The Real Reason Why Viacom and CBS Ended Discussions

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[Long VIAB]

Last week, Shari Redstone’s National Amusements surprised the business world when she and her father, Sumner, sent a letter to the boards of CBS (CBS) and Viacom (VIAB) arguing that the two should no longer pursue some type of combination.

The immediate reaction to the news was a rise in CBS’ shares and a sharp drop in Viacom’s.

Business TV immediately analyzed what the news meant and a quick narrative began to emerge: Leslie Moonves – CBS’s CEO – had nixed the deal because he didn’t want to take on the Viacom assets which have been assumed to be by many unsalvageable.

Although I do think there are elements of truth to that view – I have heard rumblings for months that the CBS side wanted a no or low premium bid for Viacom and that Moonves worried about what a tough slog turning around the Viacom assets would be – I don’t think it’s at the heart of what happened.

LONDON, UNITED KINGDOM – MAY 05: Ynon Kreiz, Chairman and CEO, Endemol; Bob Bakish, President and CEO, Viacom International Media Networks; Miki Chojnacka, Vice President, Entertainment, Emerging Markets, Viacom International Media Networks and Bhavneet Singh, MD and EVP, Emerging Markets and Viacom International Media Networks, attend the launch of the new global entertainment channel, Viacom Blink! at Sanctum Soho on May 5, 2011 in London, England. (Photo by Stuart Wilson/Getty Images for Viacom)

One of the things that Shari Redstone has done, since taking on a more significant role at Viacom last year – at the expense of now departed CEO Philippe Dauman – is installing better governance at the company with excellent directors like Ken Lerer and Nicole Seligman. Redstone obviously cares about good governance even though, through the National Amusements controlling stakes of Viacom and CBS, she and her father can ignore other minority shareholder wishes if they wish.

But the National Amusements owners are in a different position that minority shareholders who only own CBS or who only own Viacom. Obviously, the Redstones want to see the maximum value over a reasonable period of time for both CBS and Viacom.

To hand over Viacom to Moonves and his management team today for even what some might see as a “rich” premium of 20%, National Amusements would be selling the Viacom asset for a stock price in the low $40s, when it traded up to $90 a few years ago. To accept that discounted deal, you have to have enormous confidence that Moonves will do a bang-up job with a turnaround or no confidence in current Viacom management to do it themselves.

I think that a more likely reason for National Amusements dissolving the talks between CBS and Viacom last week was not Moonves pushing back from the negotiating table but because the Redstones have great confidence in new Viacom CEO Bob Bakish and his proposed turnaround plan.

Bakish is unknown to most media observers. He’s toiled in obscurity running Viacom’s International Networks for many years. Yet, his first earnings call and his appearance at the UBS media conference a couple of weeks ago have been impressive.

Bakish is straight-forward, honest in his assessment of the company and fact-based. It’s a refreshing change from the insufferable boasting of Dauman during these public appearances.

Bakish is clearly using the same playbook he followed in an international capacity for the entire Viacom organization. That means he’s much more partner-friendly – he just replaced Viacom’s head of distribution – he’s focused on long-term profitability, and experimenting with new approaches such as creating new channels and jumping in with both feet to Over The Top (OTT).

Some people were surprised a few weeks ago when Bakish (seen by many as a placeholder until Moonves would rescue them) announced he was buying Telefe in Argentina for $345 million. Bakish explained however that this was all offshore cash, the deal would be accretive next year and it was following the Channel 5 purchase they made a couple of years ago.

Viacom now consists of its international operations which are the fastest-growing part of the company, its Paramount movie studio and its US cable assets.

International has profits from Channel 5 in the UK and its Indian assets should to half a billion in EBITDA in 2020. Paramount is worth $4 – 10 billion depending on what valuation you believe. Despite its string of bad releases, it throws off hundreds of millions of dollars in profits every year from its library and is one of only a handful of studios around.

While the US cable channels like Comedy Central and MTV are still in the tank, Nickelodeon has been a bright spot for the company and an example of how youth-focused channels can be turned around with a few hit shows. If they did it for Nick, why can’t they do it for the others?

If you add up all the various components, assume a higher valuation for each in a turnaround scenario, and some declining debt, you can chart a path to $70 a share over the next couple of years.

There are certainly risks as well, but Viacom is the most discounted large-cap media stock out there.

Does Shari Redstone and her father buy Bakish’s turnaround plans? If they do, why sell now to CBS in the low $40s?