Should Viacom, Inc. Sell A Stake In Paramount Pictures?

Viacom (NASDAQ: VIA) (VIAB) has recently been engaged in a dramatic succession battle with Sumner Redstone, whose family owns an 80% stake in the media giant through his holding company National Amusements. Redstone, who resigned as the executive chairman of Viacom and CBS (PARA 3.23%) in February, recently moved to oust Viacom CEO Philippe Dauman and his ally George Abrams from a seven-member trust which would acquire his voting stake after this death.

Dauman claims that 92-year old Redstone is actually incapacitated, and that his 62-year old daughter Shari Redstone is trying to "seize control" of his media empire by ousting him and his allies. Meanwhile, activist investor Eric Jackson of SpringOwl Management has also called for Dauman's resignation.

Image source: Pixabay.

At the center of all this drama is Dauman's desire to sell a stake in Paramount Pictures, a plan which Redstone's camp opposes. Let's examine both sides of this debate and see which decision would be in the best interest of Viacom's long-suffering investors.

Why Dauman wants to sell a stake in Paramount

Analysts estimate that Paramount, which Viacom bought for nearly $10 billion in 1994, is only worth between $3.5 billion to $5.5 billion today. A look at Paramount's revenue growth over the past year reveals that value is still falling.

Source: Viacom quarterly reports.

To make matters worse, the studio isn't consistently profitable. Last quarter, it posted an operating loss of $136 million, resulting in a cumulative loss of $282 million for the first half of the year. That's much wider than the operating loss of $59 million it reported in the first half of 2015. One of Paramount's core weaknesses is its lack of big multi-year franchises like Disney's Marvel and Star Wars films. Its biggest film franchise is Transformers, but that aging series won't return until next year.

By selling a stake in the studio, Dauman could get Paramount's bottom line back in the black before its value declines further. During last quarter's conference call (as transcribed by Thomson Reuters), Dauman declared that "a strong strategic partner for Paramount -- particularly one that provides international and/or technological clout and expertise -- will provide important benefits to both Paramount and Viacom."

Potential suitors include various Chinese Internet and media companies or Amazon -- which could reduce its content acquisition costs for streaming while countering Netflix's partnership with Disney. Dauman noted that the proceeds could be used to pursue strategic acquisitions and boost shareholder returns via dividends and buybacks.

Image source: Paramount Pictures.

Major Viacom investor Mario Gabelli, CEO of GAMCO Investors, agrees with Dauman's plan. Gabelli suggests that Viacom should sell off 10% to 50% of Paramount and invest the proceeds back into its core cable TV business to produce better original TV shows.

Why Redstone doesn't want to sell

Sumner Redstone's spokesman recently stated that "unless Viacom's board presents a concrete plan that convinces him otherwise, Mr. Redstone continues to believe that it is in the best interest of Viacom that Paramount Pictures should remain wholly owned by the parent company."

That doesn't tell us much about Redstone's plan for Paramount's future. However, Cowen & Co. analyst Doug Creutz recently told The Hollywood Reporter, "People are asking Viacom to sell Paramount because they think the cable networks business is falling apart, but raising a little more cash does nothing to change that." Creutz also pointed out that Lions Gate Entertainment (LGF-A 4.41%), which lost over 30% of its value over the past 12 months primarily due to the end its Hunger Games franchise, could be more appealing to potential suitors with an enterprise value of just $4.4 billion.

Moreover, recent layoffs of top creative staff at MTV, Paramount, and other business units indicates that Dauman is more interested in generating cash by cutting costs and selling assets. This means that the proceeds of the Paramount sale might be used to temporarily inflate earnings instead of improving Viacom's lackluster theatrical releases and cable TV content.

MTV's Scream is one of Viacom's newer original shows. Image source: MTV.

Which would be better for investors?

I believe that selling a stake in Paramount might benefit shareholders if it's executed correctly. However, I think Dauman's plan is half-baked and seems like a knee-jerk reaction to stem the unit's widening losses. Therefore, I think Redstone's camp is right about Viacom needing to present a "concrete" plan for Paramount before trying to sell a stake. Otherwise, the sale will just generate some excess cash which might be spent on buybacks, dividends, or bad acquisitions instead of improving its core entertainment businesses.