Viacom Needs "Substantial Creative Refresh," But Has "Healthy" TV Content Budget, Analyst Says

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As investors "ponder the potential for board composition and management changes," Michael Morris, in a report entitled "To Spend More or Spend Better," takes "a deeper look at what a new leader of the company would have to work with."

Viacom needs "a substantial creative refresh," but has a "healthy" TV programming budget that wouldn't need a major boost, Guggenheim Securities analyst Michael Morris said in a report on Wednesday.

In the report, entitled "To Spend More or Spend Better — That is the Question," he explained that he was taking "a deeper look at what a new leader of the company would have to work with" as investors "ponder the potential for board composition and management changes at Viacom."

Morris said that over the past several years, "Viacom has consistently underperformed the peer group with respect to audience erosion, advertising revenue growth and, more recently, affiliate fee growth. We believe that this relatively weaker performance has led some investors to conclude that new leadership would have to increase spending to improve results."

Chairman and CEO Philippe Dauman has been highlighting increased content spending and an increased focus on developing new hit shows amid investor concern about ratings and ad trends.

The analyst compared Viacom's domestic content budget to that of its peers, saying "Viacom is poised to expense a very robust $3.1 billion on entertainment content in 2016, similar to amounts amortized by industry peers." Based on company reports and his own projections, he cited estimates for U.S. programming rights amortization of $815 million for Discovery Communications, $2.3 billion for Netflix, $2.8 billion for Walt Disney, $3.1 billion for CBS Corp., $3.5 billion for Time Warner, $3.7 billion for 21st Century Fox and $4.6 billion for Comcast/NBCUniversal, among others.

Viacom's utilization of that budget to drive revenue is also broadly in line with the peer group. "However ... Viacom lags more robust subscription services (Neftlix, HBO) with respect to affiliate fee yield and lags cable network peers (Scripps Networks Interactive, Discovery, AMC Networks) in advertising yield," Morris concluded.

Netflix leads his estimates for 2016 subscription revenue as a percentage of content amortization with 216 percent, ahead of Discovery (186 percent), HBO owner Time Warner (177 percent), AMC Networks (141 percent) and Viacom (122 percent), followed by Fox and Disney (121 percent each). Scripps leads his estimates for 2016 advertising revenue as a percentage of content amortization with 245 percent, ahead of Discovery (212 percent), AMC (150 percent) and Viacom (125 percent), followed by Time Warner and Comcast/NBCU (122 percent each), CBS (111 percent), Disney (79 percent) and Fox (64 percent).

"Our conclusion is that a new strategic vision for Viacom would not necessarily need to come with a significantly higher content investment run-rate," Morris said. "We do believe that the company needs a substantial creative refresh (and would argue that the current trading multiple indicates that investors agree), which would likely come with a short-term content writedown. However, we also believe that a bear case that argues for significant, sustained investment in the company's networks may under-appreciate the opportunity embedded in the current healthy programming budget."

He added that "this is in contrast to the investment that we believe Paramount would require." Morris has in the past argued that Paramount is lacking scale and signaled that Viacom should consider selling it outright, rather than a minority stake in it, to bolster its scale. "We see Paramount as more valuable being absorbed into a larger entity that would bolster its scale position rather than entering a new phase of sub-scale investment under the same leadership team," he had said in a report at the end of February.

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