Investors are getting very excited about the current streaming wars. Pioneered by industry disruptor Netflix (NFLX -0.66%), on-demand, over-the-top streaming is set to enter a new stage. Disney (DIS 2.46%) just released Disney+, and next year AT&T (T -3.79%) will release HBO Max, while Comcast (CMCSA 0.38%) will release its own streaming service called Peacock. That's not to mention incoming tech giant Apple (AAPL 0.48%), which just released Apple TV+, and the ongoing competition from e-commerce giant Amazon (AMZN 1.21%), which groups its video service in with its one-day shipping Prime subscription.
But as excited as investors are about the big "streamers," they are just as pessimistic about certain "old media" companies, especially CBS (PARA 0.07%) and Viacom (NASDAQ: VIA) (VIAB). These two companies, both controlled by the Redstone family, are set to merge in early December in a stock-for-stock deal.
As much as the streaming stocks have soared recently, CBS and Viacom have declined by just as much, having been sold off at value-stock levels even after the merger announcement. Not only are CBS and Viacom dirt cheap, but the merged company will be stronger and could perform much better than expectations under incoming CEO Bob Bakish. That's why the new ViacomCBS is the best buy in the media sector today.
The shocking numbers
Just how cheap is ViacomCBS? There are lots of moving pieces underneath each organization, but for simplicity's sake, Viacom just ended a fiscal year in which it earned a little less than $1.64 billion in adjusted (non-GAAP) EPS. Although that was lower than last year, much of the difference can be found in the company's higher tax rate, as well as some growth investments on the content side.
For the year that's about to end, analysts are projecting CBS will earn $4.91 per share, which equates to about $1.85 billion.
That comes to around $3.5 billion in earnings for the combined company, which has a combined market capitalization of just $24.6 billion, or about 7 times those net profits. That's exceptionally cheap, especially since Bakish firmly believes the companies will achieve $500 million in cost synergies alone. That bumps up the combined earnings power of the company to around $4 billion, bringing the prospective PE ratio down to just 6.2 times earnings.
With ViacomCBS at 6.2 times earnings, consider that Netflix is currently trading at seven times sales.
Of course, Viacom and CBS also have debt loads, but the combined $18.1 billion in debt should be very manageable for two companies of this size and profitability, and all of the company's media peers also have high levels of debt as well. Even then, however, the combined enterprise value of ViacomCBS is around $42 billion, just over 10 times post-synergy earnings.
That valuation is shockingly low when compared with the valuations of leaders such as the aforementioned Netflix, whose PE ratio is an astronomical 97 times trailing earnings, and Disney, which sports a PE ratio of 22.4. It's even less than half of more value-oriented media names, such as Comcast at 16.6 times earnings and AT&T at 17 times earnings.
And operationally underrated
It appears that investors don't believe CBS and Viacom can compete in a world of rampant cord-cutting and a shift to over-the-top streaming services. However, these concerns appear to be overblown. Though cord-cutting is definitely taking a toll on the linear subscriber numbers for both companies, both CBS and Viacom are growing over-the-top revenue and earnings to make up for it.
Between its CBS all-Access and Showtime direct-to-consumer offerings, CBS's direct-to-consumer revenue surged 39% last quarter. Management also said that total CBS subscribers, when counting both linear and direct-to-consumer offerings, grew 4% year-over-year.
As for Viacom, its recent acquisition of PlutoTV, which is a free, ad-supported OTT platform, has grown monthly active users by 70% just through the first nine months of this year, from 12 million to 20 million. The direct OTT offerings, along with Viacom's new advanced marketing solutions platform, have turned Viacom's fortunes around, as the company achieved its second straight quarter of advertising growth last quarter, reversing years of declines.
An arms dealer approach
Even if a handful of streaming companies take the lion's share of subscribers in the future, did you know that both CBS and Viacom produce a lot of your favorite content on Netflix, Disney, Amazon, and other streaming channels?
For instance, CBS produces the hit shows Insatiable and Dead to Me for Netflix, as well as Diary of a Female President for Disney+. Viacom's Paramount Studios produces even more shows for third parties, including The Haunting of Hill House and 13 Reasons Why on Netflix, Jack Ryan on Amazon, Shantaram on Apple, and The Alienist for TNT. Just recently, Viacom inked two massive deals with third parties: a multi-year distribution deal for Nickelodeon content on Netflix, and a licensed deal with HBO Max for the iconic South Park for over $500 million.
In a world where the large platforms are beginning to hoard all of their own content, ViacomCBS is doing the opposite, agreeing to be the arms dealer to the streaming wars. "Zigging" when all others are "zagging" could actually bring lots of advantages, as management will be able to pick and choose the right outlet for the right piece of content, thereby maximizing financial returns on its investments.
With so much demand for diverse content, both CBS and Viacom are investing heavily. Paramount TV has 26 series currently in production, up from 22 last quarter, and CBS is increasing content investment by 20% compared to last year.
A very cheap stock
Last quarter, Viacom's revenue was flat, but would have been positive if not for negative growth at the Paramount movie studio, which was lapping last year's Mission: Impossible movie. The company's main media networks segment actually grew 6%. CBS, on the other hand, grew its revenue only 1%, but that was despite lapping significant advertising revenue from last year's mid-term elections, and a 19-day blackout of CBS channels on AT&T's distribution platforms in the third quarter, which was eventually resolved.
Both companies seem to be in fairly stable places right now, and could outgrow these figures next year, when 2020 election political spending kicks in and the two companies seek even more in the way of bundled revenue synergies. At just over six times earnings, the new ViacomCBS is looking like the best bargain in a crowded media sector today.