Is Cable A Value Trap?

Many value investors have loaded up on shares of the nation’s leading cable companies in recent years as share prices have lagged. The Dolan family even considered taking Cablevision (CVC) private, but then pulled the offer off of the table. While the stock of CVC and others such as Comcast (CMCSA) do look attractive by historical measures, the outlook for these operators has changed meaningfully, in my opinion, over the last few months.

The argument for the Comcasts of the world was pretty simple heading into 2005. The stocks were down big, investors were ignoring them, and cash flow was very strong, growing 10% per year. In addition, cable broadband access seemed to be maintaining its lead over the Baby Bells’ DSL offerings.

Since cable modems were faster than digital subscriber lines, and many voice customers were scrapping their landlines, the cable companies stood to benefit greatly by bundling digital cable television, high speed broadband access, and VOIP phone services. Throw in Tivo boxes and video on-demand movies and customers could get everything they needed, on one bill, for $100 to $125 per month.

The stocks have languished this year though, even as financial results have been pretty good. The three-pronged attack of bundling voice, data, and video has hit a snag. Some of these services are simple commodity businesses that anyone can offer. Vonage offers unlimited long distance, just as Comcast does. Since the service is the same, pricing will continue to fall.

Then things got even worse. Companies such as Skype began offering VOIP phone service for free. Rumors began swirling that Google (GOOG) was looking into offering free wireless Internet access in order to drive net traffic to its advertising-based sites.

While pricing for cable television will remain fairly flat, and VoD movie libraries could lead to Blockbuster (BBI) becoming extinct, it is entirely possible that wireless Internet access and VOIP long distance phone service are eventually offered for free. If that happens, the cable companies will be back to only offering one service, not bundling three through a single coaxial cable. If this happens, cable operator stocks will go down in history as a major value trap.

Martha Stewart Living Shares: You’re Fired!

Shares of Martha Stewart’s company were down as much as 20 percent today, after the company reported a pretty bad earnings report. I’ve been very bearish on MSO stock for quite some time now on this blog, but even at $17 and change, I can’t reverse course just yet. I just don’t see how they are going to make any meaningful amount of money, and without consistent profitability, MSO is not worth nearly $1 billion. Even a forward price-to-sales multiple of 3 times (a very rich valuation in my opinion) would mean the stock has further to fall from here.

Is Vegas Growth Peaking?

After exhausting my own reading materials on a recent Southwest Airlines flight to Baltimore, I thumbed through the air carrier’s in-flight magazine entitled Attache. What I found in its pages was very interesting. Nearly every single page of advertising (probably half the entire magazine) had something to do with Las Vegas. Either a plug for a Vegas casino, a specific show at one of the Vegas casinos, or most frequently, a new high-rise condominium project in Vegas.

The constant marketing of Vegas with each turn of the page showed me that growth in that city may very well be peaking. After all, can construction there really accelerate from here? With so much capacity being added to Las Vegas, I can’t help but wonder how all of it is going to be filled. The new Wynn hotel recently opened to much fanfare, and there was even an article about MGM’s new massive building project along with all of those ads. No fewer than a dozen new condo buildings are going up, with the likes of Ivana Trump gracing their colorful advertisements.

While demand may be high, I doubt so much more supply is going to be good for the city. With vacant desert land as far as the eye can see, I sure hope people keep coming to Vegas, both vacationers and new residents. If the economy were to slow down noticeably, travel would likely decrease, leaving billions in new projects at risk. Investing in Vegas now, whether it be via the companies that are building there, or directly in the local real estate market seems like a risky bet to me.

As attractive as the growth opportunities for the country’s largest gaming companies are, I am having a hard time justifying Vegas-related investments at this point in time. The rapid growth could very well continue for several more years, but the downside risk is evident enough to me that I prefer looking elsewhere for my consumer discretionary holdings. In fact, I have sold all gaming related stocks aside from a hedged pair trade of long WYNN, short LVS.

Martha’s Apprentice Starts Slow

Viewership for the premiere of “The Apprentice – Martha Stewart” was below expectations, at 7 million, and shares of Stewart’s company, MSO, have dropped 30% in the last two weeks to under $25 per share. After missing the first episode, I tuned in tonight to see how the show compared to Trump’s version, and also to see David, a contestant who recently graduated from my alma mater.

After an hour, David survived the second week and it was easy to see why ratings have not been very good. Martha just isn’t the draw that Donald Trump is. She’s boring to watch, and her background voiceovers sound like a bad actress reading from a cue card, not someone who draws a lot of attention and interest on television. It takes more than just a successful entrepreneur to draw viewers in prime time. Just ask Mark Cuban after his show, The Benefactor, completely bombed.

Ad pages in Martha’s magazine might be up nicely year-over-year, but Martha Stewart Living Omnimedia stock remains overvalued at 5 times sales.

Breaking Down TiVo’s Valuation

Since last month, shares of TiVo (TIVO) have dropped from over $7 to under $5 each. This 32% selloff got my attention. Based on the company’s 3.6 million subscribers, each customer is being valued at $114 given the stock’s current price of $4.94 per share.

Since TiVo’s large distribution deal with Comcast (CMCSA) won’t take shape until mid-to-late 2006, the company has chosen to invest heavily in marketing (and show operating losses) until such deals kick in. Fortunately, the company has a large net cash position of $104 million, which can fund the company’s projected quarterly loss projection of $20-$25 million.

There is no doubt that TiVo faces extreme competitive pressures in the DVR marketplace. Nonetheless, the current value per subscriber of $114 seems low to me, given the scope of TiVo’s service and brand. Why somebody would not want to consider buying this company at this valuation escapes me. TiVo looks like an attractive speculative play at current levels.

What Do You Do When Your Market Is Going Away?

This is a question movie rental giant Blockbuster (BBI) is trying to answer. So far though, the company is at a loss for words. BBI shares lost 12% of their value Tuesday as the company lost more than twice as much money as expected in its second quarter. Blockbuster’s CEO predicted a return to profitability in Q4 and for all of fiscal 2006, but that will be a tall task.

With the advent of online DVD rental services and movies available on-demand from your local cable operator, the storefront-based rental market is going away. It might not be overnight, but instead little-by-little over the course of many years, but it is still going away.

Is it completely farfetched to think that 10 years from now you will be able to get Blockbuster’s entire movie lineup straight from your cable box? If this happens, and you can be sure companies like Comcast (CMCSA) have this idea in mind, Blockbuster’s stores and DVD mail order service are rendered useless.

Blockbuster’s Q2 2005 sales dropped 2% to $1.4 billion. The revenue breakdown was as follows: rentals 73% (down 5% vs 2004), merchandise sales 26% (up 12%), and late fees 1% (down 87%). Included in rental sales were the company’s 1 million online customers, who will now pay $17.99 per month. BBI raised the price from $14.99 this week since it wasn’t making money at the lower price originally targeted at taking market share from NetFlix (NFLX).

Now granted, merchandise sales were the only category up year-over-year, but Blockbuster has huge compeititon in this area. Best Buy (BBY), Wal-Mart (WMT), Circuit City (CC), Target (TGT), Amazon (AMZN), and the list goes on. All in all, how BBI expects to make money going forward is questionable.

As for the $7 stock, Blockbuster’s market cap is $1.35 billion, but they have more than $1.2 billion in debt and cash in the bank is falling precipitously. Blockbuster needs to figure out how to change their current business model to a profitable one in order to justify a $2.5 billion enterprise value.

Martha’s Rich Share Price

Somebody seriously should call Martha Stewart and give her a stock tip; tell her to sell her own stock. Martha Stewart Living Omnimedia (MSO) reported 2nd quarter numbers and the results do little to explain why the stock, at $28, is worth $1.43 billion.

Sales for the quarter were $46 million, broken down as follows: publishing (69%), merchandise sales (22%), internet sales (5%), and television programming (4%). Amazingly, MSO lost $33 million in the quarter, hardly a profitable business model. Even if you exclude items like equity compensation, and focus just on product costs as well as selling, general, and administrative expenses, MSO lost $11 million on $46 million sales.

Clearly investors are focused on the upcoming Apprentice show for added profitability. However, given that Martha’s current shows are contributing only 4% of sales, investors would be correct in asking how much the new NBC series could possibly materially add to earnings.

Can anyone out there please explain how this company is being valued at more than $1.4 billion? Until I can understand such a justification, I’d be betting against MSO shares.

Martha is Creeping Back Up

After making a hefty profit betting against Martha Stewart Living Omnimedia (MSO) earlier this year, it appears investors will get another chance to repeat that performance.

With Martha’s Apprentice show gearing up for its premiere, MSO shares once again look too expensive at nearly $30 each after rising 50% in the last few months. If the recent momentum carries this stock back into the 30’s, it’ll look like a good one to bet against again. To find out why I was bearish earlier in 2005, you can read my MSO piece from February 19th here

Sirius Momentum Accelerates Yet Again

Five Year Chart of Sirius:

The last year or so has been very volatile for shareholders of Sirius Satellite Radio (SIRI). A deluge of retail investor buying sent the stock soaring from $4 all the way up over $9 per share. However, such a dramatic move was not rooted in fundamentals but rather a feeling that the stock was a “must own”, especially in the single digits. Sirius quickly fell back to the $5 level and settled down.

In recent weeks the momentum has picked up once again, with SIRI shares trading above $7 each. The market value of the company stands at $9.44 billion, prompting me to once again remind investors that although the share price alone seems “cheap” on an absolute price basis, the expectations of the market are indeed very high once again.

Let’s assume a very bullish scenario and project the ultimate value of the Sirius franchise. There are about 200 million vehicles in the United States. Let’s assume half of all vehicles eventually have satellite radio, and of these, XM and Sirius split them 50/50. A subscriber count of 50 million nets Sirius annual revenue of $7.77 billion. It’s conceivable that Sirius could ultimately generate a 20% EBITDA margin when it gets to be that large. That puts annual EBITDA at $1.55 billion. A very generous 15x EBITDA multiple puts a fair value on Sirius of $23.25 billion, about 146% above current levels.

Sirius began 2005 with 1.1 million subscribers. It could take 20 years to get 50 million subs, much like it did with the cable tv industry. Investors willing to wait that long have a 7% annual return over 20 years waiting for them. Hardly impressive. And that assumes a lot of good things happen in the future that have not happened yet, such as a profitable business model and a 50% market share. And who’s not to say there won’t be more than two competitors in the marketplace in the future?

Kodak, Take Two

The upswing I caught in shares of film giant Eastman Kodak during 2003 and 2004 pretty much defines the kind of contrarian calls I tend to look for. The stock had fallen from nearly $100 down to the low 20’s. Sentiment was about as negative as it could get. Nobody was recommending investors buy and nearly everybody had a sell rating on it. The story was pretty bleak from a fundamental point of view. Consumers were all shifting from film-based cameras to digital and Kodak was far, far behind.

To diversify away from the traditional film business, EK started to beef up their digital camera product line and made some acquisitions in the medical imaging business, hoping for higher margins. In fact, they borrowed money to pay for the acquisitions. You can imagine how much Wall Street liked that. Investors hate it when companies take out debt for mergers or dividends, and usually they’re right.

However, what the Street failed to realize was that medical imaging was indeed a faster growing and more profitable business than film. Kodak cut their once 7% dividend to help fund the turnaround plan. Did it work? Well, the stock went from the low 20’s to the mid 30’s. Few people noticed because nobody owned the stock, but I was happy to cash out with a more than 50% gain in less than a year.

All of the sudden a weak first quarter earnings report has sent EK shares back down to $25 each. There haven’t been many downgrades though, as only 2 analysts have buy ratings on the stock, versus 6 with sells. Most people have dropped coeverage completely. The strategy must have failed, right?

Well, not exactly. Do you know who is the leading digital camera maker in the United States? That’s right, it’s Kodak. Just because they got a late start and didn’t think the digital revolution would sweep the world as quickly as it did, they still are selling a lot of cameras. After all, Kodak is a pretty good brand, so consumers have warmed to their products very quickly.

The stock is down 30 percent. The P/E is 10. The dividend is 2 percent, and sustainable. The company’s total debt load was cut from $3.2 billion to $2.3 billion during the 2004. Sounds like it’s prime time to start focusing on Kodak stock once again.