Media & Entertainment: Silver linings: The Playbook -- RBC Capital Markets

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As Media content distribution and consumption evolves we think investors have become skeptical of the growth potential of the sector. We know that 2015 was tough for consensus revisions and sentiment, but CY15A EPS growth was still an impressive 11% (and hurt by FX). The biggest challenge is arguably deciphering which Media stocks can grow and prosper in a fast changing world whereby customers will have increasing choice in what, when and how they consume content. Investors will increasingly take a more nuanced view of the stocks in light of these dynamic secular themes.

Silver linings playbook: 5 themes to rule them all

  1. Weak sentiment may have created a buying opportunity for stocks that can continue to grow and may even benefit from disintermediation. We see this as the silver lining to the 'Media Meltdown' but it requires a thematic approach. Our stock selection is driven heavily on our thematic playbook of 5 themes:
  2. Cord cutting - a detailed scenario analysis reveals EPS risk is quite low at ~5% for most stocks (excl. VIAB);
  3. Content leadership - CBS and TWX are the best of the best;
  4. Not fans of advertising - we think Ad earnings are losing value as digital means TV Ad revenue is less predictable;
  5. International - Pay TV is still a growing market overseas; and 5) operational excellence - the bottom line still counts.

In the end, our playbook suggests CBS, DIS, DISCA, FOXA, HMTV and TWX are the best positioned Media stocks thematically. We are least favorable on VIAB and to a lesser extent SNI.

The revenant

Many Media stocks are now at recessionary-level discounts to the S&P500. In many cases this is despite superior sales growth, EPS growth and margins. Our thematic leaders are trading 2x-4x P/E turns below their historically implied valuations based on their EPS growth, and we think they will rerate as their strong positioning is better appreciated. These stocks also have stable cash flows that support high levels of capital deployment, which should provide investors with visible earnings growth and valuation support.

CBS, DISCA, FOXA TWX get out of the hurt locker, VIAB does not

We derive stock picks by marrying our playbook with our valuation analysis. CBS, DISCA, FOXA, HMTV and TWX rise to the top with Outperform ratings as we think they have thematic strength + EPS growth that should command a higher valuation, and they are deploying lots of capital with cash yields of 7-11%. DIS appears fully valued at these growth levels, while LGF and SNI have more risk so we're Sector Perform on these three. VIAB has significant structural challenges in our view and epitomizes ecosystem concerns, so we rate it Underperform.

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Priced as of prior trading day's market close, EST (unless otherwise stated).

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