While 55% of CBS’ (NYSE:CBS) value can be attributed to advertising-based businesses, its affiliate fee, content licensing and syndication businesses are where the future growth lies. We note that CBS’ cable networks business has been growing like a clockwork the past few years. Fueled by the growth in subscribers, subscription fees and licensing revenues, the company’s cable networks revenues have grown from $1.26 billion in 2008 to $1.77 billion in 2012. Going forward, we expect growth to remain healthy and robust and forecast cable networks revenues to reach close to $2.6 billion by the end of our forecast period. However, there is an opportunity of 5-10% upside if CBS can tap international markets and expand its cable networks’ subscription base beyond the U.S.
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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.
What Historical Growth Suggests
From $1.16 billion in 2007, CBS’ cable networks revenues grew to $1.77 billion in 2012, which implies a compounded annual growth rate (CAGR) of 8.8%. The individual growth rates for these years have not fluctuated much either. Except for 2009 when revenue growth stood at 6.5%, the other years have posted growth ranging between 8.8% and 9.9%. Given these trends, we expect future growth to remain healthy. There was a minor slowdown in 2012 when growth declined to 9.3% from 9.9% in 2011. We expect revenue growth to remain high for the next few years and slowly taper to near 5% by the end of our forecast period.
The Nature Of The Business Suggests Positive Future
CBS’ cable networks earn revenues via subscription and licensing. There is clear evidence that the subscription and licensing businesses have garnered tremendous growth across the industry over the past few years. If we look beyond CBS, we note that media companies such as Time Warner (NYSE:TWX), Viacom (NASDAQ:VIAB), Disney (NYSE:DIS) and News Corp (NASDAQ:NWS) have seen high growth in their subscription businesses while advertising has struggled.
Viacom’s affiliate fee has grown at a CAGR of 10.9% for the last 5 years driven by growth in subscribers and subscription fee.  The figure for Disney stood at 8.8% while that for News Corp was 17.4% aided by the disproportionate growth in its international affiliate fee. 
Cable networks focusing on a particular niche or demographic are also gaining popularity due to their investment in original programming. In addition, the pay-TV service providers that carry these cable networks typically enter into multi-year agreements with media companies. Such agreements specify an annual increase in carriage fee, thus ensuring revenue growth even if the subscriber base doesn’t grow much.
There Is An Opportunity To Expand The Subscriber Base
Showtime, Flix and The Movie Channel have increased their combined subscriber base from 55 million in 2007 to 76 million in 2012.  Given the premium nature of the content, this roughly 30% growth is commendable. However, during the same period, revenues grew by about 40%, and this indicates growth in subscription pricing and content licensing. 
If we look at HBO, which is a premium channel and has close to 40 million subscribers, we believe that CBS’ cable networks still have some room to grow. The 76 million subscriber base is split among Showtime, Flix and The Movie Channel. This suggests that it is quite likely that neither of these networks come close to HBO in terms of subscribers, and there is a clear opportunity to expand and the growth in cable networks revenues for CBS will remain robust and healthy for the foreseeable future.
Potential Valuation Impact
We estimate that cable networks constitute more than 25% of CBS’ value and is the most important business for the media company. This contribution is based on our expectation that revenues from cable networks will grow to close to $2.6 billion by the end of our forecast period.
However, if CBS can sustain the current growth rate for the next few years and cable network revenues reach $3 billion by the end of our forecast period, there could be 5% upside to our current price estimate. Such a scenario would imply a CAGR of close to 7.8% for the next 6 to 7 years. CBS can potentially sustain such a growth rate if it can expand internationally, similar to what HBO is doing right now.
In fact, a successful expansion overseas could even increase the CAGR to 10% which would imply close to 10% upside to our current price estimate. Given the strong demand for cable networks and immense international opportunity, we do not expect the growth rates to decline below our current forecast which we feel are conservative.Notes: