Viacom’s Struggles Add To Concerns About TV Programming Prospects

[W]e view the June quarter’s results as evidence that the leadership of new CEO Bob Bakish has the company heading in the right direction, and while turning around a number of underperforming assets will take time, we see some early signs that Bakish’s restructuring plan is working.

We continue to believe the turnaround strategy for [Viacom’s] cable networks business has a good chance of success. We also believe past investments position the company well to capture share of targeted TV advertising dollars, which we regard as a potentially very large market opportunity long term. However, it is also clear that accelerating subscriber declines… and continued aggressive investment by SVOD platforms on original content that directly competes with [Viacom’s] networks, mean the clock is ticking fast. Meanwhile, having to find a new financing deal for Paramount could delay investment in the slate if the current Huahua deal falls through.

With U.S. affiliate revenue not growing and advertising still in decline, investors are likely to be quite disappointed in both the current state of revenue trends and how long it might take a turnaround to take hold. Key from here is executing on its ratings turnaround, successful affiliate renewals (perhaps Verizon at year-end), delivering FY18 EBITDA growth by offsetting any U.S. networks revenue shortfalls with cost cuts, plus int’l network growth…and Paramount losses improving… and strengthening the balance sheet to the point that capital returns are possible.

Despite positive improvements in the trajectory of domestic advertising, concerns regarding affiliate growth and the China financing deal overshadowed otherwise strong results. With a reset, need ratings to improve further, subs losses remain stable, or a positive outcome on China / Charter to change the narrative.

Viacom continues to execute well on the elements of its turnaround that are in its control. This execution, however, is happening in the face of industry headwinds, sins of the past, and issues with foreign partners.

Viacom continues to struggle with negative domestic audience trends, impacting advertising revenue. We also think the company’s affiliate fees are at some risk given the company’s reliance on having many networks that are not necessarily adequately supported with high quality content. While shares appear very inexpensive, we prefer to remain on the sidelines until we see evidence that management is making real progress against the company’s challenges.

During the quarter [Viacom’s] portfolio of networks was up 1% y/y in C3 ratings. We note, however, that after years of under-investment the bar for ratings improvement at many of [Viacom’s] networks has been set low.

Put simply, the issue is that with long-term domestic affiliate growth of low single digits and advertising growth of, at best, low single digits, we just don’t know how Viacom can sustainably grow Cable Networks cash flow unless they can count on a massive recurring cost cutting strategy. However, because of the arms race in content spending, we wouldn’t welcome or suggest that choice.

Excluding the impact of the SVOD timing, domestic affiliate fees would have been flat in [the June quarter], as would guidance for [the September quarter]. With subs declining at ~3.5% Viacom needs better terms on its renewals, or better penetration in vMVPDs to get to a positive growth trajectory.

[C]omments regarding management’s expectations around affiliate fee inflation, subscriber declines and the “ship” sailing on $100 [pay TV] bundles suggest that longer-term expectations embedded in our model have probably been too high given the challenges that Viacom (and most other cable network groups) face. Ongoing needs to invest in content while skinnier bundles proliferate and advertising stagnates or declines lead to slower revenue growth and margin compression as time progresses.

[Viacom] had a decent [June quarter] and is showing early promise with revitalized content. BUT, while we credit management’s efforts the revenue pressures remain apparent, leading to yet more downward revisions.

Viacom claims their relationship with HuaHua (the source of the $1bn slate financing for Paramount) is “just fine.” That can’t possibly be a completely accurate description, given HuaHua withheld a scheduled cash payment in June. This cash infusion is vital to Paramount’s turnaround strategy (which we would summarize as: “make better movies, and more of them”). Increasing movie output eats cash. If they lose the financing, Viacom will either need to change its strategy (unlikely), finance the working capital itself (unlikely), or find another financing partner, probably at much less attractive terms (their only real option).