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Monday, November 13, 2006

That's the Way it Was

From Value Discipline

Years ago, that was the sign-off for Walter Cronkite on CBS News. Back then television and broadcasting were in their heyday.My purpose is not to reminisce, but rather to find today's parallels to what were very exciting times! In a lot of ways, Central European Media Enterprises (CETV) represents today's version of what was.

Central European Media Enterprises is the leading broadcaster in Central and Eastern Europe, operating thirteen networks in six countries and reaching about 92 million viewers. Launched in 1994, CETV, along with its local partners, operate ten stations that include TV Nova and Galaxie Sport in the Czech Republic, PRO TV, Acasa and PRO CINEMA in Romania, Nova TV in Croatia, Markiza TV and Galaxie Sport in the Slovak Republic, POP TV and Kanal A in Slovenia and Studio 1+1 in Ukraine.

Eastern European economies are growing at a much faster pace than the established Western European or US economies with growth rates of some 10-12% per annum. Advertising spending is still in its germinal stages accounting for only about 0.50% of GDP versus Western Europe at about 0.90% of GDP and the US at about 1.25% of GDP. As these markets grow in their sophistication and pricing, revenue growth for CETV should be some multiple of GDP growth over the next four or five years. This is particularly true as Eastern European society develops into a more consumption focused society.

CETV ranks first in each of its major markets except Croatia (where the network is only 2 years old) and receives over 50% of advertising revenues. To its viewers, CETV appears to be a local broadcaster so language, content, and independent local news seems to be authentic and local.

Like North America, the main barrier to entry is regulatory...government regulation determines the number of signals or channels that are allowed.

In last week's Wall Street Transcript (subscription required) there is an interview of the CEO Michael Garin and the CFO Wallace MacMillan. Michael Garin has an outstanding background in media having started at Time Inc (wel before AOL and Warner) and in co-founding Lorimar Telepictures which ultimately was sold to Warner Communications. He was a first rate investment banker at a first rate firm for entertainment and media investment banking, Furman Selz. He has extensive board experience in Europe including Cablecom, the largest cable TV company in Switzerland and Canal Plus Nordic, the top pay TV provider in Scaninavia. MacMillan was a finance type with Bertelsmann, Virgin Music, and EMI.

Garin describes the strategy as follows:

"Our revenues are approximately $500 million. Our EBITDA is approximately $200 million, so our company is of significant scale. We have two sets of aspirations looking forward to our future. One is to increase the number of outlets that we have within the current six countries in which we operate and also at the same time, to be a leading provider of media, including the Internet, telphony,and other forms of new media communications. The second is to remain the dominant broadcaster in each of our countries."

The Eastern European world looks quite different than what we are used to. Cable penetration in the Ukrained is only about 20% Only about 10% of the audience will be reached by broadband Internet access by 2011. The competitive advantage period appears to be elongated by these circumstances.

Cost advantages also seem to be sustainable. The cost of production can be amortized over a much bigger scale and bigger audience compared to its competitors. For some programming, the unit costs can be half that of the competition. Local culture can be respected, neighboring and adjacent cultures can be served with common programming and hence provide synergies.

EBITDA margins are very sizable at about 49.6% for the TTM period. This is about twice the profitability of a US TV network.

The recently reported third quarter seemed to disappoint some investors with a slight revenue miss. The stock traded down about 4% on Friday.

Regrettably, this kind of excitement comes at a fairly substantial price. The stock is trading at about 21 times TTM EBITDA and 29 times TTM EBIT, a royal price indeed. Given its growth attributes and acquistive nature, the business has yet to generate any free cash flow. Surprising, given the huge EBITDA margins.

Earnings estimates for next year on the Street range from $2.22 to $3.12. Such a range! The street remains quite bullish here with only two hold opinions and six buy/outperforms.

Discipline demands that one separate a good story from a good stock. The margin of safety at current levels is nil, the stock is fairly valued in my opinion, given the superb economics of its growth. Great story, great management, great properties but not enough downside protection at current prices.

Disclaimer: I, my family, and clients do not currently have a position in CETV.

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