Earlier this week, John (@portfolio14) reminded me of the first company write-up on this blog, CTC Media (CTCM) – a Russian TV broadcaster. All the negative news from Russia are attracting more and more value investors’ attention. While US stocks are among the most expensive in terms of CAPE (and with the most clustered valuations), Russian stocks are the cheapest ones after Greek stocks. So, this is a good time to take another look at CTCM.

Since the last time I looked at CTCM (7/26/2012), the company has narrowed down the age targeting of its channels to make it more attractive to advertisers. However, this didn’t help. CTC’s, the flagship channel, average audience share has been steadily declining since 2009. It has gone from 9% to 6.7%. Audience share and ratings are the key drivers of advertising revenue. The other two channels – Domashny and Peretz – have fared a little better. Their audience share has been a relatively steady 2.5% and 2.0%, respectively. This is hardly an accomplishment when starting from a low base and operating in a growing market.

The Russian TV advertising market grew 9.0% in 2012 and 8.8% in 2013. Not quite the expected 15%, but decent growth nonetheless. The major players dropped some 12% average audience share in the 6 years 2008-2013. Most of it was picked up by Channel 5, Disney, and non-free-to-air and local channels that the report doesn’t break out. This doesn’t bode well for CTCM, because gaining audience share is practically the only way it can increase advertising revenue. It cannot sell more slots, because, by law, commercial time is limited to 9 minutes every hour. The company is also not in the position to increase prices.

Between 2014 and 2018, Russia will be transitioning to digital broadcasting. CTC and Domashny will be included in the second multiplex. Peretz is not included in the second and tenders for the third multiplex will be held later this year. The big hit is that each channel participating in the second multiplex has to pay $26m annually in digital transmission fees once the multiplex is fully rolled out. CTCM will also be incurring $24m analog transmission costs during the transition period. The company doesn’t say how long this period will be. The government’s plan is for it to happen between 2014-2018, but I wouldn’t count on a quick and efficient rollout. For 2014, the company expects to pay $25m in digital transmission fees for both channels. Without any further information, I assume this will be the rate for remaining transition period.

As part of the transition, CTCM will face considerable amortization of its analog licenses due to the move to digital. For the 5 years 2014-2018, the company estimates charges of approximately $59.7m or $17.3, $16.4, $12.8, $9.1 and $4.1 million, respectively. This is on top of an impairment loss of $82.5m in 2012. Overall, the company has jacked up $210m in impairments, net of the tax benefit, in the last 5 years. Half of this is due to the analog licenses and the other half – to goodwill at Peretz and the in-house production unit. When I see impairment charges every year for 5 years straight, I consider them a regular cost of doing business, not an extraordinary charge.

Also related to the transition, the company doesn’t appear certain in the viability of the Peretz channel. It is possible that the new distribution costs will make Peretz uneconomic. This may actually be a good development since Peretz has lost more than $100m since its inception in 2008. By the way of comparison, Domashny, which has just a little higher average audience share, has made over $80m in the same period.

In my last post, I summed up some lessons from The Outsiders. The operational success of cable cowboy John Malone was, in large part, due to scaling up. This way he could drive out small competitors, consolidate the industry, and use this leverage in negotiating low-cost programming. Being the largest player and low-cost producer means you have a moat. From Tom Murphy, we learn that maximizing advertising market share is the other pillar of operational success in the media business. Now, relating this to the case at hand, Russia’s TV market is becoming more fragmented instead of consolidating and CTCM’s advertising market share is declining. This is the exact opposite of the outsider CEOs recipe for success. And speaking of CEOs, the records of the one interim and two permanent CEOs since the 2006 IPO are too short to judge, but overall, there is a distinct lack of evidence regarding the presence of an outsider CEO.

Depending on final digital transmission fees, on the effect of digitization on competitive dynamics, and on whether the endless impairments ever subside, CTCM should be able to generate $150-200m pretax, if it just stands its ground. I don’t have a clear view on whether it will do this. It’s hard to make predictions, especially about the future, especially in Russia. Note that I haven’t discussed the threat of the internet and mobile alternatives at all. Maybe next time.

In conclusion, I would say CTCM is an average company trading at a somewhat below average price. As I said in my first post about this company, it is worth keeping on the watch list. The price is volatile and at some point Mr Market may offer you a great deal on this one. But for now, I will pass.

For those of you interested in emerging and frontier markets, John has an excellent post on a London based trade show organizer ITE Group (ITE:LN). It is an asset-light, high-return business worth a look. The P/E of 15 makes it a borderline case for me, but definitely an interesting one for the watch list.