Viacom Inc. Faces Major Headwinds as Management Fights for Control of the Company

Sumner Redstone’s health has been the subject of numerous rumors and legal battles, and it remains unclear whether he still possesses the mental faculty to make major business decisions for his large media empire.

In this week's consumer goods episode of Industry Focus, Vincent Shen and Daniel Kline take a look at the drama unfolding at Viacom (NASDAQ: VIA) (VIAB), the company behind Paramount Studios and cable networks like Comedy Central, Nickelodeon, and MTV (to name a few). Shari Redstone, Sumner’s daughter, is locked in a heated dispute with Viacom CEO Philippe Dauman, as she shuffles the make-up of the family trust that will decide the fate of both Viacom and CBS upon Sumner's death or loss of competence.

Find out about the Game of Thrones-worthy intrigue and how it could affect the company and shareholders caught in the middle of the dispute. Shen and Kline also look at why cord-cutting (and cord shaving) is likely to hurt the company, how its film segment continues to struggle, and how the management drama will likely end.

A full transcript follows the video.

This podcast was recorded on May 31, 2016. 

Vincent Shen: Hey, Fools! Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It is Tuesday, May 31st, so consumer and retail is on tap. I am your host, Vincent Shen, and I hope all of our listeners were able to enjoy their long weekends. I'm joined today by Fool.com contributor Daniel Kline, who's calling in remotely from Connecticut. Dan, very, very happy to have you on the show. How was your Memorial Day?

Daniel Kline: Oh, not so bad. Happy to be back.

Shen: Awesome. Jumping right into it, and our topic -- really our main topic of the day. Back in early April, Sean and I had discussed some of the high-level drama at Walt Disney when Thomas Staggs, who was then the Chief Operating Officer of the company, and who appeared to be the natural choice to replace CEO Bob Iger after his retirement ... he ended up actually resigning rather abruptly, and he threw the established succession plan into question. There were some reports that touched on the behind-the-scenes conversations that may have been happening among the management team and board of directors at Disney that may have led to Staggs' departure after working at the company for about a quarter century.

This kind of corporate drama is, really surprisingly, not that uncommon among even some of the world's largest publicly traded companies, and today, Dan and I will be looking at the scene that's currently unfolding at Viacom. Just to give our listeners some high-level perspective of the story here, the setting is Viacom, which has suffered about a 45% decline in its share price over the past two years.

The company operates via two primary segments: its media networks, so think about channels like Nickelodeon, Comedy Central, MTV, Spike, and then also its filmed-entertainment business with Paramount Studios, and they have some pretty well-known franchises, like Mission Impossible and Transformers. Both these businesses are facing headwinds: I think, on one hand, cord-cutting among its television networks, and then, on another hand, its lack of steady movie franchises for its film business.

Now, to the actors that we have involved. So, first that's the founder of the company, Sumner Redstone, the media mogul. He acquired Viacom back in '87 and is the...

Kline: He bought the company when it was still part of CBS, and then eventually they were split into two. To dial it back, Sumner Redstone controls about 80% of the voting shares in Viacom through a trust, and that's where the intrigue is starting to happen.

Shen: Absolutely, yeah. Thank you for clarifying. I realize not quite so much a founder, but the person who's brought Viacom and curated it to the business that it is today.

Kline: He's been the unquestioned kingpin of Viacom and CBS, no matter what his title has been. He's been CEO, he's been chairman, he's been super-duper chairman, sort-of-whatever title. I just made that last one up; but whatever title you need, he's had, and now the question is, is he still the one calling the shots?

He's had some major health issues, and recently, there was a court case where his longtime caretaker and partner sued and basically said, "Hey, I should be making his decisions, that's what he wants, he's not capable." He was actually seen by a geriatric psychologist -- I may not be getting that title exactly right -- who determined that, while he clearly had some dementia, he was capable of deciding who would take care of him.

Now, what wasn't ruled upon -- and that's very important here -- it was not decided if he was actually competent to be making business decisions. That's something that the Viacom board would like to force, but it has not happened yet.

Shen: Yes, yes. You know, beyond Sumner Redstone, I think, the really important people who are involved in this drama right now are his daughter, Shari Redstone, and then CEO and executive chairman -- which is a title that he got somewhat recently, earlier this year -- Philippe Dauman, and then the rest of the board of directors at Viacom.

Kline: Well, the challenge here... so Shari Redstone will eventually own all of her father's stock, or have control of it through a trust. And what has been happening is, Dauman and another trustee have been kicked off the trust, and they're suing to prevent that. The reason this is important is, whoever controls that trust eventually controls Viacom and CBS, and you can look at this one of two ways. The Viacom board is alleging that Shari Redstone is orchestrating all this, that she wants to replace these people so she can have control. Shari Redstone is saying, "No, this is what my father wants, he's not happy with the performance at Viacom," which could ultimately lead to a major change on the board there, and even Dauman losing his job.

That's something that the independent directors on the board have been fighting, so there's a lot of, sort of, policy intrigue here. The big question is -- and we talked about this a little while ago -- is it good business sense? Is it that Viacom's not doing well, so, "Hey, let's make some changes," and that's what both Shari and Sumner want; or is this Shari Redstone saying, "Hey, I'm going to use this as a way to consolidate my power base, kick this guy out, and then I'll be the puppet master behind the throne?" It's really hard to know, because Sumner Redstone has been held in seclusion.

Shen: Yes, absolutely. From what I saw, he actually hasn't made a public appearance, I think, since his birthday, his 92nd birthday party last year, and he actually just turned 93 on Friday.

Kline: Yeah, and I think it's worth talking about, so I read the transcript of his interview for this court case, and at times he... he needed to work through an interpreter. At times he was completely unaware. He used language that I would say was salty even by construction-site standards. He was definitely not the in-command media mogul we know, so just by reading the transcript, it's very clear that Sumner Redstone, while you can't make a judgment of whether he's aware of what's going on, he's clearly diminished.

He's not the person he once was, so we don't know. Is he calling the shots? Is Shari Redstone calling the shots? Should Dauman be replaced? The company has not done very well, and the big issue is Dauman and the board want to sell a stake in Paramount, and supposedly Redstone is against that, or Sumner Redstone is against that.

Shen: Yes, yes. He has generally been a big supporter of the idea of keeping all of Paramount ownership in house. It comes down to, with Dauman and another director, George Abrams, being essentially removed from the trust, so from seven to five people, and essentially the idea that Shari will probably fill those two spots, if she does, with people who kind of support what she wants.

Kline: She's actually named her daughter and another close confidant to those spots.

Shen: There you go.

Kline: That said, this is the Redstone family trust. Who would you expect to be named to it? I mean, I was hoping, but my name did not come up. Once again, I think if I had to look at this as an analyst, I would say it's probably a little from Column A, a little from Column B. Of course, Shari Redstone wants to make the decisions, but I think she's also at least trying to interpret what her father wants. How much of that he's stating, and how much she's guessing or trying to infer, we don't know; but Dauman obviously doesn't want to lose his job, so he's going to work hard to keep the board independent and try to fight any of this.

Shen: Absolutely. Let's, I guess, look a little bit at the struggles that Viacom has actually faced. We know that filmed-entertainment revenue has declined 50% since 2011, and that tracks pretty much a five-year slide in total revenue for the company over that same period. We know that a lot of this is coming from the fact that the main studio, Paramount, is struggling with these hits that... when we spoke earlier, Dan, like you had mentioned, Disney knows that its Star Wars or Marvel films will deliver at a certain level.

Kline: Right. Paramount has the problem that we've moved to a franchise-based movie world. If you're going to spend $200 million to make a film, it better do a billion to a billion-five. You could say Transformers will do that. You can say that maybe Mission: Impossible has another couple of movies left; but the other franchises they own -- you know, Sponge Bob -- it's generally not things that are sure-fire hits.

You know, a World War Z sequel, a Jack Reacher sequel -- these are not things you can automatically say are going to do as well as a Marvel movie, or even a Despicable Me sequel, to look at some things. They are making 15 movies a year, and maybe 11, 12 of them are a guess, and that's not really where you want to be. You know, when your slate says, Untitled Mark Wahlberg film, that doesn't give you the same confidence as when it says Thor IV.

Then on the other side, on the cable side, they own some valuable properties; but I think we've seen how quickly they can slide. I mean, if you look at something like Comedy Central, just the transition from John Stewart to Trevor Noah has cost them, you know, 35%-40% of their audience. They'll say, "Oh, well, the kids watch it digitally," but you don't make as much money as when they actually watch it live on television.

In the changing cord-cutting world, they own all these properties; but they don't own distribution. If people are moving to skinny bundles or streaming, are they really going to pay for VH1 Classic, or MTV 4, or whatever some of these lesser networks are? It puts Viacom in a really difficult position.

Shen: Yeah. I'm glad you brought that up, because one of these skinny bundles, that you might call it, or these services with Sling TV, for example -- I think specifically does not include a lot of these Viacom properties.

Kline: Viacom has largely been on the outside looking in. I want to say Comedy Central is on there, but I might be wrong. The challenge they have is they're not Comcast. They don't own the pipe and the channel. They could launch their own bundle, but we're at a time where MTV is not at the height of its powers. They don't have a Total Request Live, or something that's capturing the 13-to-15-year-olds where they're going to make their parents buy it. If you're picking, if I'm sitting with my kids -- and I only have one kid -- if I'm sitting with my kid and saying, "Hey, what channels do we want," I don't know that Spike or MTV or VH1, certainly -- even Comedy Central -- is going to come up.

Shen: Yes. Just to step back a little bit, too, if you're looking, as an investor, at their media-networks business -- how they make money -- so as the viewership drops, it's going to immediately start impacting a lot of their advertising revenue, because the fact of the matter is, the more viewers you have, the more you can charge.

Kline: I think it goes beyond advertising revenue, and it goes into carriage fees. MTV and VH1 each have three or four spinoff channels, and while the carriage might only be a nickel a month, a nickel a month times 94 million cable homes being forced to carry those is a lot of money when you have a channel that doesn't have any programming costs. As you take that away, skinny bundles are not going to have these channels; or if they do, they're not going to pay for them. When you take these stations that 60,000, 80,000 people are watching, there's no advertising revenue for that amount of people -- or at least not enough that matters.

I think you're going to see Viacom take some real hits, and they don't have a way to get those channels out to people. Other than Transformers, they don't have the movie properties to go make a deal with people that own distribution to say, "Hey, look, take our whole package, take MTV plus these six movie franchises." They don't have that.

Shen: Yeah. Right now, as far as I know, I believe a lot of those carriage fees get negotiated on longer-term contracts -- might be a few years. But the sustained headwinds are hitting media-networks business, and they're not able to control that, or command that same kind of viewership. The carriage fees are going to see the hits, not just in terms of what they're charging, but how many people, essentially, that base of viewers they're able to charge it on.

Kline: Yeah. I mean, it's a shrinking universe, which we'll talk about in a few minutes. I think the other thing to think about, as an investor, is Viacom and CBS have always made me nervous because they're 80% controlled by the Redstone family -- by, for many years, Sumner Redstone, and maybe now Sumner Redstone. As an individual investor, if he controls 80%, is he managing the company for me, or is he managing it for himself? I know there's an independent board at both companies, and theoretically independent CEOs, but it's hard to see how this is a company that's looking to maximize shareholder value.

Shen: Yes. Even if you look at Philippe Dauman, who is currently the CEO of Viacom, he was previously seen as longtime protege to Sumner Redstone; and some of the reports I saw when he was still estranged from his kids, he actually favored Dauman even more than both of them, so you can see.

Kline: Well, that's what makes this all sort of a Game of Thrones subplot, because Shari Redstone didn't speak to her dad for a long time. Now, that's not uncommon in family businesses. I have plenty of relatives I haven't spoken to because of family businesses. But now they've sort of put it back together; but does that mean he's willing to get rid of his longtime friend, or would he come up with some other solution? Maybe minimize his power, or maybe just block the Paramount sale, but not get rid of him. You really don't know who's making the decisions. I mean, look, Sumner Redstone might have moments of clarity, and be making clear decisions, or Shari Redstone might just be doing what she thinks benefits her dad.

Shen: Yes, absolutely. Taking a bigger-picture look, I wanted to talk about Broadcasting & Cable. Recently, they reported on Nielsen's monthly estimates for cable TV subscriptions. Thank you for sharing those with me, Dan.

Kline: No problem.

Shen: They pointed to the ongoing trend of what you had mentioned -- cord shaving -- as cable TV households are expected to decline about 2.2% in June. What do you think? Longer term, is this just something else that Viacom is really going to have to be thinking about?

Kline: I think it's going to be a big problem. I mean, for years we worried about cord-cutting. That was people completely getting rid of cable in favor of streaming services -- Hulu, Netflix, Amazon Prime, whatever it was -- and that really hasn't happened. There were signs this year that those numbers may be topped out. In the fourth quarter of 2015 and the first quarter of 2016, the industry actually made gains -- small ones -- in the first quarter.

If you look at cord shaving, which is the idea of, "Okay, I have 200 channels and that's ridiculous, I only watch 25." Now the challenge is that, if for 200 channels, maybe you pay $103 a month -- I'm guessing at a number -- but your average cost per channel is about $0.50. When you get down to 20-25, you might pay a dollar or two, but you might still pay a lower price overall, and get everything you want. I think we're going to see more of that, and when that happens, we end TV socialism. Right now, if I love the History Channel -- I don't, but let's pretend I did -- you might be subsidizing that by paying for it in carriage fees.

The second they give you the option to get rid of it, you're not going to pay for the Tennis Channel, the History Channel, the Discovery ID, or whatever these stations are, and all of a sudden a channel might have 200,000 or 300,000 users, and either those people are going to have to pay $20 a month, or they're not going to get the channel. Maybe there's a few things like the Tennis Channel that can exist just as a subscription model, but I'm not going to pay for The Cooking Network just because I watch it sometimes if it all of a sudden costs $15 a month.

Shen: Do you see this, Dan, as kind of, like, a shift in power? Essentially, now that these companies like Viacom are unable to get these carriage fees among this massive base of viewers, and earn lots of revenue that way, and they're losing that leverage they have in negotiations, essentially?

Kline: I use this word lightly, sort of in a joking manner, but I think it's the end of a scam. The reality, should I have to pay for 17 Disney channels that I don't watch? Of course not. Now, if you could find ways with packages to make me want to subsidize what you like, I think we'll see some of that, where everyone or almost everyone is still probably going to pay for ESPN on any of the skinny bundles, which is the most expensive of all the channels; but this was never a logical system. I don't force you, when you go do the movies, to go see X-Men: Apocalypse, to buy tickets to The Nice Guys in case someone else wants to see that. That's just not how it works.

I think we're going to see television have to stand on its own merits. On one hand, that's bad. On the other hand, on Netflix, something like the Unbreakable Kimmy Schmidt, which does about 4 million viewers, is considered a hit, whereas on NBC, that would be a huge flop. You really have a changing world, where if you create content and it stands on its own and it finds an audience, it'll work; but the public isn't necessarily going to pay for content that almost nobody is watching.

Shen: Yeah. Okay. Any other thoughts that you wanted to leave our listeners off with about Viacom, or the industry overall? I really think, the point that you touched on that is most important when you're investing in a company like this, is that, what you mentioned with the fact that National Amusements, the company that Sumner Redstone's father founded, which was originally a movie theater company -- still operates theaters -- but is now mainly the investment vehicle for the control of Viacom and CBS. The fact that it has this 80% controlling voting share of these two massive companies, these individual shareholders, I feel like their voices can get lost. But anything else you wanted to leave off with?

Kline: Yeah. I think, as you look at this now, it's all very exciting. Oh, the board is suing, and will Dauman be replaced? There's a lot of Shakespearean intrigue here, but if you really step back, the reality is Shari Redstone is going to end up controlling this. It's a question of whether she controls it before her father dies, after her father dies, or maybe it'll take a few years; but she'll end up controlling this trust, and independent people and outsiders are not going to be able to get in the way of a family-dominated, Sumner Redstone hand-picked board of trustees.

No matter what you call her, if you're looking at CBS and Viacom, you have to realize she's the big boss at the end of it. That's not fair to Les Moonves, or Philippe Dauman, or whoever takes their jobs next; but she is Big Brother when it comes to all this. If you're going to invest in these companies, I think you have to look at her track record.

Shen: That's a great point. Otherwise, that's all from Dan and me today. You can always reach out to us via Twitter at @MFindustryfocus, or shoot us an email with any questions or comments to [email protected]. You can also discover other podcasts from Motley Fool by checking out www.fool.com/podcasts.

As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks mentioned, so don't buy or sell anything based solely on what you hear during the program. For Dan Kline, this is Vincent Shen. Thank you for listening, and Fool on!