Viacom getting ‘Buy’ on Street

Analysts turn positive on stock

Worries about Viacom’s prospects for completing an initial public offering of vid chain Blockbuster have dragged down Viacom’s stock price 20% in the past two months, prompting some on Wall Street to turn positive on the stock for the first time in several months.

That trend was highlighted Friday when Lehman Bros. analyst Larry Petrella upgraded his rating on Viacom to a “buy,” noting that the stock was cheaper than most of its entertainment rivals. Lehman’s upgrade sent Viacom stock jumping $2.31, or 6%, to $40.68.

Before the upgrade, Viacom stock had fallen as low as $37.56 from its high of $48.68 in mid-April (prices reflect a two-for-one stock split earlier this year).

Sliding more than most

Most of the major entertainment stocks rallied to record highs earlier this year, prompting many analysts to scale down their usual bullish recommendations for the sector. Many of the showbiz stocks have come down somewhat in the past few weeks, as the overall market has weakened, but Viacom has slid more than most.

In his note to clients Friday, Petrella said “concern over Blockbuster’s financial results, pending IPO and disposition … tend to have a disproportionate impact on Viacom’s share price, despite the highly likely separation from Viacom around year-end 1999.”

Petrella added that Viacom’s other businesses are doing well, particularly its MTV Networks unit, and the company’s balance sheet is strong in the wake of a spate of asset sales.

Blockbuster worries

Wall Streeters agree that Viacom’s stock price reflects apprehension about Blockbuster. “The market is looking weak, and people are worried about getting the (Blockbuster) deal off,” said one entertainment industry institutional investor.

“People are waiting to see what happens to Blockbuster,” said an analyst.

Some investors believe Viacom’s recent stock slump was overdone. “I don’t like Blockbuster, and I don’t really know what is going to happen with the IPO, but at $35 (a share), I don’t have a lot of downside,” said one money manager, who noted that other investors didn’t wait for it to fall as low as $35 before buying.

Viacom plans to sell about 15% of Blockbuster in a deal many analysts believe will raise $350 million to $500 million. Viacom plans to split off the rest of Blockbuster later this year.

While investor worries partly reflect how market volatility could affect the offering, one Wall Street analyst noted that investor anxiety may have grown after Viacom spelled out the wide range of risks facing Blockbuster’s business in its preliminary prospectus filed early in May.

“It wasn’t exactly a pretty picture,” said the analyst, who did not want to be identified because his firm is involved with the offering.

New technology threat

While it is standard practice for companies to set out business risks they face in prospectuses, Blockbuster’s description of its risks was unusually lengthy. The prospectus noted Blockbuster’s video rental business could be hurt by new technologies, such as video on demand or by a change in studio distribution patterns.

Blockbuster also notes that it must compete with other video rental stores and could be hurt if more pics were released in video sell-through rather than video rental.

Viacom execs have previously downplayed the impact of new technologies on Blockbuster. But evidence is growing that video on demand, now close to a reality as cablers start to roll out digital cable services, will hurt video rental.

In a recent report titled “Video on Demand is Coming — Watch Out Blockbuster,” Merrill Lynch analyst Jessica Reif Cohen noted that all market trials of video on demand “have pointed to the same conclusions. Consumers embrace the service because of the ability to control their time, greater choice and convenience as two trips to the video store become unnecessary.”

Reif Cohen estimates that after 10 years of video on demand, it could command almost half of the video rental/video on demand market.

Investors will still want in

Concern over such developments is more likely to reduce the price investors are willing to pay for Blockbuster rather than deter them from buying at all, Wall Street analysts say. In his note Friday, Petrella declared, “Viacom management is now committed to completing the IPO and subsequent spin of Blockbuster regardless of price.” Viacom declined any comment about Blockbuster.

Petrella estimates Blockbuster to be valued at about $3 billion in the IPO but notes that a $1 billion reduction in its valuation translates to only a $2 per share drop for Viacom stock.

Blockbuster has not yet had a chance to sell its offering to the Street, of course. The company is not expected to begin its roadshow, usually a two-week tour of institutional investors in the U.S., until July, Wall Streeters say, ahead of a tentative offering date of Aug. 2.

Blockbuster CEO John Antioco is expected to make strong presentations on the roadshow, one analyst said, adding that “video on demand is clearly going to be the major issue.”

One issue which could still hurt Viacom is another disappointing earnings report from Blockbuster. The IPO was delayed by several months because the vid chain’s heavy marketing campaign has been holding back cash flow growth, even as revenue growth has accelerated. (Cash flow is earnings before interest, taxes, depreciation and amortization).

For the June quarter, most analysts are predicting cash flow growth of about 15%-20% for Blockbuster, compared with a poor quarter a year ago.