This Media Giant Is About to Produce a Lot More Free Cash Flow

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

Media companies -- and TV broadcasters in particular -- are known to trade at relatively high multiples of free cash flow. This is because broadcasting is an inherently stable business, so future results are more predictable than companies in other industries. However, the market can still get it wrong with broadcasters, as has become clear with CBS's stock price.

Low valuation, lots of opportunities

CBS trades at just 12x trailing free cash flow and 7.5x EV/EBITDA. For most companies, these are not particularly cheap multiples. But for a leading broadcaster like CBS, it is quite a surprise. By comparison, News Corp (NASDAQ: NWS) trades at 19x free cash flow and 16.7x EV/EBITDA. Time Warner (NYSE: TWX) trades at 13.5x free cash flow and 8.6x EV/EBITDA. Disney (NYSE: DIS) trades at 22.4x free cash flow and 9.5x EV/EBITDA.

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Time Warner deserves a lower multiple than the other companies because it is facing intense competition from other cable providers and a couple of its businesses have no economic moat. Disney owns valuable assets like Pixar and has a deep library of hit movies, so it should trade at a higher multiple than its peers. News Corp, on the other hand, earns lower margins than CBS and similar returns on invested capital, so CBS should trade somewhere between News Corp and Disney, especially considering the company's opportunities.

Opportunities for growth

CBS has numerous growth opportunities in each of its segments. The biggest opportunity is in the re-transmission fees it expects to earn from its local TV and radio assets. Although the competition is intense, management expects to earn about $1 billion annually in free cash flow by 2016 from re-transmission fees alone. By comparison, the entire company generated about $1.5 billion in free cash flow for all of 2011.

In addition, even as cable networks become more popular (about 90% of U.S. households have some sort of pay TV subscription), CBS will earn higher advertising and syndication dollars. CBS earns higher rates from advertisers than cable companies due to the wider audience on non-Cable networks. This is becoming even more valuable as diverse media outlets makes it difficult for advertisers to target a mass audience. CBS also profits from licensing its programs on cable networks like TNT.

CBS has a major opportunity to grow its Showtime network. It currently plays second fiddle to Time Warner's HBO, but a few changes in the business model may improve its standing. Showtime licenses almost all of its content, whereas HBO creates original content. With CBS' vast distribution platform, it has been able to attract content producers to its non-cable networks with ease. If it can do the same for Showtime, then the cable network could go toe-to-toe with HBO.

Finally, CBS benefits from the government-created barriers to entry in its outdoor segment. U.S. governments regulate the construction of new billboards, making it difficult for new entrants to build a portfolio of billboards. In addition, the company is revamping its army of billboards by turning them into digital billboards, which can display multiple advertisements throughout the day and charge higher rates during peak hours. This is akin to charging more for advertising during prime time. This pricing and content flexibility should improve the profitability of this segment in the coming years.

Final thoughts

CBS is a gigantic company with a vast distribution network. Its steady and predictable free cash flows will continue to grow as the company takes advantage of opportunities in local TV and radio, its Showtime network, and its Outdoor segment. If it takes advantage of these opportunities, the company can easily earn $2 billion in free cash flow annually. At a 15x FCF multiple, the company is worth $46.87 per share. At a 20x multiple, it's worth $65.50 per share. At a recent price below $38, CBS appears to be undervalued.

titans8904 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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