Why the market is wrong about Paramount Global (NASDAQ:PARA)


Andrew Burton

Investment thesis

Paramount shares (NASDAQ: PARA, NASDAQ: PARAA) have fallen more than 20% since its last quarterly report. This is largely due to the slowdown in linear television, streaming and advertising. But the company continues to show healthy growth in paid streaming subscribers. I believe its best-in-class television ecosystem will continue to be a competitive advantage.

Advertising will likely remain a source of volatility. But I think there are significant tailwinds in the second half of the year. Overall, I think the stocks are undervalued at the current price.

Cord-cutting and headwinds to profitability

Paramount reported another quarter of strong results. Revenue was up 19% year-over-year, driven by strong growth in streaming and theatrical releases. The company’s flagship Paramount+ added 4.9 million new subscribers during the quarter. These are the best subscribers and net additions results of any streaming service during the quarter.

But the company’s advice was more moderate. Management did not withdraw its 60% revenue growth target from DTC, but noted that it could miss it by a bit. The current environment is volatile. Management has limited visibility over the second half of the year.

The shares are down more than 20% since that earnings announcement. Part of this poor performance is due to concerns about Paramount’s linear television ecosystem. Last quarter, Paramount’s TV Media segment generated $1.38 billion in adjusted EBITDA. That’s down 8% year over year. The cord cut is happening faster than analysts had expected. The total number of pay-TV subscribers fell by 8.2% in the second quarter.

These legacy media segments are a key part of my bullish thesis. Paramount’s direct-to-consumer segment continues to experience significant operating losses. But its other media segments are still generating a solid profit. Content created by these traditional media segments can then be added to Paramount+. This model effectively subsidizes the company’s streaming content. This ecosystem is critical to Paramount’s long-term success.

Primordial properties

Paramount Media Properties (Paramount Second Quarter 2022 Earnings Press Release)

Paramount’s profitability is therefore still largely exposed to linear television. The company derives the vast majority of its operating profit from this segment. The broader linear TV ecosystem is experiencing headwinds. But overall, I think Paramount can be more resilient. The company’s CBS network is consistently the number one network for a number of metrics. It was the number one network for the twentieth consecutive quarter. Paramount had seven of the ten most-watched programs. I think that can help Paramount fight those profitability headwinds. Segment revenue is actually up about a full percentage point year-over-year.

Additionally, the company offers many sports on its CBS network, such as the NFL and PGA. The company recently acquired the rights to the Big Ten conference in a joint deal. He also renewed his right to wear the UEFA Champions League. These programs require viewers to interact with one of Paramount’s services. This should help retain linear TV subscribers. Cord cutters will also be pushed to Paramount’s streaming offerings.

Advertising sweetness

Paramount’s advertising business was weaker in the quarter. Within the company’s TV Media segment, advertising revenue was down 5% year-over-year. Total ad revenue was down 2% year-over-year or flat in constant currency.

This hurt Pluto TV, Paramount’s FAST service. Pluto reported a 33% year-over-year increase in monthly active users, but only a 10% increase in revenue. This means revenue per monthly active user was down 17% year-over-year. But management says there are tailwinds that could boost ad revenue in the second half. They discussed these dynamics during their last earnings call.

As we look to the future in this advertising market, there are two things I would like to note. First of all, we’re really happy with how the upfront went and especially the volume dynamics, which increased nicely. Second, there are two significant tailwinds in the new category that we will likely see late in Q3 and certainly in Q4. The first concerns pharmaceuticals. It came back big at first. It’s super important to us because it’s a big category for us given our demographics and specifically CBS demos.

And the second is political. We expect the publicity related to the medium term to be very strong given what is happening there. And I would note that historically it’s really been a station thing and for sure it’s going to be a station thing this year. But also with targeting, we see IQ and Pluto playing it and therefore benefiting from it as well.

Political and pharmaceutical spending should help boost ad revenue in the second half. These are spaces where Paramount is better positioned than its competitors. I think the company can take advantage of the current situation. It can improve its user count and engagement when ad revenue starts to come back.

Strength of paid subscribers

Paramount’s paid streaming services are still doing quite well. The company added 5.2 million subscribers during the quarter. 4.9 million of those ads were associated with Paramount+. The company grew Paramount+ subscribers by 102% year-over-year and revenue by 120%. This indicates a solid expansion in paid ARPU of 9% year-over-year. It’s promising that Paramount is increasing paid ARPU without a direct price increase. The company’s model allows it to generate ARPU growth without a price hike.

Main schedules direct to consumer subscribers

Paramount Q2 2022 Trending Calendars

Paramount’s other paid streaming metrics are still strong. Titles watched per user have increased. Hours watched per active user also increased. Management says this has significantly reduced subscriber churn. This is a promising sign for the future.

The company continued to expand its services in international markets. Paramount+ has launched in the UK, Ireland and South Korea. The company plans to launch in Italy, Germany, Switzerland, Austria and France in the second half. Paramount’s partnership strategy with local broadcasters is a competitive advantage. This gives the company low churn subscribers at a cheap customer acquisition cost. This should be a continued tailwind for subscriber growth next year.

Cheap price and reduced debt burden

Paramount is still trading at a cheap valuation. The company has a 3.5x LTM P/E and a 0.41x P/S. The company is still heavily indebted, with $15.8 billion in debt on its balance sheet. Adjusting for net debt, the company has an adjusted EV/EBITDA of 6.9 times. I think that’s a cheap valuation for a company with that profile.

Balance sheet and vital liquidity

Paramount Second Quarter 2022 Earnings Press Release

Paramount has good liquidity, with $4 billion in cash and an undrawn credit facility of $3.5 billion. The company is also reducing its debt. During the first half of the year, the company repaid $2.39 billion of its debt due before 2026. In its place, the company issued $1 billion of debt due in 2062. Although this burden of debt amounted to 3.4 times adjusted EBITDA, the company has very long-term debt. This, together with asset sales, should improve the company’s net debt position.

The company has started to generate positive free cash flow again. But the company is still struggling with cash generation. The company reported free cash flow of $440 million in the first half. That barely covers the company’s quarterly dividend.

Management expects maximum losses in 2023. It will likely take some time before the company starts generating significant cash. Until then, the quarterly dividend will likely be the only direct return for shareholders. At the same time, it yields more than 5% at the current price. That’s solid, especially if Paramount is earning free cash flow to pay for it instead of covering it with cash on hand.

There are still risks associated with critical business transformation. But I think the risk-reward ratio is very favorable at the current valuation.

final verdict

Paramount is still going through a risky transition in its business. Headwinds from linear television and advertising further depressed the stock price. But I think the bull case is still intact. The company’s paid offerings continue to bring in fantastic metrics. I believe Paramount shares are undervalued at the current price.


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