Here Is Why We Reduced Our Price Estimate For Viacom

We recently reduced our price estimate for Viacom (NYSE:VIAB), considering the increased risk due to debt downgrade, management turmoil, and lack of clarity on ratings revival. Viacom’s debt has been downgraded to Baa3 by Moody’s, just one notch above junk status. The company has suspended share buybacks and has cut  dividends as well. It further plans to finance its debt maturities within the next two years with the help of new debt offerings. We believe that the current situation warranted a significant change in Viacom’s cost of capital. While we still maintain our business forecasts, we have raised the cost of capital significantly reflecting our expectation of continued high debt burden and hence, higher default risk.

We Expect Debt Burden To Remain High

Viacom’s current debt to equity ratio is 3.47. The figure has increased nearly 200% in the last 3 years. Some of the comparable firms including Time Warner, CBS, and 20th Century Fox have debt to equity ratios ranging from 0.29 to 1, which are significantly lower compared to Viacom. The company’s management has slashed dividends by half, thus saving $300 million annually. However, this will not be enough to retire more than $2 billion in debt which is due in the next two years. This, along with Viacom’s declining ratings, poses significant risks for shareholders.  We believe Viacom will need to make new investments which would require more capital. Additionally, we think the company will keep share repurchases suspended for the next two years, unti business conditions improve. Therefore, we expect the leverage to remain high for the foreseeable future and have raised cost of capital to reflect this expectation.

The Problem With The Core Business

Viacom’s business is suffering due to lower ratings from its core channels (such as MTV and VH1) and movie failures from Paramount Pictures, which recently took a $115 million write down related to the expected performance of ‘Monster Trucks’. Viacom’s previous CEO (Philippe Daubman) thought the sale of Paramount was the way to go, but the current management (Sumner and Shari Redstone) has ruled out any such possibility.

The company’s struggling TV channels pose significant risk as we estimate that TV channels account for more than 95% of the company’s valuation. Significant investment will be required to counter the decline. Additionally, the decision regarding the CEO remains uncertain and until this problem is solved, the business strategy is likely to remain unclear.

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