PARAP - Paramount: Trading Below The Sum Of Its Parts

2023-07-26 07:24:26 ET

Summary

• Paramount Global owns countless businesses and brands, which could be worth far more than the market is currently valuing the firm.
• The company is already in the process of selling assets such as BET, Simon and Schuster, and its CBS Studio in New York City.
• If the firm achieves streaming profitability as executives claim it soon will, the market will almost certainly have to re-evaluate the recent bearish trend.
• If analyst projections are correct, shareholders could receive large returns in an acquisition.

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Intro and Thesis

Paramount Global (PARA) (PARAA) is substantially undervalued because the market is not properly evaluating either the company's net asset value or its future earning power. Shares have fallen without any significant fundamental change in the business and are now worth buying.

To be clear: Paramount Global is not a "buy" because I believe it will corner the market in cable, subscription-based streaming, or free ad-supported television (though its subsidiary, Pluto TV, does lead in this market). Paramount is a buy because it doesn't need to "win the streaming war" or even become a hugely profitable business in order to unlock value for shareholders. It is trading at a valuation far less than its liquidation value, and the very real chance of business profitability through growth in streaming is just an added bonus.

Paramount's valuation, at the time of writing, is $10.56 billion, or just under $16/share. That may seem like a hefty valuation for a company with a great deal of uncertainty as to the timing and amount of future profitability, but the assets alone are enough to justify buying shares and imply a large margin of safety. Additionally, an optimistic view of Paramount's future profitability is perfectly reasonable given the high quality of its content rights.

Paramount's Economic Moat

PARA derives its inherent advantage from the fact that it is an all-in-one content company. It produces various movies and TV shows in-house, unlike competitors such as Netflix. This gives Paramount a cost advantage against Netflix and others. Not having to pay other producers for content gives Paramount more room to cut costs as it turns its focus to profitability.

Paramount's content advantage also consists of its proven quality. Paramount owns the rights to classics and new hits alike, including Star Trek, Top Gun, Yellowstone, and South Park, and the full brand rights to Nickelodeon, BET, Comedy Central, MTV, and many more iconic channels. The ability to churn out unique content year after year, geared toward passionate fan bases has enabled Paramount+ and Pluto TV to continuously grow their subscriber counts, with Pluto becoming the leader in free ad-supported television (also known as FAST).

Paramount's cable branches also retain unique competitive advantages through their news and sports broadcasting rights. CBS maintains contracts with leagues such as the NCAA, the NFL, the NBA, and non-American organizations such as the Champion's League. While cable TV as a whole may face serious headwinds in coming years, Sports and News channels should maintain their viewership better than most other cable channels.

Thus, all of Paramount's business segments are built around their competitive advantages, and thus deserve the Warren Buffett description of an "economic moat", which competitors cannot cross. This idea is best expressed by the fact that a would-be competitor, with capital equal to PARA's market capitalization, could not replicate the businesses that Paramount has built.

Liquidation Value

It is important to note PARA's liquidation value - not because the company is facing bankruptcy or because its business is near failure, but because its current value presents an attractive acquisition target to larger firms.

Paramount is currently obtaining bids for BET, Simon and Schuster, and its CBS Studios location in NYC. These sales are important for the reduction of Paramount's debt, but they also serve as a reminder of the sizable discount at which PARA is currently trading. Paramount's management maintains that selling non-core business segments will benefit the firm by freeing up capital. Let's examine these three sales, and the cash value that Paramount might gain as a result:

• Many sources have claimed that Paramount's price tag for BET will be around $3 billion. Bidders include Tyler Perry, Byron Allen, and Urban One, per several reports . With established competition, it is possible that Paramount can get a real premium for BET.
• Simon and Schuster, a brand that is far from a "core" business unit for Paramount, was set to be sold to Penguin Random House, a competitor, for $2.2 billion before the sale was shut down by regulators. According to Reuters , S&S is up for sale again and could be valued anywhere in the range of $2-2.5 billion.
• The firm is also pursuing a sale of its CBS Broadcast building in New York City. It is unclear how much Paramount will ask for the property, but it's important to note that this is not a downsizing move. The company has already taken steps to move operations to more cost-effective locations.

These three sales alone, then, are expected to be completed in 2023 or 2024, and may total anywhere from 4 billion to 7 billion (37-66% of PARA's market cap), while having a seemingly minor impact on future cash flows from its main business units. If this trend continues, the firm could unlock value of up to $30 billion, according to a Wells Fargo analyst report . A full sale to a firm like Apple, Disney, or even Berkshire Hathaway (which already owns 15.3% of the company's stock) would unlock great value for PARA shareholders as well as the controlling stockholder, Shari Redstone. For reference, a market capitalization of $30 billion would mean a share price of over $45, nearly triple the current market price. If this liquidation happens in the next two years as some analysts believe, shareholders could achieve great returns by buying the stock today.

All of this talk of liquidation ignores the very real possibility that Paramount+, Pluto TV, and all of Paramount's other subsidiary brands could become a highly profitable enterprise. I'm no expert on streaming or the advertising market (and I suspect most of the bearish analysts aren't either), but according to company guidance, 2023 will be the year of peak spending for the firm, and profitability may come as soon as FY 2024. If Paramount achieves both profitability and the sales of its non-core segments, value for shareholders could be far greater than even the 200% return that may be possible in a liquidation scenario.

Profitability Projections

I'll start these projections with some simple arithmetic on streaming: 100 million subscribers at $10/month revenue per user (RPU) would put Paramount+ at a revenue of over $12 billion per year. CEO Bob Bakish has stated that PARA's target is $5-6 billion per year in content spending, which should serve to gradually improve RPU. In this hypothetical scenario, then, Paramount+ alone would be profitable to the tune of $6-7 billion per year. At just a 10 P/E ratio, the successful streaming service (without all of PARA's other assets) could be valued at $60 billion, nearly six times the market valuation for the entire business. This may seem like a lofty goal, but consider that Paramount+ had over 60 million subscribers as of the end of Q1 2023, and Paramount+ remains one of the fastest-growing streaming services. Keep in mind, as well, that Netflix's valuation is currently $194 billion.

Of course, that scenario would be an optimistic outcome for Paramount, but it is not unreasonable to expect similar results. Q1 saw subscriber growth of 4.1 million. At that rate, Paramount could achieve 100 million subscribers by 2026. If growth slows, and that subscriber level isn't achieved until 2030, the firm's price appreciation to $60 billion would still show a very high compound annual growth rate of 29.1%.

While growth could slow or stagnate even more than that estimate, the immense margin of safety provided would be more than enough to justify overweighting Paramount's stock.

Valuation & Modeling

For a more direct quantitative analysis, I have employed a residual income valuation model . Residual income valuations are based on a combination of factors: a "clean surplus accounting" book value, which includes adjustments for dividends and share buybacks; "residual income," defined as net income above a certain return on equity; and a terminal value to estimate the long-term growth (or decline) of the business. While Residual Income modeling isn't the most common way to value a business, it has been shown by multiple studies, including Ohlson (1995) that the model has significant predictive value.

As a general rule, it is most effective to use conservative estimates in financial modelling, so my assumption is a permanent 2% annual decline in residual income to reflect a sizable annual decline in cable viewership which is not offset by streaming growth (as is a bear-case scenario for Paramount). The result of this valuation is that Paramount could be reasonably valued at about $24.7 billion, or $37.91 per share. Clearly, at current prices of $16/share, PARA shares are trading at a substantial discount to fair value.

Risk Factors and Possible Results

There are, in my view, three basic possibilities for Paramount's future.

The most likely scenario is that Paramount's growth is fairly sustainable and the firm will achieve profitability. If this happens, the market will almost certainly have to re-value the firm, which should result in significant price appreciation.

Another possibility that would benefit shareholders is if CEO Bob Bakish determines that the company cannot achieve significant profitability and it needs to liquidate its assets immediately. This would be much riskier for shareholders, and the volatility that comes with liquidation would not be for the faint of heart, but in the end it's very likely that PARA could liquidate for a significant premium over its current stock price.

The third possibility, and the one I believe the market is assuming, is that Paramount fails to achieve streaming profitability and the controlling shareholder, Shari Redstone, will refuse to sell or liquidate until the firm is worthless. This is a real risk that investors should not discount, especially given the fact that Sumner Redstone, Shari's father, originally built the company. If Shari refuses to acknowledge the reality that Paramount won't be profitable (if indeed that is the reality), it could lead to serious losses and a continuation of the current downward trend for PARA shares.

Another major risk is an unfavorable interest rate environment. Paramount does carry a large debt burden, totaling around $35 billion in liabilities. In a sustained high-rate environment, the firm may have trouble making interest payments and could have to liquidate at an inopportune time, and through bankruptcy rather than voluntarily selling off the firm's assets.

Conclusion

Paramount Global shares are currently trading at a substantial discount to fair value, regardless of whether that fair value comes from an income model or from its liquidation value. If the streaming segment is not successful, it's likely that shareholders will receive a significant premium to the current share price after either a sale or liquidation. If streaming is successful, though, the upside is even greater. I strongly encourage readers to buy Paramount Global shares, particularly the Class B non-voting shares ( PARA ).

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