Streaming Is Paramount

Sector: Cable/Media Dave Novosel February 26, 2021 [email protected]

 ViacomCBS (VIAC) hosted an analyst day in conjunction with the release of fourth quarter results, and it was all about streaming. Management bragged about Paramount+ bringing together great content in live sports, breaking news, TV shows, movies, kids programming, reality TV and more. It emphasized the uniqueness of offering three distinct lanes of programming – free (Pluto TV), pay (Paramount+), and premium (Showtime OTT and BET+). ViacomCBS now boasts 19 million domestic streaming subscribers, nearly 30 million global streaming subscribers, and 43 million global monthly active users of Pluto TV. Streaming advertising revenue rose to $1.4 billion in 2020, while streaming subscription revenue was $1.1 billion, bringing the total to $2.6 billion ($3.6 billion on a run rate basis). Management has set a goal of 65 to 75 million streaming subs, 100 to 120 million monthly active users on Pluto TV, and $7 billion of streaming revenue by the end of 2024. While those targets seem reasonable, they still put the company dramatically behind where Netflix, Disney, and Prime Video are today, let alone in four years. Moreover, the streaming effort is going to require a substantial investment. Management expects to spend at least $5 billion on content for streaming by 2024. The company spent roughly $15 billion on overall content last year. Margins in the TV Entertainment segment declined 240 basis points in the fourth quarter, reflecting increased expenses to support the growth and expansion of CBS All Access. Margins for the full year dropped more than 300 basis points. We expect continued margin pressure this year. Margins in the Cable Networks segment fell 230 basis points in the fourth quarter, attributable to increased expenses for programming, participations, advertising, and promotions, including support for the growth of its streaming services. Again, we expect these expenses to continue given the huge commitment to the streaming initiative and the focus on growth.  Considering that 2020 was a difficult year, with revenue down 6% and advertising off 12%, we are projecting growth of approximately 7% in 2021. The bulk of that growth should be in the TV Entertainment segment. Film should improve drastically as theaters begin to open. Margins will be hampered again by the support for streaming.  ViacomCBS generated almost $1.4 billion of free cash flow in 2020, substantially better than in previous years. We estimate that free cash flow will be much lower this year because of increased spending on production, much of which was delayed in 2020. Debt increased in 2020, but the increase in EBITDA allowed leverage to decline to 4.4x versus 4.5x at the end of 2019. The better EBITDA we are anticipating this year should knock leverage down to 4.0x by year-end. Debt may be reduced with the proceeds from the sale of its publishing unit. Nevertheless, ViacomCBS is still a long way from its leverage goal of 2.75x.  ViacomCBS has pivoted toward its streaming initiative, similar to Disney and others. We understand the logic behind the strategy. However, the company is competing in a crowded field with several rivals that have even deeper financial resources. It is not certain if consumers will pay for five or more streaming services. Success in streaming could be offset by weakness in linear as some distributors may be reluctant to pay for programing that is available elsewhere. Furthermore, even if the company reaches its subscriber and revenue targets by 2024 as recently outlined, it will require huge spending on content in the meantime. As such, margins are likely to be constrained. Again, even if its goals are achieved in streaming, that still likely represents less than 25% of total revenue. We assume that the focus on Paramount+ will constrain content licensing revenue. We feel these factors outweigh the outlook for good free cash flow and lower leverage in the near term. We maintain our sell recommendation, with the 2031 notes trading at a spread of +117.

Gimme Credit LLC Analyst's Data Sheet ($ in millions)

ViacomCBS Inc. Dave Novosel, CFA Date Produced: February 26, 2021 Y/Y 2021E 2020 Change 2019 2018 Sales 26,985 25,285 6.7% 26,998 14,514 Adjusted Gross Profit 10,255 10,293 -0.4% 10,285 5,403 Adjusted EBITDA 4,930 4,355 13.2% 4,035 2,991 Adjusted Operating Income 4,530 3,925 15.4% 3,597 2,768 Interest Expense 1,040 1,031 0.9% 962 467

Cash Flow from Operations 1,460 2,294 -36.4% 1,230 1,426 Capital Spending (325) (324) 0.3% (353) (165) Dividends (600) (600) 0.0% (595) (276) Free Cash Flow 535 1,370 -60.9% 282 985

Cash 3,654 3,119 834 442 Total Debt 19,733 19,733 18,719 10,139 Net Debt 16,079 16,614 17,885 9,697 Shareowners' Equity 17,500 16,056 13,289 2,804 Book Leverage 53% 55% 58% 78% Net Leverage 48% 51% 57% 78%

Ratios and Margins: Debt/EBITDA 4.0 4.5 4.6 3.4 EBITDA/Interest 4.7 4.2 4.2 6.4 Gross Margin 38.0% 40.7% 38.1% 37.2% EBITDA Margin 18.3% 17.2% 14.9% 20.6% Operating Margin 16.8% 15.5% 13.3% 19.1% Cash Flow from Opers/Debt 7% 12% 7% 14% Free Cash Flow/Debt 3% 7% 2% 10%