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Cable Pumps Up Viacom

Media giant Viacom is on a path to report 15% earnings growth in 2008 according to Bear Stearns media analyst Spencer Wang, fueled by strong gains in cable advertising, improved ratings and growth in its international advertising business.

Wang, who made Viacom his top pick in the entertainment sector earlier this year, wrote in a research report last week that evidence is growing in support of his original thesis and he continues to believe that 2007 Wall Street consensus estimates for the company are too low. Fueling his belief that 2008 will be a strong one for Viacom are double-digit increases in CPMs for the scatter market — which he claims led to a strong upfront market this year — and continued gains in the international advertising market. For example, international ad revenue was up 6% in the second quarter — beating Wang’s estimate of a 5% increase — and comes off a 10% gain in the first quarter.

Despite the improved financial metrics, Wang noted that Viacom stock has so far been disappointing this year — the stock is down by almost 9% year to date, compared to a 7.1% decline for its large-cap entertainment peers.

“Certainly, turmoil in the broader market and poor sentiment toward the media sector in general have not helped, but, in our view, Viacom’s lackluster relative stock performance also reflects ongoing concerns about weakness in cable-network ratings and the Street’s 'wait-and-see’ attitude toward Viacom’s new management (appointed on Sept. 5, 2006),” Wang wrote.

But Wang believes Viacom’s fortunes could change next year and wrote that the primary earnings variable for the year will be growth in advertising, which accounts for 38% of its overall revenue and 58% of cable-networks revenue.

Wall Street has been concerned that ad revenue will slow down in light of ratings weakness — through Aug. 5, third-quarter ratings were down about 6.1% on a total-day basis, he wrote. Further muddying the picture is the change in Nielsen Media Research’s methodology to incorporate commercial ratings with digital video recorder viewership, so-called C3 ratings.

Wang wrote that the shift to C3 ratings clearly benefited CPMs in the upfront as fewer ratings increased pricing due to reduced supply of ratings points.

“Given that the same dynamic should occur in this year’s scatter vs. last year, we would expect to see at least similar growth as the networks witnessed in the upfront,” Wang wrote.

He added that the other positive for the scatter market is that more inventory was sold during the upfront, leaving less supply for scatter and driving up pricing.

“Coupled with continued erosion from broadcast networks, we believe that scatter pricing could be up mid-teens both year over year and relative to upfront pricing,” Wang wrote. “Assuming that 50% of the ad inventory was sold at the upfront and remaining will be in scatter would imply that overall 2008 CPM could be up about 12.7% year over year.”

Although Wang estimates that ratings will continue to erode by about 2.1% in 2008, he expects those higher CPMs and a 2.5% increase in subscribers (based mainly on typical multichannel household growth) will fuel a 5.4% rise in ad revenue for the year.

Given that expected 5.4% revenue increase, Wang believes that Viacom can report earnings per share of between $2.65 and $2.70 for the year, a 15% increase over his $2.33 per share earnings estimate for 2007.

“Overall, we remain comfortable with our positive thesis on Viacom and we maintain our 'outperform’ rating,” Wang wrote.