Investor Ross Gerber on Undervalued Media Stocks

For long-time investors in the entertainment industry, this is a frustrating time. Stock prices for most large-cap companies in the sector appear undervalued and rising interest rates reduce the likelihood of transformative transactions (Paramount-Warner Bros. Discovery notwithstanding).

Veteran money manager Ross Gerber wants entertainment companies to embrace change, adopt AI and other new technologies and move into growing businesses that attract young viewers like creator content and video gaming.

Gerber, who also appeared on a panel at TheWrap’s Grill business conference this week (more on that later), expands on these themes and shares a few picks with me.

Meanwhile, a federal judge has cleared the way for Paramount to close its acquisition of WBD, signing off on a settlement that clears the final hurdle for the deal. And one analyst tries to calculate the effect AI will have on the media and entertainment business.

Thanks for reading.

THE DEEP DIVE

No More Mega Media Mergers?

Rising interest rates are likely to put a chill on merger and acquisition activity in the media and entertainment space, according to Ross Gerber, CEO and president of Gerber Kawasaki.

Gerber, who is also the chief investment officer of the firm, which has $4.78 billion under management, has been in the business long enough to get a sense of where the winds are blowing.

“I don’t see deals getting done right now,” Gerber told The Ledger. “When rates move this quickly, it changes the numbers on every deal fairly substantially.”

Even the industry’s biggest deal, Paramount’s acquisition of Warner Bros. Discovery, is impacted by higher rates. “This is the worst thing that could have happened to them, with rates soaring,” he said. “To take on $80 billion of debt to buy Warner Bros. right now is insanity.”

Every 1% increase in interest rates created $800 million in added costs for Paramount. “You can fire people, but you reach a point where you’re hitting muscle,” Gerber said. “I don’t think entertainment is very bloated right now. I thought that maybe five years ago, certainly not today.”

High interest rates are putting a damper on merger and acquisition activity.
Large cap entertainment stocks are undervalued by the market and need to make acquisitions to boost growth and adopt new technology rather than stick to outdated business models.
Gerber Kawasaki increased its position in Take Two Interactive. The company has a new version of “Grand Theft Auto” coming out and could be a takeover target for Netflix.
YouTube is dominating video and parent company Alphabet, which also owns Google, is a “cash cow.”

Paramount’s focus on debt will benefit companies like Disney and Netflix that are not over levered, Gerber said. But even those companies should be looking to cut deals to boost their growth and attract investors.

Even though aspects of the entertainment industry are booming — movie box office ticket sales are at record levels — he believes the best of the traditional media companies are still undervalued by the market.

“The industry dynamics are changing in ways the industry itself has a hard time adapting to,” according to Gerber. He said the executives leading entertainment companies don’t know how to cope with new technologies and changes in consumer behavior.

“AI is going to revolutionize many industries including entertainment, and in a good way,” Gerber said. “I think the entertainment people are scared of the wrong thing, because with AI, you’ll be able to make content a lot cheaper.”

Scene from ‘Grand Theft Auto VI’ (Take Two Interactive)

That new technology, he argued, would be key to unlocking additional value in the industry, and with the big cap companies in particular. One example is Netflix, whose shares are down about 45% from their 52-week high and now trade below $70.

“There’s very little downside in Netflix,” Gerber said. “As a long-term investor, I look for brand names that aren’t going anywhere that are now beaten up for whatever reason.”

Gerber thinks Netflix needs to make a deal because its earnings multiple has shrunk due to slowing growth. With about $4 per share in earnings, if it can get its multiple back up to 25 times earnings, that would put the stock at $100. “I think it’s worth closer to $120,” he said.

Gerber Kawasaki recently increased its position in Take Two Interactive. The game maker has “Grand Theft Auto VI,” the most highly anticipated AAA title in years, coming out in November. “Once we get to Christmas, most kids are going to be spending half their day just on ‘Grand Theft Auto’ if the game is as good as I think it is,” Gerber said.

Another reason why Gerber likes Take Two is as a potential acquisition target: Netflix could be an acquirer when rates settle down.

“They need to take in a business that would bring in at least $5 billion a year in revenue,” Gerber said. “With Take Two, you get the last independent game publisher.”

Buying Take Two would give Netflix more IP. “You get sports games, which dovetails nicely with their move into sports,” Gerber said. “They’ve got IP with ‘Red Dead Redemption’ and ‘Grand Theft Auto.’ It would be easy for Netflix to create streaming shows based on ‘Grand Theft Auto’ and other game IP,” he said.

The games would also give Netflix an opportunity to sell ads and promote its shows.

Disney stock is also cheap, Gerber argued. “People here hate Disney because the price hasn’t risen for five years, but they forgot they got a wonderful return from 2010 to 2020.”

Gerber thinks Disney is in a perfect position to take advantage of all the different genres of entertainment. So why isn’t it getting a premium?

“Everything seems to be working at Disney, but nobody will buy the stock. It’s just been mired here. The market just doesn’t like legacy assets like cable, which are declining profitability and revenue businesses,” he said. “It’s super frustrating for me because any way you slice it, they have a great set of assets trading at a discount.”

Gerber said most large-cap media companies are wedded to old models that they would rather argue should continue than accept as broken.

An exception might be Comcast, which spun off its cable assets into Versant earlier this year, and is planning to split NBCUniversal from Comcast’s cable and broadband operations. After the split, Gerber thinks NBCU would be a good investment, particularly because of its theme parks. “I think if you separate that business, it looks much more interesting.”

While movie box offices are booming and theme parks remain popular, when it comes to screens, viewing time has moved to gaming and YouTube.

“Young people are glued to Roblox or Fortnite or Call of Duty or Grand Theft Auto. Gaming takes up a lot of the share of time that used to go to watching television and movies. Gaming has become so immersive that it’s like being in the movie,” Gerber said.

And when it comes to video, “YouTube is where it’s at,” said Gerber. Content is cheap to produce and traditional media companies are poaching YouTube creators.

“Alphabet is one of our top positions,” Gerber said, noting its strength in video as well as search and advertising with Google. “How do you not own Google? They are a cash cow. It’s really nice.”

Related: If you can’t get enough of Gerber, check out the write-up of his TheGrill panel, where he was joined by Raine partner Erik Hodge and Loeb & Loeb partner John Kulback. Their discussion about where media M&A goes from here was moderated by my colleague Roger Cheng.

DEAL SHEET

Scholastic Corp. agreed to buy Cottage Door Press, an independent children’s publisher, for about $71 million. “We view Cottage Door as a quality asset and a sound strategic fit, given Scholastic’s expertise in children’s book publishing and distribution, though likely less material to the financials in the interim,” said Drew Crum, analyst at B. Riley Securities.

Brodie Rec League raised $3.6 million in a seed round led by Lerer Hippeau and Golden Ventures. The company, which organizes adult basketball leagues with games that are officiated and filmed, is expanding into Atlanta, Long Island, New Jersey and Seattle. It operates leagues with 12-week seasons in 20 cities for more than 50,000 players in six different skill levels.

Shamrock Capital acquired a majority stake in Saylor, a social media agency. Saylor will merge with Mutiny, a gaming agency acquired by Shamrock in February. Financial terms were not disclosed. Will Trowbridge will remain CEO of Saylor, overseeing the full family of specialist brands. Geordie Larratt-Smith will transition from CEO of Mutiny to Chief Commercial Officer of Saylor, in addition to managing the Mutiny team.

MSG Sports said the spinoff of MSG Rangers Corp., which will own the New York Rangers of the NHL, will happen Oct. 26. MSG Sports will continue to own the World Champion New York Knicks and be renamed MSG Knickerbockers Corp. James Dolan will head both companies.

OptimizeGEO, a company that measures brand metrics on AI platforms, has a pre-Series A round of financing led by Young Capital that valued the company at $80 million. Other investors include former MediaLink CEO Michael Kassan, who will serve as an advisor to the company.

Singer Sia sold a 50% stake in her publishing and music rights for $180 million to Pophouse Entertainment. Pophouse is a Swedish music catalog investment firm co-founded by Bjorn Ulvaeus, a member of the group ABBA. Pophouse will help launch digital avatar productions based on Sia’s music.

Bending Spoons syndicated a $1.25 billion add-on to its dollar denominated senior secured term loan B, due 2031, and a €395 million add-on to its euro-denominated senior secured terms loan B, due 2031. The deals follow debt-rating upgrades by Moody’s and S&P. Bending Spoons has bought digital brands including AOL, Brightcove and Vimeo.

WRAP 20 INDEX

Here’s how the companies in our Wrap 20 Index performed this week.

FINANCIAL ROUNDUP

The Paramount-WBD Saga (Nearly Over)

A judge approved the settlement of the antitrust suit, finally clearing the way for Paramount’s $110 billion acquisition of Warner Bros. Discovery.

While it was waiting for the approval, the company–to be named Skydance– filed a $41.4 billion debt offering to finance the deal. The heavy debt that Paramount needs to take on has been a concern for critics who worry that it will impair its ability to invest in content and business operations.

Paramount said it is planning to close the acquisition on Oct. 6.

The executive scramble at the combined company has begun.

Paramount named Ynon Kriez as co-CEO with David Ellison, who will also be chairman. Kreiz resigned as CEO of toymaker Mattel.
HBO head Casey Bloys is expected to head the company’s combined streaming operations.
Cindy Holland, head of Paramount Streaming, said she was leaving the company, creating an opening Bloys could fill (he’s stayed mum on the prospect).
Ellison has asked CNN CEO Mark Thompson to stay with the company after the acquisition.

About that settlement: California Attorney General Rob Bonta, speaking at TheGrill event, said that he disagreed “vehemently, respectfully” with those who believed he caved. There were reports that Bonta was pressured by other California officials — including Gov. Gavin Newsom and Los Angeles Mayor Karen Bass — worried about Paramount Ellison’s threat to move the company out of the state, something he denied when pressed by our Sharon Waxman.

Bonta also said that, despite establishing a five-member board to protect editorial independence at CNN and CBS News, he is concerned about the country’s “broken” information ecosystem. Connecticut AG William Tong unsuccessfully pushed for Paramount-WBD to divest CNN and CBS News during negotiations.

We Ain’t in Kansas

Analyst Robert Fishman of MoffettNathanson tackled the big topic of AI and entertainment in a report last week entitled “We Ain’t in Kansas Anymore,” with the aim to answer two questions: Will AI lead to the end of traditional media engagement and monetization? And, what happens to AI content spending efficiencies?

Fishman estimates that over the next three years, theoretical AI content efficiencies could result in savings of 8% or $10 billion that will benefit TV and movie studios.

Meanwhile, a business with lower barriers to entry in premium content creation and nearly unlimited production of lower quality content benefits platforms that are agnostic. “Tonnage and infinite choice are the name of the game here, and endless content required aggregation and algorithmic surfacing,” the report said.

“The biggest ‘winners’ should be the most-scaled, content-agnostic distributors (i.e. YouTube) and brands synonymous with the highest quality human-led storytelling (i.e. Disney), while we expect those in the middle to feel the greatest pressure,” Fishman said.