CBS/Viacom: Recombination Edges Closer -- Credit Suisse

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Assessing value of combination: Following the letter written by controlling shareholder National Amusements Inc. (NAI) asking the boards of CBS and Viacom to consider a potential combination of the companies, we assess the strategic and financial merits of the transaction. We believe a merger would yield substantial near-term cost savings, but may also be the best catalyst for improving Paramount's profitability and for putting in place a much-needed restructuring of Viacom's cable network portfolio. We reiterate our OP ratings on both CBS (OP, $75 target) and VIAB (OP, $42 target), but highlight more upside potential for CBS from current levels

•Substantial near-term synergies: We estimate a merger would generate cost savings from (i) reducing corporate overhead; and (ii) reducing SG&A in the networks businesses of both CBS and Viacom. Our initial estimate is this could reach $400-500m within the first 1-2 years following a merger, equating to 2.0-2.5% of the combined cost base vs. the 2.5% targeted by FOXA in its proposed merger with TWX.

•Significant turnaround potential for VIAB assets long term: In addition to near-term cost savings, we also believe that substantial value can be created if a merger is a catalyst for improving Viacom's operational performance, specifically: (i) focusing the current programming and marketing spend of the core cable networks business on a smaller number of brands; and (ii) returning Paramount to historical levels of profitability. On the former, we highlight that 90% of domestic networks' operating profit is likely generated by the top 10 networks, suggesting any "step-down" in EBIT from closing networks can likely be recouped by increased affiliate pricing power in the remaining portfolio. On Paramount, we highlight that the 3,400-title library likely generates EBITDA of close to $175m pa, suggesting that even a break-even slate should deliver a substantial improvement in the studio's profitability.

•CBS may own 61% of NewCo: At current market prices and assuming a 1:1 share swap for a NewCo with the same dual-class share structure, CBS shareholders would have a 50% economic interest in the combined (voting) A shares; 63% economic interest in the combined (non-voting) B shares; and 61% of the total share capital. These ownership stakes for CBS are close to an all-time high – for the B shares, the average since the original split with Viacom is 44%. On these terms, we argue CBS B shareholders therefore will capture substantially more of the economic benefits of the near- and long-term synergies from combining the two companies than would have been the case historically, suggesting a recombination of the two companies could be highly attractive for CBS B shareholders over time.  

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