Merkuri2
Background
As part of my past articles (Paramount Global: A Good Stock In Turbulent Time, Paramount: Don’t Fear The Increased Content Spending), I emphasized the investment attractiveness of Paramount’s (NASDAQ:PARA) shares. Nevertheless, the company’s shares are still below $30. Although my forecast for the growth of the Paramount+ streaming service is being successfully realized, the reduction of the advertising budgets puts pressure on the growth of the Pluto TV service. Taking into account the state of the global economy, there is no need to wait for a positive in the advertising business yet. Nevertheless, I maintain my positive view regarding the company’s shares, as the growth potential of Paramount+ is still very promising. Let’s look at the results of the latest reporting and make sure that the company’s business is still attractive.
Looking at the High Level Results
Total revenue was $7.8 billion (+19% YoY, 2% better than expected). The main contributions to revenue growth were the DTC segment and the Filmed Entertainment segment. Subscription revenue increased by 12% YoY. Advertising revenue fell by 2% YoY. Revenue from content licensing increased by 27% YoY. Adjusted OIBDA was $963 million (-22% YoY, 6% better than expected, margin 12%). Adjusted EPS of $0.64 (1% better than expected, a year earlier, it was at $0.97). Free cash flow was at $81 million (2% worse than expected, margin of 1%, 0% a year earlier). The company ended the quarter with a net debt of $11.8 billion.
The DTC Segment Overview
The revenue of the DTC segment was at the level of $1.19 billion (+56% YoY, 2% worse than expected). Subscription revenue was at $830 million (+74% YoY, 1% better than expected). Advertising revenue from streaming was at $363 million (+25% YoY, 9% worse than expected, a strong slowdown compared to 59% growth a quarter earlier). OIBDA loss was at $445 million (1% worse than expected, margin (-37%), a year earlier (-19%). The deterioration of margins is expected, as there are active investments in the promotion of the streaming service and in the content creation. The improvement of marginality is only expected after 2023. The total number of paid subscribers at the end of the quarter was 63.7 million (+5.2 million QoQ (+1.3 million, taking into account the termination of activities in the Russian Federation)). The result was 1% worse than expected. The termination of operations in the Russian Federation led to a reduction in the number of paid subscribers by 3.9 million (1.2 million Paramount+ subs). The Paramount+ service added 4.9 million (3.7 million adjusted for Russia). Consensus expected a net inflow of 3.5 million. The number of subscribers of the company’s other paid streaming services (Showtime OTT, etc.) at the end of the quarter was 20.4 million, while 21.4 million were expected, and the quarter before it was 22.8 million.
Paramount+ and Pluto TV in Details
Total revenue from Paramount+ increased by 120% (to $672 million), subscription revenue increased by 126% (to $574 million), and advertising revenue grew by 92% (to $98 million). The main drivers of subscriber growth were the series, Star Trek: Strange New Worlds, 1883, Halo, and the special episode (Streaming Wars) of the animated series South Park. The films, Sonic 2, The Lost City, and sports content (the UEFA Cup final, etc.) also contributed to the influx of new users.
I expect subscribers to grow both due to the current regions of presence and due to geographical expansion. From what will drive further engagement in the current countries of presence, it is worth noting the return in September of NFL and college football games broadcasts, as well as the release of season 5 of the Yellowstone series. As part of the global expansion, there has recently been a launch in England and Ireland (partnership with Sky) and in South Korea (partnership with CJ Entertainment). In September, there will be a launch in partnership with Sky Italy in Italy. By the end of the year, the launch is also expected in Germany, Switzerland, Austria (partnership with Sky) and in France (partnership with Canal+). It is also expected to be released in India (partnership with Viacom 18). A total geographical presence at the end of the year is expected in 60 countries. The management also noted that the new launches will be within the hard bundle offer, which implies low costs for the acquisition of users and a low churn of subscribers.
The weakness of the advertising market puts pressure on the revenue growth of Pluto TV. PlutoTV added 2.1 million new users in the quarter and increased the audience to 69.6 million. Revenue increased by 10% YoY. The slowdown in revenue (in Q1, the growth was 51%) was due to the narrowing of the advertising market due to a reduction in advertising budgets. Nevertheless, the service is the #1 AVOD-service in the USA. In the coming quarters, the service is expected to launch in Canada (partnership with Corus) and Nordic countries (Viaplay Group).
TV Media
The segment brought the company revenue of $5.25 billion (+1% YoY, within expectations). Licensing revenue growth ($1 billion, +27% YoY, 4% better than expected) was offset by a drop in subscription revenue ($2.05 billion, -3% YoY, 1% worse than expected) and advertising ($2.17 billion, -6% YoY, 2% worse than expected). The main decrease in advertising revenue was in the international segment. The segment’s OIBDA decreased by 8% to $1.4 billion (margin of 26%, 29% a year earlier).
Filmed Entertainment
Segment revenue of $1.36 billion (+126% YoY, 22% better than expected), more than 2 times higher than last year’s result. Box office revenue ($764 million, 38% better than expected) increased by $630 million thanks to the Top Gun: Maverick film. Licensing revenue increased by 27% YoY to $587 million (5% better than expected). OIBDA was at $181 million (margin of 13%, 9% a year earlier). To date, Top Gun: Maverick has grossed $1.35 billion in box office, which makes it the 13th highest-grossing film in history and the second for Paramount (second only to the film Titanic). Until the end of the year, there is one more anticipating film – Babylon, starring Brad Pitt and Margot Robbie. The schedule for next year is also promising – new films on the Transformers, Teenage Mutant Ninja Turtles and Paw Patrol franchises and others.
Some Thoughts About Valuation
In my previous articles, I emphasized the undervaluation of both the entire company’s business and the Paramount+ streaming service separately. As before, the DCF model is the basis of my valuation. Basic inputs in my model are:
1) The revenue CAGR until 2027 is 5%.
2) Terminal OIBDA margin is 14%. Terminal FCF margin is 10%.
3) WACC 9%.
With a conservative growth rate of 1% in the terminal period and the inputs mentioned above, PARA’s fair value turns out to be $37.8 per share. However, I note that 1% TGR is very conservative. If we take the standard 3% as a TGR, we get $53.5.
What upside can there be to my valuation? OIBDA streaming margin is forecasted by management at the level of the TV Media segment, at the mid-20% level. In my estimation, the terminal OIBDA margin of streaming will be at the level of 18%. So, there can be upside there. What downside can there be to my valuation? The outflow of viewers of traditional businesses can offset the growth rate of streaming. If the revenue remains unchanged after 2022, the target price at a TGR of 1% drops to the level of $23. With a TRG of 3%, a fair value will be at $34.7. Thus, the current target price assumes no change to or reduction of revenue from the current level, which seems unlikely to me.
The Final Thoughts and Risks
I believe that the narrowing of the advertising market will lead to a slowdown in revenue growth of some segments of the company in the coming quarters. Nevertheless, Paramount+’s geographical expansion plan and the studio’s expected film releases give me reason to believe that the company’s shares are undervalued, so I maintain my positive view of the company’s shares. Nevertheless, any investment has its own risks, so I recommend that you familiarize yourself with the risks of Paramount+ in detail in the latest annual reports (10-K). It is also important to note that since my last article, there has been important news about the purchase of a 10% stake in the company by Warren Buffett. This news confirms my thesis about the investment attractiveness of the company’s shares. Being in the same boat with Buffett is very good, so in the coming months, I will increase my holdings of the company’s shares. However, I note that I do not expect a rapid increase in share price in the current economic environment. However, as a long-term investment, the company suits me very well.
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