Transcendental Generalization

Originally broadcast Thursday January 26, 4:30 PM EST and available at www.cbscorporation.com.

Highlights:

CEO Leslie Moonves and CFO Fredric G. Reynolds spoke.

2005 earnings are expected to be released the 3rd week of February.

CBS Corporation announced a two-cent increase to the dividend yielded by the old Viacom. With this increase, CBS leads a peer group of $20 billion market-cap companies in yield, but trails the peer group’s P/E (16-17).

CBS is exploring divestiture of Paramount Parks because it is not a content-driven business.

The company plans to focus on growing revenue and profits, exploiting content across traditional and new digital platforms (hence recent deals with Google and Comcast). The company wants to maintain an “investment-grade balance sheet” and return a portion of cash-flow to owners via dividends. Share re-purchases are not expected in the short-term. Expect revenue growth in low to mid single digits and EPS to grow in mid to high single digits.

A nice article by Richard Bach, author of The Automatic Millionaire .

After reading Joel Greenblatt’s You Can Be a Stock Market Genius, I have been on the lookout for special situations–mergers, acquisitions, and spinoffs. The attractive investment instruments often created in such situations (stocks, bonds, warrants, options, etc.) remind me of the exotic short-lived varieties created in when particles are fused or split in accelerators.

One special situation I have been following closely is Viacom’s spinoff of CBS. Others worth looking at:

• Disney’s acquisition of Pixar
• McDonald’s spin-off of Chipotle Mexican Grill (yum!)
• Tyco’s split into three different companies
• Cendant’s split into four different companies
• First Data’s spin-off of Western Union
• Update: Altria is considering spinning off Kraft. (The June 2001 IPO of Kraft was not a “spin-off”.)
• Update: Time Warner is considering a spin-off of AOL.
• Update: Home Depot is acquiring Hughes Supply Inc.
• Update: Valley National Bancorp and BankAtlantic Bancorp may get sold (subscription required) in the near future.
• Update: Merrill Lynch and BlackRock are forming an investment management firm.
• Update: Sovereign Bancorp’s sale of a 20% stake to Banco Santander Central Hispano SA.
• Update: Halliburton’s proposed sale of a 20% stake in KBR.
• Update: Sara Lee has spun off Hanes Brands
• Update: Sprint has spun off Embarq

IPO Home aggregates good information on IPOs and spin-offs.

Don’t throw flourescent (or compact flourescent for that matter) bulbs in the garbage! They contain mercury which could enter the water supply and which is hazardous to human health. Earth 911 is a great site for finding out how to dispose of household hazardous waste. You just enter your zip code and it tells you about local facilities for safely disposing of old computers, cellular phones, NiCd batteries, flourescent bulbs and other household hazardous waste.

Blackberry users should check out this hilarious video. Warning: brief nudity! Via greg hughes - dot - net.

Previously in Transcendental Generalization:

Geocaching “gee-oh-cash-ing� is a new form of recreation facilitated by inexpensive Global Positioning System components.

This article on CNN discusses the sorry fates suffered by some geocaches, at the hands of law enforcement sensitive to terrorist threats.

I conclude that CBS is trading at a significant discount to its fair-market value. There is an opportunity to make a significant gain in a relatively short time as the value of this business becomes apparent to the broader market. Furthermore, a chain of options including LEAPs (Long-Term Equity Anticipation Securities) is available, allowing an investor large amounts of upside with limited downside.

This appears to be a case straight out of Joel Greenblatt’s You Can Be a Stock Market Genius .

Viacom announced in early 2005 that it was going to split into two publicly-traded companies,

• (new) Viacom, consisting of cable networks and entertainment brands
• CBS, consisting of broadcast networks

Viacom filed an amended S-4 on November 23rd [4]. As discussed in that document,

The separation will provide investors two largely pure-play investment options that may be more attractive than one combined company…New Viacom may be more attractive to investors who wish to invest in the potential of the pure content business and who believe that New Viacom offers more share price appreciation potential due to its ability to employ its anticipated cash flows to reinvest in its businesses and engage in complementary acquisitions, and CBS Corp. may be more attractive to investors who wish to invest in the potential of the mass-media business and who are interested in receiving a dividend that represents a higher payout ratio than Viacom’s current dividend…After the separation, New Viacom will have the opportunity to finance acquisitions with its own equity.

CBS would be allocated a majority of the debt ($7 billion vs. $3.7 billion) and a minority of the historical earnings ($982 million vs. $1.1 billion for the nine months ending September 30, 2005) of the old Viacom. Furthermore, Viacom’s $18 billion loss in the fourth quarter of 2004 would be allocated to CBS. Considering this, CBS might be considered “toxic waste” in the breakup of the company, discouraging institutions from doing further research on the stock.

However, a number of factors encourage further consideration of CBS.

1. A literature search yields far more press surrounding announcement (in March of 2005) of the split than around the actual split itself (January 1st, 2006). Indeed, even though the split has been consummated, recent press surrounds Paramount’s (a new Viacom company) acquisition of Dreamworks SKG, and is silent on CBS. It may be that ignorance about CBS could be depressing its price. Furthermore, The Economist in June described CBS as a “slow-growing company” [5]. This may draw attention away from CBS, but even slow growth can allow stock market gains.
2. All of old Viacom’s dividends are expected to be distributed to CBS shareholders [4].
3. Leslie Moonves, the new CEO of CBS, is younger (56 vs. 60) than and will hold more stock options and a command a higher salary ($5.7 million vs. $4.2 million) than Thomas E. Freston, the CEO of the new Viacom. In fact, he will earn a higher salary than Sumner Redstone, the chairman of the board.
4. The 2004 loss was due to a one-time charge ($10.43 per share) for accounting of goodwill [1,2,3]. Excluding this charge, CBS grew profits to $1.84 (2 * $10.43 - $19.02) in 2004.
5. CBS trades near its book value and for only 15 times earnings projected for 2005 ($1.64 per share, assuming four-thirds what it earned in the first nine months of 2005). Meanwhile, the P/E ratio for the television broadcasting industry is 37.7.
6. A chain of call options on CBS is available, allowing an investor to buy, for a fraction of the stock price, the right to purchase CBS for $25-$30 dollars. If the stock rises, then such options will grow in value dramatically. If it falls, they could expire worthless.

It seems reasonable to expect CBS to announce a profitable 2005, a profitable 1st quarter of 2006, as well as a quarterly dividend. These well-publicized events should cause investors to assign a P/E multiple closer to the peer group’s multiple, resulting in a stock price at least twice what it is today.

[1] DVD Dip Tugs Viacom Bottom Line, Video Business, February 28, 2005
[2] Sherman, Jay, Viacom Loses $18 Billion in Fourth Quarter, Television Week, February 28, 2005
[3] Viacom Inc. Form 10-K for the fiscal year ended December 31st, 2004
[4] S-4/A, Amendment Number 1 to Form S-4, filed November 23rd, 2005
[5] Old and New Media Part Ways, The Economist, June 18, 2005

Despite a couple of flaws, this book is worth reading and I even found it worth giving as a gift. First the flaws:

• The book is sprinkled with occasional suggestions to attend the author’s educational seminar, and even to pay big bucks for it. That said, if you buy the book, you can apparently get two free tickets to the course.
• To further his own arguments, the author occasionally misrepresents referenced authorities on finance.

If you’re the type to throw the baby out with the bathwater, then you won’t get past these flaws, so don’t waste your time with this book.

This is more of a motivational seminar than a manual of personal finance. Sort of a featherweight version of The Seven Habits of Highly Effective People, it’s primarily about changing patterns of thought that obstruct people from making money and achieving financial success. It assumes (not unreasonably, in my opinion) that once this internal battle is won, opportunities for financial success will become readily apparent and surprisingly easy to exploit. The heart of the book consists of 17 “wealth files,” statements contrasting the thoughts and attitudes of “rich people” with those of “poor people”. Each is accompanied with affirmations and exercises to help the reader internalize changes in thought and attitude.

I suggest borrowing it from the library (like I did) for a fast read. Buy it if you then feel committed enough to work through the exercises.

This book by David F. Swensen, Chief Investment Officer and manager of Yale’s endowment, contains some of the driest prose I have ever encountered. However, the content is solid, comprehensive, well-informed, and backed up by Swensen’s years of success as well as his research into the history of a variety of markets.

Swensen reminded me that markets lacking liquidity and frequent pricing (like the real estate market) are fertile ground for inefficiencies that present lucrative investment opportunities.

He had the following to say about Wall Street Research:

Wall Street research suffers from a number of significant problems: it comes from conflicted sources, tends to represent consensus positions, and enjoys wide distribution…Reports circulate widely as investment banks attempt to gain the largest advantage possible. The wider the distribution of information, the less value it has, as the implications of the report become incorporated into security prices in short order.

I had also discussed this previously in Transcendental Generalization:

…I have learned not to trust analysts. It is not that they are stupid, but they are highly motivated to publicize their reports, which the market responds to quickly.

One of the most interesting things Swensen does is compare high-risk private funds (e.g. leveraged buyout funds) with lower-risk equity index funds. For an apples-to-apples comparison, he normalizes the amount of leverage, concluding that a similarly leveraged investment in the S&P 500 beats the performance of buyout funds by nearly 40% annually. This is despite a couple of biases in the data favoring buyout funds, and doesn’t include management fees that such funds charge. This suggests that superior returns are available to the average investor, and not just to the wealthy who can invest in leveraged buyouts.

The book is (naturally) written from the perspective of the institutional investor. Hence, it includes chapters on choosing, negotiating with, and managing people and companies to invest your money. However, there is also a wealth of guidance for investors managing their own money.

Swensen eloquently discredits the efficient-market hypothesis by referring to the work of a fellow Yale professor:

Yale economist Robert Shiller argues that markets exhibit excess volatility. That is, security prices tend to fluctuate more than necessary to respond to the fundamental factors, such as earnings and interest rates, that determine intrinsic value. In other words, “if price movements were rescaled down…so as to be less variable, then price would do a better job of forecasting fundamentals.” Shiller’s self-described “controversial claim” provides “evidence of a failure of the efficient markets model.” Anyone attempting to understand October 1987’s market crash from a fundamental perspective sees merit in Shiller’s position.

He also makes what I consider to be a critical distinction between volatility and risk, a distinction that is frequently neglected by economists and investors:

Under some circumstances, following a significant decline in price, an asset actually becomes less risky, since it can be acquired more cheaply. The common-sense conclusion of bottom-fishing invstors contrasts with the statistician’s conclusion that a dramatic drop in price increases observed (historical) volatility, implying a higher risk level for the asset.

This article on attaining independent wealth is one of a series I wrote, trying to distill a complex subject down to a single page of text (and in other cases, graphics).

I don’t claim to have mastered this subject, nor to have conveyed its full depth so briefly. I do hope to communicate, in simple terms, the principal steps to attaining independent wealth. I also hope to motivate others to pursue this path with guidance from the referenced authorities on the subject.