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Paramount: An Immensely Misunderstood Linear Networks Business

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Paramount: An Immensely Misunderstood Linear Networks Business

Paramount Global Posts Large Decline In Quarter Earnings

When discussing Paramount’s (NASDAQ: PARA) business, the focus often falls on the streaming industry. However, the Linear Networks business, which is Paramount’s cash cow, is often overlooked and misunderstood. Many believe that this segment is doomed, but is it really as bad as it seems? In this analysis, we will take a closer look at Paramount’s Linear Networks business and explore why it could be a long-term investment opportunity.

Linear Networks Business

a. CBS

One of the key components of the Linear Networks business is CBS. While the linear TV industry is seen as dying, CBS is a highly misunderstood asset with more attractiveness than meets the eye. Let’s examine its performance over the past few years:

CBS is divided into three segments: Advertising, Affiliate, and Licensing.

Advertising: The revenue mix in this segment is mainly derived from advertising during sports programs, prime time/non-sports programming, news, and political advertising. While revenue in this area can fluctuate due to the cyclical nature of the business, sports programming and political ads provide stable income. For instance, CBS generated around $1 billion in NFL advertising revenue in the 21/22 season. Political ads revenue is estimated to be around $800 million+ in political years. Overall, more than 50% of CBS’s advertising revenue comes from sources that are not significantly affected by secular decline.

Affiliate: The affiliate segment represents revenues from MVPDs (cable/satellite providers) and vMVPDs (streaming services) as well as revenues from local TV stations. CBS, as the owner of content rights, has a dominant bargaining position and generates stable affiliate fees. The segment is expected to grow with high margins in the long run.

Licensing: CBS licenses its content to various providers, and while revenues can fluctuate, the business is expected to remain stable.

CBS in the Long Term

CBS has secured long-term rights for major sporting events like the NFL, PGA Tour, Big Ten, and UEFA Champions League. These rights provide a predictable stream of revenue, especially as sports advertising and political advertising continue to grow in importance. Furthermore, CBS benefits from its position as the largest broadcaster with the highest-rated content, ensuring continued attractiveness to advertisers. While licensing costs for these rights may increase, the actual impact on profitability is expected to be lower than anticipated due to annual price increases.

Overall, CBS is a valuable asset that is likely to generate consistent cash flow in the coming years. A conservative estimate suggests an average of over $1.5 billion in EBIT. Considering the company’s scale, reach, and valuable sports and political content, a valuation of $15-18 billion seems justified.

b. Linear Networks

The Linear Networks segment, which includes networks like BET, Showtime, Paramount, MTV, Nickelodeon, and Comedy Central, faces different challenges. While advertising and affiliate revenues are affected by the decline of linear TV, the Licensing segment experiences fluctuating revenues. However, even in this declining market, Paramount stands out as an attractive asset.

Based on conservative estimates, the Linear Networks segment generates around $3 billion in EBIT. Considering the industry’s declining trend, a valuation of $12-18 billion, equivalent to 4-6x EBIT, appears appropriate. This valuation is conservative compared to other linear networks assets.

Streaming

Streaming is often seen as a highly competitive and saturated market. However, unconventional thinking suggests that it can become a good business through price increases or consolidation. Price increases across the board require indirect coordination among streaming providers. While consolidation is already underway, it remains to be seen how the market will develop.

The Direct-to-Consumer (DTC) business, including streaming services like Paramount+, is facing intense competition and lacks pricing power. As a result, profitability is uncertain. However, there are potential positive surprises, such as the growth of PlutoTV, which could significantly impact the business in the future.

Filmed Entertainment

Filmed Entertainment, represented by Paramount Studios, is a highly volatile business due to its dependence on theatrical releases. Comparing Paramount Studios to MGM’s recent sale to Amazon for $8.5 billion, a conservative valuation seems justified. Additionally, Paramount owns valuable real estate that provides significant downside protection.

Valuation

A sum-of-the-parts (SOTP) valuation of Paramount suggests an upside potential of 110% to 260%. The various assets, including CBS, Linear Networks, Streaming, and Filmed Entertainment, contribute to the overall value.

Risks

Potential risks include a turning advertising cycle, decreasing bargaining power in the affiliate business, rising streaming costs, National Amusements insolvency, and a writers strike. These risks could impact short-term performance but do not undermine the overall fundamentals of the business.

Conclusion

Paramount, particularly its CBS and Linear Networks businesses, presents an overlooked investment opportunity. While the streaming business faces challenges, the Linear Networks segment has significant potential for cash flow generation. Combined with downside protection from asset value and attractive IPs, Paramount offers an investment thesis with a “Heads I win, Tails I don’t lose much” scenario.