CBS Upside & Downside Scenarios to $27.50 Valuation

CBS (NYSE:CBS) competes with media conglomerates like News Corp (NASDAQ:NWS), Disney (NYSE:DIS), Time Warner (NYSE:TWX) and Viacom (NYSE:VIA) primarily in broadcasting, cable networks and publishing businesses. CBS’s main business segments include company owned TV stations and CBS radio, cable networks, CBS network and TV licensing product which contribute about 38%, 24%, 16% and 14% to CBS’ stock respectively as per our estimates. Our price estimate for CBS stands at $27.50, which is slightly below the market price.

Summary of Key Drivers

1. CBS Owned TV Station Revenues: Advertising revenues from company-owned TV stations declined from about $1.9 billion in 2005 to $1.2 billion in 2009. There was some recovery in 2010 and we expect these revenues to reach historic levels of $1.9 billion by end of our forecast period.

2. CBS Radio Market Share: This figure has fallen consistently since 2005 followed by a mild recovery in 2010 amounting to a little over 8%. The prime reason has been divestiture of some radio assets. Going forward we expect share to remain flat.

3. CBS Owned TV Stations & CBS Radio EBITDA Margin: This figure declined from 35% in 2005 to 22% in 2009 before recovering significantly in 2010. Going forward, we expect margin to sustain these new levels.

4. Cable Networks EBITDA Margin: This figure has been on a consistent improvement since 2008 and we expect it to sustain current levels of 39% to 40%.

5. CBS Network Ad Pricing: The ad pricing for CBS network has fallen after its peak in 2007, amounting to about $3.35 in 2010. Going forward we expect this figure to grow.

25% upside scenario | $34.50 Trefis price estimate for CBS stock

1. Profit Margin Improvement (+10%)

Here we specifically refer to CBS owned TV stations and CBS radio ebitda margin and cable networks ebitda margin, which we believe may hold potential of rising higher than we forecast. More specifically, if the first figure was to rise to historical levels of close to 36% and cable network margins were to rise to over 44% (which is where Disney’s cable networks margins seem to be heading) by end of our forecast period, there could be an upside of about 10% to our price estimate.

This potential growth could be closely tied to how economy grows in next few years as well as to what extent will CBS’ efforts of reducing costs in past few quarters will show up in margins (they already have to a large extent).

2. Higher Growth in CBS Owned TV Station Revenues (+5%)

CBS owned TV station revenues represents advertisement revenues earned by several broadcast TV stations owned by the company through CBS Television Stations Group. These stations produce news and broadcast public affairs, sports and other programming to serve their local markets and offer CBS, The CW and MyNetworkTV programming and syndicated programming.

The dependence on advertising ultimately ties this business to the state of economy. If the economic recovery and growth in the U.S. is strong in the coming years, the advertising market will grow faster than we forecast. If these revenues grow to $2.5 billion by end of our forecast period, there can be an upside of about 5% to our price estimate for CBS.

3. CBS Radio Market Share Rebounds (+5%)

CBS radio market share refers to the share of CBS radio in total radio revenues in the U.S. Its market share has decreased in recent years as the company divested some radio station though we don’t expect this to continue. If instead of staying flat the market share can rebound to high levels of close to 11% as were seen back in 2005, there could be an upside of 5% to our price estimate for CBS.

What could make this happen? CBS is facing competition from Internet radio as well as other players like Sirius/XM who are taking a chunk of radio advertising revenues. The company will need to play effectively against these players by focusing on content which is well directed. CBS is already gaining from its focus on some large markets as evident from its audience share growing in top 10 markets.

4. CBS Network’s Ad Pricing Increases (+5%)

We currently forecast modest growth in this figure. However, if ad pricing was to grow past $4.50 by end of our forecast period our price estimate for CBS could see potential upside of 5%. This could happen if CBS continues to gain major share of audience and economic growth is favorable. Although we acknowledge that this might not be an easy task given cable networks are attracting a lot of younger audiences who tend to be primary targets for advertisers.

10+% downside scenario | $24 Trefis price estimate for CBS stock

1. Economy and competition leads to margins suffering (-5%)

If an unfavorable economy and competition force CBS owned TV stations and CBS radio ebitda margin and cable networks ebitda margin below our current expectations by even as much as 3%, there could be downside of about 5% to our current price estimate.

2. Economy stays sluggish, CBS owned TV station revenue growth slows down (-4%)

There is still some uncertainty around recovery and growth of economy. The consumer confidence still seems a bit low although recent index on factory productivity showed some improvement. Overall, the growth in the economy hasn’t been what many expected and this could directly impact advertising market. If, as a result, CBS owned TV station revenue growth stunts, there could be downside of about 4% to our price estimate.

3. CBS radio loses out to new competitors (-4%)

Although CBS radio seems to be holding its ground against competitors and fast growing internet radio players like Pandora, it is interesting to see what could happen to CBS if it loses share in radio market. Pandora has a critical edge on traditional radio players through its advertising capabilities. According to Ford’s digital marketing manager, Pandora can use several metrics like age, gender or musical taste of the user to increase the effectiveness of advertising. If this really becomes a threat and CBS indeed loses share, going down to as low as 6% by end of our forecast period, there could be a downside of 4% to our price estimate.