Free cash flow drives returns
Television content producers have experienced an impressive year, as the value of the content they produce has climbed quickly, reaching growth rates of 10% or more per year. As we discussed in Part 1 of this series, the free cash flow produced as an outcome of their strong operational performance has been a central driver of returns on the stocks. This has put many media companies’ shares on a tear of late. Over the last 12 months, shares of Disney (DIS), Viacom (VIAB), Time Warner Inc. (TWX), and CBS (CBS) have returned between 40% and 65%. CBS, Disney, and Timer Warner are members of the PowerShares Dynamic Media ETF (PBS), which provides exposure to an index of media companies. Viacom is a member of the PowerShares Dynamic Consumer Discretionary Sector ETF (PEZ).
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Aggressive share repurchases
Investors prefer companies with strong free cash flow because it raises expectations for excess cash deployment through reinvestment, debt pay-down, or increased shareholder returns. Shareholder returns can be provided in the form of dividends or stock repurchases.
Media companies that have experienced strong financial performance have satisfied investor expectations with aggressive share repurchases. Reducing the number of shares should increase each share’s value as earnings spread out over a lower share count. Viacom has been the most aggressive in buying back shares, with a 21.5% reduction in share count helping to explain the stock’s nearly 60% return over the last year. Time Warner, CBS, and Disney have bought back a total of 20.6%, 11.8%, and 7.1% of their shares, respectively, since the beginning of 2010. If the companies can continue to plow FCF into sustaining the rate of share buybacks, their stock prices are likely to continue running up as each share becomes more valuable.