This past quarter, American households with internet-connected TV passed households with cable subscriptions for the first time. The trend of cord cutting, or switching from a bundled TV concept to specific services, is picking up steam amid the pandemic. With no live sports being aired, and limits to live content offerings, traditional differentiators cable once relied on are now absent.

For the nation's largest network, CBS, these trends pose an existential threat. Parent company, ViacomCBS (NASDAQ:VIAC), relies on advertising revenue from cable. With the pandemic severely limiting ad-buyer's budgets, that revenue stream has been relegated to more of a trickle at this point. For their first quarter, which did include some normal weeks pre-pandemic, ad revenue still fell 19%. Quarter two is expected to be worse before a recovery takes hold. Traditional TV's uncertain future places a ceiling on Cable's value proposition and is perhaps the reason behind ViacomCBS's low valuation.

Family watching TV together.

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Financial Resilience 

In quarter one of this year, without any live sports and a damaged ad market, the company managed to yield $500 million in free cash flow.  Annualizing would imply an extremely pessimistic cash generation going forward of $2 billion a year. This does not consider anticipated free cash flow growth upon live sports returning and advertising markets recovering. My pessimistic estimation stamps a cash flow multiple under 5 times on the company, a steep market discount even without the expected improvement.

Compelling Fundamentals

Diving deeper into financials, the entertainment company is trading under .5 times the 2020 price to sales (P/S) with a sub-5 times 2020 price to earnings (P/E).  To compare, next-generation competition like Netflix trades at 8 times and 70 times their P/S and P/E respectively. Today, with its rapidly broadening reach, Netflix deserves some valuation premium over predecessor ViacomCBS, but not much. This severe discount depicts investor fear that ViacomCBS cannot compete with new entrants. I wholeheartedly disagree with that sentiment.

CEO Bob Bakish has crafted a surgical approach to CBS' evolution placing impactful consumer connections at the center stage. While the prior business model may have been lacking, the new approach deserves a much richer valuation. Assets are in place to compete, and recent actions taken by the company depict an understanding of how to mirror shifting consumer needs. ViacomCBS tomorrow will look nothing like it did in the past. No longer is ViacomCBS reliant on the reach of cable.

ViacomCBS Transformation

The first foundational piece key to ViacomCBS's success going forward will be its free streaming service: Pluto. As of this month, the service advertises to 24 million monthly active users. Thanks to shutdowns, ViacomCBS's free streaming viewers grew 55% year over year. Bakish is using the strong growth to draw in ad buyers thus offsetting losses in cable revenue. Pluto will be imperative to attracting cord cutters long after coronavirus, as households switch to connected TV.

Beyond strengthening and diversifying advertising revenue, ViacomCBS plans to use Pluto as a platform for attracting consumers to its paid services: CBS All Access and Showtime. These services also grew over 50% this quarter.  With 24 million content-consuming American's, Pluto can serve as a powerful vehicle for graduating consumers into one of ViacomCBS's subscriptions. Yes, Bakish plans to aggressively sell ad space to other companies, but he also plans to market his own paid services on Pluto to lure consumers.

In the most recent earnings commentary, Bakish openly discussed his plans to soon relaunch CBS All Access as an umbrella encompassing all the company's content. Critics' main complaint toward the original All Access was its sparse library. This should help. Combining studios like Paramount, iconic stations such as Nickelodeon, BET, MTV, and Showtime and brands like Star trek is powerful.

To make their offerings even more tempting, Bakish is expected to eventually include the company's news and sports content in the newly launched CBS All Access.  While not having golf or March Madness this year has hurt them, the pain is temporary: sports will be back. This temporary headwind will be a strong tailwind as soon as leagues resume. Live sports drive ad revenue for the entire industry. Content rights to the NFL, NCAAF, NCAAM, and the PGA will be a competitive differentiator between CBS All Access and the field.

By Bakish aggregating ViacomCBS's intellectual property, content rights and brand power, we are left with an organization equipped to compete in a crowded field. The streaming wars are in full force as coronavirus accelerates an already powerful trend in cord cutting. To keep up with the streaming movement, acceleration in Pluto will fuel subscriber growth for an enhanced CBS All Access. That competitive niche is underappreciated. They have the assets, and the know how to win going forward.