Analysis: VIAB CBS T

Before the opening bell Thursday, Viacom (VIAB) reported a top and bottom line beat with its fiscal third quarter earnings results. Revenues of $3.357 billion (+4% YoY, +6% on constant currency) topped the consensus of $3.324 billion, and adjusted earnings per share of $1.20 (+2% YoY; +3% on constant currency) exceeded estimates by $0.14.

Before we get into the great results, we first want to mention how management stated that they will not comment on potential M&A today. This of course is in reference to the ongoing merger talks with CBS (CBS) . Recent reports have suggested that a deal is close, but negotiations over the exchange ratio, which is basically how many shares of the new company current Viacom shareholders will receive, is still to be determined. As you will see from the "return to growth" results below, we think it is likely that Viacom is holding out for a better price. We expect more updates on the deal in the coming days.

"Viacom delivered another strong quarter, as our core businesses and investments in strategic priorities fuel our growth and evolution," Viacom CEO Bob Bakish said in the press release. "Importantly, we returned Domestic Advertising Revenue to growth, which is a direct result of the strategy we have been executing for the last two years and the significant progress we have made in scaling Advanced Marketing Solutions. Paramount's momentum also continues, keeping us on track to deliver full year profitability. As this quarter shows, Viacom's brands are strong, our strategy is delivering, and our investments continue to position us well for the future."

At Filmed Entertainment, revenues of $877 million (+14% YoY) topped estimates of $852 million while adjusted operating income of $85 million (+93% YoY) also exceeded estimates of $62 million. Exemplary of Viacom's turnaround, Paramount's revenue increased 14% YoY thanks to growth in licensing and home entertainment, partially offset by a modest decline in theatrical revenue. Importantly, Paramount delivered its tenth consecutive quarter of year-over-year adjusted operating income improvement - an incredible feat considering how much cash this business used to burn - and is on track for full year profitability. This momentum should continue in 2020 thanks to a robust film slate that includes titles like the Will Smith starring Gemini Man, a new Terminator, Quiet Place 2, a SpongeBob movie, and a highly anticipated sequel to Top Gun starring Tom Cruise. Plus, the TV slate looks beefed up as well. By division, Theatrical revenue was $152 million, down 27% YoY due to tough comps from last year's A Quiet Place hit and reflects strong performance of Rocketman and Pet Semetary. Home Entertainment increased 35% YoY to $161 million, reflecting a carryover of revenue associated with Bumblebee. Licensing revenue increased 29% YoY to $521 million, driven by library monetization and growth in TV production.

At Media Networks, revenues of $2.504 billion (flat YoY, +3% constant currency) was in-line with $2.517 billion consensus expectations, while adjusted operating income of $748 million (-6% YoY, -5% constant currency) was slightly higher than $709 million expectations. Breaking this segment down further, Advertising revenue increased to $1.226 billion, driven by accelerating growth in Advanced Marketing Solutions (AMS) which contributed to the 6% YoY increase in Domestic Advertising. Management believes the scale of AMS compares to the adverting businesses of market leaders Hulu and Roku, which is a product/company with larger valuations than that of the entire Viacom enterprise. As another example of how Viacom has completely turned around the company under CEO Bob Bakish's direction, this was the first quarter of YoY Domestic Advertising revenue growth in 20 (yes, 20) quarters.

Affiliate revenue of $1.189 billion (-1% YoY) was in-line with $1.192 billion estimates. The decline in revenues were driven by subscriber declines, partially offset by higher contractual rates, OTT, and studio production revenues. There was also some domestic revenue that shifted from this quarter into the next one as well. Following last week's announcement of a new carriage deal with NCTC, Viacom's management team has renewed or extended almost all of Viacom's traditional subbase. This accomplishment should reduce fears and uncertainty that typically arise when contracts are up for negotiation, much like what occurred earlier in the year with AT&T (T) . Lastly, Consumer Products, Recreation & Live Events revenue fell 18% YoY to $89 million.

Speaking more to Pluto TV, the free TV streaming service, Bakish said this product is in "hyper growth mode". Backing up this claim is the trajectory of monthly active users, which has increased to 18 million from 16 million last quarter, and 12 million from when the product was first acquired back at the start of 2019. Management expects user growth to continue as they further expand content offering and broaden distribution. Essentially, management sees Pluto as a way to reach an audience who is consuming more and more content on connected TV's, which is a group that has seen growth of 400% YoY, according to them. And what's unique about Pluto TV is that it isn't fixed cost heavy, meaning that Viacom doesn't have to pursue huge content distribution and license deals to populate the platform.

Taking a look at the balance sheet, gross debt was flat QoQ at $8.958 billion, but is down 11% YoY. Year to date net cash provided by operating activities is $1.103 billion, up from $997 million a year ago. And year to date cash flow is $984 million, up from $895 million a year ago. Just more signs of operational improvement here.

On the outlook for the remained of the year, Viacom reaffirmed full year total company revenue growth in the low to mid-single digits on a constant currency basis, with growth from both Media Networks and Filmed Entertainment. Domestic ad sales growth is expected to be "meaningful" next quarter, leading to a return of full year growth. Looking at Fiscal 2019, AMS will represent 20% of total domestic ad sales. Domestic affiliate revenue is expected to have low single digit growth. Finally, adjusted operating income guidance of down low to mid-single digits, a decline due to investments in growth initiatives, was reaffirmed. But Filmed Entertainment is expected to be profitable and Viacom hasn't delivered that since 2015.

Overall, this was an excellent quarter for Viacom, highlighted by the 10th straight quarter of year over year adjusted operating income at Paramount and the first quarter of year over year domestic ad sales growth in about five years. Long ago, management promised that its strategic initiatives would lead to a return of growth in these key areas, and while there were plenty of skeptics in the market, we are seeing this inflection come to fruition today. Bakish and his team's focus and execution in this turnaround are just a few reasons why he was tapped to lead the combined CBS-Viacom entity, whenever a deal is officially announced.

Shares are up nicely in late morning trading Thursday, and we think the stock would probably be up even more if there wasn't this uncertainty over what the exchange ratio with CBS will be. But if Viacom's last piece of negotiation was letting the market see this fantastic quarter, we are glad they didn't settle on a deal before today because we think this company is still tremendously undervalued.