Although 55% of CBS’s (NYSE:CBS) value can be attributed to advertising-based businesses, its affiliate fee, content licensing and syndication businesses are where future growth lies. In this context, we note that CBS’ cable networks business has been growing like a clockwork the past few years. The smooth growth curve is being fueled by growth in subscribers, rising subscription fees and growth in licensing revenues.
Can there be further upside?
Yes, if the company can maintain margin growth that it has shown in the last few years. We have already priced in continued revenue growth in our estimates but forecast margins to stabilize. A lot of emphasis has been placed on how well CBS’s network has been performing and where its local broadcasting business is headed. While that is important, we believe that the cable networks business has been an unsung hero. See our complete analysis for CBS
CBS operates premium cable networks such as Showtime, Flix and The Movie Channel. In addition, the company also operates Smithsonian Networks and CBS Sports Network. The premium networks are ad-free and thus rely on quality content that allows CBS to charge a high fee per subscriber. Showtime, Flix and The Movie Channel have increased their combined subscriber base from 55 million in 2007 to 73 million in 2011.  Given their premium nature, this roughly 30% growth is commendable. However, during the same period, revenues increased from about $1.16 billion to $1.62 billion, implying growth of 40%.  This indicates growth in subscription pricing, content licensing as well as contribution from other networks mentioned above.
As revenues grew, margins have improved drastically. From 31% in 2007, the cable networks EBITDA margins (earnings before interest, taxes, depreciation and amortization) increased to 46% in 2011. A lot of this can be attributed to CBS’s conscious efforts to transition to lower cost structure and that is why we are slightly skeptical about the company’s ability to grow margins further. These efforts have already borne fruits. The 46% level is already quite competitive and similar to what Disney (NYSE:DIS) has been able to achieve despite having the advantage of ESPN. However, its growth in digital licensing and the potential to further increase pricing while maintaining demand for content are some factors that can possibly help CBS fuel further margin growth.
If CBS’s cable networks EBITDA margin can grow to 55% instead of 48% we currently forecast, there can be further upside of more than 5% to our price estimate.
Our price estimate for CBS stands $38.70, implying a premium of about 10% to the market price.Notes: