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, <ul> <li>(new) Viacom, consisting of cable networks and entertainment brands</li> <li>CBS, consisting of broadcast networks</li> </ul>

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