4 Factors To Consider Before Buying Media Stocks

David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

If you are looking to invest in media, there are several variables you should consider. The most important concerns (1) what the company is doing to innovate, or at least "ride" secular changes. With media moving more into handheld and online mediums and away from the television screen, companies cannot rest on their laurels. Additional variables concern (2) growth investments, (3) return on invested capital, and (4) future competition in existing segments. Below, I focus on two media investments with these variables in mind.

Disney (NYSE: DIS) Still Going Strong

Stanford Bernstein alone says ESPN should be valued at $66 billion based on the multiples News Corp (NASDAQ: NWS) used in acquiring a 49% interest in YES Network. Under the deal, News Corp has the right to increase its interest to as much as four-fifths of the sports network. Needless to say, Disney, at its current $88 billion valuation, looks undervalued in comparison. Media Networks--which includes the popular Disney Channel and ABC Television Group in addition to ESPN--contributed less than half (46%) of Disney's revenue in 2011. Parks & resorts contributed 29% and Studio Entertainment (the movie segment) contributed 16%. To be sure, in terms of EBIT, Media Networks contributed two-thirds.

But how will Disney's ESPN fare against YES Network? ESPN has what is regarded as a monopoly in sports entertainment with north of 100 million viewing households. Its economic moat is so strong that it is able to receive business not just from ads but from affiliate fees. With a contract with the NFL lasting up until 2021, I don't expect this lead to change any time soon. YES Network is a great brand but will struggle to compete. It is the official broadcaster of the the New York Yankees and was averaging around 72,000 viewers per day in primetime. If News Corp can bring in quality reports and expand coverage beyond the core Yankees and Brooklyn Nets focus, it will create value but will also still be miles away from taking over ESPN's lead. YES Network is estimated to have EBITDA of around $200 million annually, and the deal values it between 15x to 19x that amount (19x if the 80% interest is secured). By contrast, ESPN generates 17.5x more in EBITDA.  In addition to Disney being just undervalued, News Corp probably overpaid.

There are several other catalysts that make Disney undervalued. After buying out Lucasfilm for $4 billion, a lot of media attention surrounding Disney concerns Star Wars: Episode VII. But the company won't be resting on its laurels until the 2015 release--they will be rolling out Star Wars toys in theme parks, which will, in turn, drive greater demand for the film! Expansion into Shanghai also represents the biggest emerging market catalyst that the company has seen for years. In almost anticipation for the strong streams of free cash flow, management has hiked the payout by 25%--above analyst expectations. With a ROIC of 10.9% and forecasts for 12.6% annual EPS growth over the next 5 years, Disney is both a good and an undervalued company.

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The Pros & Cons Of A CBS (NYSE: CBS) Investment

If you want more diversification, consider backing CBS. It trades at a compelling 15.5x and 12.4x past and forward earnings. Analysts forecast it to grow EPS by 14.1% annually over the next 5 years. Assuming expectations are met, 2016 EPS will come out to $4.32. At a multiple of 15x, this translates to a future stock value of $64.80. Discounting backwards by 10% yields a present value of $40.24. This is not an incredible premium to the current market cap, but it provides enough of a margin of safety to encourage high-growth investors to enter sooner rather than later.

Return on invested capital stands at 10%, which is around 200 bps below the industry average. And the fundamentals are slightly challenged. Average primetime ratings for same-day viewings among ages 18-49 fell 10% for CBS. Entertainment revenue has also grown in the low-single digits and is reflected in the $70 million revenue miss during the third quarter. On the other hand, there are several catalysts. I like the company's foray into more Internet media. The recent agreement signed with Hulu in early November secures CBS content on Hulu Plus subscription beginning next year. Producers have flirted with the idea of introducing online-only programs, which may be a secular transition for media that other peers are failing to keep up on. I don't foresee the death of traditional television in the near future, but I certainly believe it will transition to more on-demand, mobile, and online platforms.

At a price-to-book ratio of 2.2x versus the 3.7x industry average, CBS has valuable assets. The problem is that with just less than $1 billion in cash and almost $6 billion in debt, CBS has limited takeover capacity. Media can change very quickly and without the ability to capture "rising giants", the core business may not be able out-innovate. For this reason, I recommend a comparatively smaller stake in CBS.

TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Walt Disney. Motley Fool newsletter services recommend Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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