred tax assets00%0
Prepaid expenses0100%0
Other current 5620%0
Total current3,1132,513
3 yrs SG&A and R&D2,265100%2,265
Equity method investments0100%0
Other investments496100%496
Other assets237100%237
Total LT4,8614,861
Total assets7,9747,374
Non-interest bearing liab's-83
Excess cash-1,761
Equals total net reproduction cost5,530
O/S shares130Greenwald Three States
Reproduction cost/sh43State One:
EPV/sh (avg)64AV > EPVAV = EPVAV < EPV
EPV less Reproduction cost/sh22No franchiseEquilibrium Franchise
Bank advances0100%0
ST debt32100%32
A/P and accruals83100%83
Tax payable0100%0
Other liab's182100%182
Defd rev0100%0
Total current297297

In this case, it seems that Scripps could have a theoretical franchise, in that the average of my 7.5% to 10% EPV/share scenarios at $64 per share exceeds Reproduction Cost/share of $43.

I've highlighted one line on the balance sheet which I find interesting: Scripps' Other Investments, which include its Joint Ventures and other interests carried using the Equity Method.  In early 2015, Scripps offered to purchase the 50% interest in UKTV at 500M GBP ($750M USD), which would theoretically value the entire stake at $1.5B.  Scripps carried this interest at $377M USD as at December 31, 2014, so in theory, there is an unrecognized asset equal to $1.123B on Scripps' Balance Sheet, equivalent to $8.70/share.

Next, I performed the following analysis of segment EV/EBIT and EV/EBITDA using a hypothetical acquisition multiple of 10x and 10.5x respectively (I cheated in my 2014 column by using current EV instead of EV at the end of 2014 as current EV is significantly lower than at the end of 2014, and hence more relevant to the under-valuation argument).

SNI by segment analysisEBITEBITEBITEBITEBITEBIT multipleWeighted Avg EBIT multipleValue
Lifestyle media9041,0491,1241,2021,2551010.0012,550
Mkt cap ($B's)8,7366,9308,87412,7287,5626.0360.26%Prem/Discount vs. mkt cap
Add: Debt8841,3841,3841,3843,441
Less: Cash-550-760-438-686-1,141
Lifestyle media9951,1401,2321,3201,38410.510.5014,532
EV9,0707,5549,82013,4269,8627.1367.87%Prem/Discount vs. EV
EV / EBITDA9.116.637.9710.177.13

In both cases, I came up with theoretical discounts to EV ranging from 60.26% on an EBIT basis, to 67.87% on an EBITDA basis.

Finally, I performed the following simple PE payback analysis, i.e., at what growth rate would Scripps need to grow its current EPS in order for an investor to get repaid their purchase price in terms of cumulative earnings within 10 years.  The answer: 5%.

TickerPriceEPS yr 2015P/EP/E yrs
SNI53.184.3312.2810 year payback

The most difficult determinant in this analysis is making a judgement call on whether or not current earnings (and the overall business model) are sustainable, but given the theoretically demonstrated potential margin of safety across different models, I'm inclined to think that Scripps is a worthwhile candidate, so I bought (my average cost is probably around $58).

Finally, the chart (it's ugly).  Does the tail wag the dog, or does the dog wag the tail, and should I really care?  I suppose as anything's possible, it could get down to $40 (lower support), at which point EV will be $7.5B.  I wonder if at an EV/EBITDA multiple of 4.55x, it will stay public for long.