Viacom: More Earnings Pain, Huge Recovery Potential -- Credit Suisse Equity Research

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We reduce our 2016/17 EPS forecasts by 14%/19% to $3.68/$4.25, driven by lower forecasts for Paramount, and reduce our TP to $42 (previously $53). The long term earnings recovery potential from restructuring Cable Networks and returning Paramount to profitability remains substantial, in our view, and the management changes make it more, not less, likely that this can be achieved. We remain OP.

•Paramount limping out of 2016: Paramount's disastrous fiscal 2016 has ended with a $115m programming impairment charge – twelve months ago, we expected the studio to generate just over $200m of operating income in 2016, we now forecast close to $500m of losses. For 2017, we expect continued, if narrower, losses ($270m) and only breakeven in 2018.

•Waiting for more detail on future strategic direction: Following the departure of Philippe Dauman (former CEO) and planned departure of Tom Dooley (former COO), it is reasonable to guess the new Viacom board is looking to make changes to the future strategy of the company. We expect to hear more detail on the Q4 earnings call in early November, but would highlight that a restructuring of the core Cable Networks business – to focus on a smaller number of networks with more compelling, differentiated, content – has to be at the core of any new strategy, in our view. This is likely to take time to execute, entail one-off costs, and carry no guarantees of success but could mean improved affiliate pricing power and a recovery in ad revenues. In addition, we would highlight the recovery potential of SVOD revenues ($250m in 2016 vs $600m in 2015 with high flow-through to EBIT); and at Paramount ($340m of EBIT just four years ago).

•Valuation: Viacom trades at 7.2x 2017 EV/EBITDA, vs peers trading on 8.5x. We continue to believe the stock deserves a discount multiple and value it at 7.8x, supported by our DCF model (WACC 8.2%, growth 1%).

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