I (Don't) Want My MTV: a Post-Mortem of an Investment Gone Wrong
Bad Investments Often Provide the Best Insights
The Rise and Sudden Fall
Just a few months into my new job in late 2011, I convinced my team to invest our clients’ money in Viacom. Within about two years, the investment had doubled, representing a nearly $100M position for my firm.
I felt unstoppable. I was routinely meeting with Viacom’s CEO and COO—two of the most powerful and well-paid media executives in the world—to discuss the company’s financial prospects. Still in my 20s, I was making clients huge amounts of money based on my research, and my colleagues viewed me as an invaluable asset to the firm.
By 2015, the picture had dramatically changed. Rumors were spreading that Dish Network would drop Viacom’s line-up of expensive cable channels (Nickelodeon, MTV, VH1, etc.) because viewers didn’t want their content. And other distributors like Charter and DirecTV were threatening to drop Viacom as well. Then Viacom’s ratings fell out of bed, and profits began to slide—seemingly confirming distributors’ taunts that Viacom was becoming irrelevant. Reflecting the litany of bad news and sliding profits, Viacom’s share price bled lower week after week.
While we had sold out of about half the position as the share price moved higher, I anguished over the remaining position we held. Almost more painful then the financial impact was the feeling of being wrong and realizing I had just gotten lucky in the early part of my investment.
By pure chance, in July 2015, I got so disgusted with management’s shifting narrative and denial of clear pressures facing the industry that I sold our entire remaining stake in Viacom about 30% higher than our initial cost. I breathed a sigh of relief but wondered whether I had exited at the bottom.
Two weeks later, Disney’s Bob Iger warned that his company’s stalwart lineup of channels was also facing ratings issues. That caused the share prices of all linear TV content companies to collapse. From there, Viacom bled even lower as the reality of a changing TV ecosystem settled in.
While I had escaped largely unscathed, not having lost money on the Viacom bet, this outcome was mostly driven by luck. Importantly, my investment significantly underperformed the broader market. How had I gotten here, and why did I invest in Viacom in the first place? How would I avoid stepping into another value trap like Viacom? These were the questions I grappled with at the time and still reflect on today. While it was a painful experience, my Viacom mistake provides a rich set of lessons on investing.
The Initial Set Up: A “Cheap” Multiple and Convincing Management
I had always loved media and knew the sector had rich profit pools, so it was a natural industry to gravitate towards early in my career. In assessing the media landscape, I decided radio, newspapers, and local broadcast were challenged sectors. Streaming was a nascent industry that seemed highly speculative. But traditional content providers to the linear TV market seemed intriguing: pay TV subscribers were still growing, albeit very slowly, and both advertising and affiliate revenue (the per subscriber fees cable and satellite companies paid the content providers) were growing at attractive rates, mostly due to pricing.
Viacom in particular caught my eye because it was so cheap. The company traded at a 10-11x P/E ratio, while the broader S&P 500 traded at a still very cheap 13x P/E. In addition to trading at a discount to the market, Viacom’s multiple was significantly cheaper than peers like Discovery Communications, which traded at around 17x in late 2011.
The reason for the valuation discrepancy was that Viacom’s most important network, Nickelodeon, had seen its ratings fall out of bed.
The bears argued that the rise of Netflix, YouTube, and other modern media created alternatives to Viacom’s stale lineup. In the old days of linear TV where there were few alternatives, kids had to watch Nickelodeon, Disney, or PBS. But in the new fragmented media environment, the bears argued, children watched what they wanted, and that meant less and less Nickelodeon. The obvious conclusion was that MTV, VH1, Comedy Central, and Viacom’s other assets would face the same fate.
This problem would only become more acute over time, the bears argued, because the company’s lawyer turned CEO—Philippe Dauman—was a suit with no creative vision. Installed by controlling shareholder Sumner Redstone, Dauman managed Viacom as if it were manufacturing widgets. Dauman’s mantra was that costs needed to be optimized to drive margins higher. He gutted investment across the board, including at the once venerable Paramount Pictures, Viacom’s movie unit. Dauman promised that the ratings decline was temporary and on the other side investors would be rewarded by stable revenue, higher margins, and a massive share buyback.
Redstone protected Dauman at all costs. Competitors and many investors questioned Viacom’s strategy and argued Redstone was out of touch and potentially even being manipulated by Dauman.
Somehow Dauman’s narrative appealed to me. I liked the contrarian nature of the investment, and I loved the valuation. Furthermore, his commitment to not reinvest profits in acquisitions or growth projects and to instead focus on massive share repurchase seemed like a low-risk but high probability means to growing EPS.
After carefully evaluating past ratings declines and subsequent recoveries, I concluded Nickelodeon’s viewership contraction was indeed an aberration and that ratings would recover. Furthermore, I built a massive network by network financial model projecting earnings and cash flows, concluding that the sheer amount of cash being produced would protect investors even if ratings stayed low. But I wanted to meet management first, so I arranged a meeting with Viacom’s COO Tom Dooley.
Dooley invited me to Viacom headquarters in Manhattan’s Times Square. The COO offered me a full hour in his office to discuss Viacom’s ratings, the media landscape, and the company’s financial situation. Dooley was incredibly affable and down to earth, and we almost immediately connected over a shared travel experience. His thick New York accent conveyed a salt of the earth approach despite his clear success and stature. Gazing out at the Hudson River from his office’s spectacular array of windows, I was convinced. Within a day we bought a substantial stake in Viacom.
Looking Good Louis…Feeling Good Todd!
Much like Louis Winthorpe III in Trading Places—before he is fired and rendered homeless by his greedy and racist uncles—I felt like my investment in Viacom was looking good, and I was certainly feeling good.
Nickelodeon ratings did start improving. As a result, advertising revenue began growing in 2013. Meanwhile, affiliate revenues continued to power higher as Viacom imposed roughly 10% annual price increases on its distributors. In addition, the company began a massive share repurchase of $3-5Bn annually, representing roughly 10% of the company’s market cap at the time. Amazingly, the company even levered up to repurchase even more shares than its free cash flow alone would allow. This drove the share count lower and thus EPS substantially higher.
The market responded favorably, and I felt vindicated as the share price ripped higher.
A Changing Landscape: Viacom in Denial
Although Viacom’s share price marched higher in 2012 and 2013, the world was changing. The distributors of pay TV began consolidating, led by Charter, AT&T, and Altice. A key motivation of this consolidation was to squeeze down content providers relentlessly raising pricing on distributors despite stagnating viewership.
Over the subsequent two years, I repeatedly met with management of Viacom, its competitors, and its distributors. A consistent narrative evolved among Viacom’s competitors: they began acknowledging ratings pressures and planning for a fragmented, unbundled TV environment with much more competition. Distributors tired of sustaining pricing increases began openly saying that certain linear content providers like Disney were relevant, but others like Viacom were less relevant given the proliferation of streaming substitutes.
Meanwhile, Viacom management seemed to be in complete denial. CEO Philippe Dauman would sit in investor meetings and on quarterly calls delivering rambling and long-winded answers to tough questions, effectively running out the clock like a savvy lawyer. COO Tom Dooley acknowledged some pressures but began talking up a new content push.
Somehow, I got strung along by Viacom management. I actually had invested in Charter by this point and fully believed in the distributor consolidation thesis Charter was executing. But I denied the damning reality that Viacom was in trouble.
I also took comfort in my complex model, which kept projecting large cash flows, despite the obvious headwinds. When times got tough, I would tweak my model and constantly apply 10-12x multiples on out year cash flows that were juiced by buyback. The false precision of my model provided comfort in a rapidly changing industry.
But before I knew it, Viacom’s troubles materialized, exactly as a rational person would have predicted. In April 2015, Viacom took a $785M write-down and suspended its share repurchase as viewership began declining. Profits were now clearly in structural freefall.
Meanwhile, management had been buying back stock at absurdly high prices. According to Reuters: “between October 2012 and March 2015, Viacom spent about $9.7 billion on buybacks, at an average cost of $73.58 per share. Viacom’s busiest quarter of share repurchases was in the quarter ending September 30, 2013, when it bought back about $2.7 billion in stock at an average price of about $80 a share.” By July 2015, Viacom’s share price was $57.00.
Management clearly had no clue what it was doing in terms of capital allocation. Rather than exploring acquisitions of competitors to gain scale, pursuing a direct to consumer business, or reinvesting in its existing networks, Viacom management bought back billions of dollars of its own shares at inflated prices.
I finally exited the position in July, disgusted with management’s constant excuses and unwillingness to accept responsibility for terrible capital allocation.
Conclusion: Lessons Learned
I learned several lessons from my investment in Viacom.
Lesson 1: Don’t focus on valuation first.
I had first been attracted to Viacom because of its valuation. I took comfort in a 10x P/E. Amazingly, the company traded as low as 5x NTM P/E, so clearly valuation hadn’t provided much support.
Lesson 2: Focus on quality
Ever since my Viacom debacle, I have focused my investing on quality first. In my estimation, a company must have a durable competitive advantage that leads to attractive returns on capital at the unit level. Moreover, it must have an attractive reinvestment opportunity at high incremental returns, ensuring sustainable growth. In many ways, Viacom was the exact opposite.
I still focus on valuation for entry point and seek attractive multiples, but I never will invest in a company because it’s “cheap.”
Lesson 3: Evaluate Management Without Being Coopted
Evaluating management is critical, but management teams tend to hold their leadership positions because they’re talented at convincing others to follow them. They tend to be very affable, which can distort one’s judgement. And they exude power (even if they’re not charismatic), which can influence investors.
I firmly believe in evaluating management and their incentives. And I like to talk to management periodically. But I now am very cautious about my interactions with management and investor relations department; I seek a healthy distance. I think reading transcripts of quarterly calls and conferences can tell you a lot while lowering the risk of management coopting you. Carefully reading proxies to evaluate incentives is a must. Talking to former colleagues can also offer great insights. And evaluating a management team’s past actions and track record is critical.
Lesson 4: Don’t Take Comfort in Complex Models
My background in investment banking and private equity led me to always built highly complex three-statement models. These models gave me a false sense of comfort, and I would fall back on them in times of uncertainty.
In reality, a very simple model is way more powerful. More than anything, I seek to understand unit economics, and my models today seek to distill great complexity into a simple projection of future earnings and cash flow.
Lesson 5: Be Wary of Underinvestment
Earlier in my career, I viewed M&A as highly risky. Share repurchase and dividends seemed like great ways to ensure management teams didn’t torch shareholder value on vanity projects. However, I have developed a much more nuanced view. I now view companies that reinvest most or even all cash flow in the business as potentially great capital allocators, as long as the incremental returns on this reinvestment add up. I would much rather a management team spend all operating cash flow on a capex project if the returns are high and durable than on share repurchase or dividend.
I’ve seen the risks of underinvestment play out time and time again. Disney and Viacom are great examples of disastrous underinvestment and smart reinvestment, respectively. Disney thoughtfully has committed to investing in its assets to transform the business, sacrificing near-term earnings and cash flow for a long-term payoff. Viacom refused (until recently with new management now following the Disney path) to reinvest and in fact laid waste to its asset base in the name of margin and earnings optimization. The long-term results were terrible.
Lesson 6: Be Wary of Financial Engineering
Given my background in private equity, I used to look favorably on companies that used aggressive financial engineering to drive shareholder returns. Today, I recognize financial engineering can play a role, but underlying business fundamentals are far more important.
If a company is generating copious cash flow and can’t reinvest that cash flow, then aggressive share repurchase, or even levered share repurchase, can make sense. But share repurchase and leverage should be an output of a great business with excess cash, not the goal.