The Tycoon Report

Why Sumner Redstone Finally Gets It.

Sumner Redstone, the iron-fisted Chairman of Viacom is debating whether to split his company into two.Why it's the best move he could make.

 NOT ALL PROFITS ARE CREATED EQUAL.

As a matter of fact, ONE company could earn BILLIONS of DOLLARS in Profit and NOT create any real value for shareholders. While another company could earn $100 million in Profit and create tremendous value for shareholders.

How could this be, you ask? It has nothing to do with bad accounting. It's all about the difference between "Accounting" Profit and "Economic" Profit. And that involves the "Cost-of-Capital."

Let me explain:

The cost-of-capital is the amount that it cost a company to utilize the capital it has. Here's a simple but revealing example. Let's say that you owned a company that had $1,000 in capital. And all of the capital was debt that you borrowed at 5 percent. That means that your cost-of-capital would be $50 per year. That would be your "hurdle" rate.

So, let's say that one year you earned $75. That means you had an ECONOMIC PROFIT - a profit above your cost-of-capital - of $25. Now let's say that the following year you earned $20. While you would still have an ACCOUNTING PROFIT OF $20, you have an ECONOMIC LOSS of $30. In other words, you would have EARNED LESS than the amount it costs you to USE THE CAPITAL!

So, what does this have to do with Old Iron Fist? Plenty. You see, Sumner Redstone, is beginning to learn what his cost-of-capital is. After years of getting large for the sake of size and years of doing deals for the sake of cash flow only, he's learning.

Let me explain:

He's debating whether to break Viacom in two. One company - called "Cable Networks" - will include MTV and Nickelodean. The other company - called 'Broadcast" - will include Infinity Broadcasting and CBS. And therein lies the clue to judge which group has a higher ECONOMIC PROFIT.

You see, the Broadcast group is in an industry that is in decline. Sure, CBS and Infinity earn BILLIONS in ACCOUNTING PROFITS, but they really don't earn ECONOMIC PROFITS. I know, I know - that's a hard concept to swallow. To earn BILLIONS in Net Income and NOT create real value for shareholders.

But think about it for a moment - if you earn $3 BILLION in net income and it cost you $3 BILLION to do that, have you added any REAL VALUE? Not by a long shot. In contrast, fast growing MTV and Nickelodeon earn both ACCOUNTING PROFITS AND ECONOMIC PROFITS.

And that's why Old Iron Fist will end up splitting his company in two. Companies that earn ECONOMIC PROFITS ARE VALUED MUCH HIGHER THAN COMPANIES THAT DON'T. And based upon projections, it might mean that Mr. Redstone will increase his net worth by $2 Billion alone just by unlocking the value in his companies.

Do you want to know how you could increase your net worth by a proportionate amount? I'll let you in on a secret: Fallen Angel Stocks ONLY RECOMMENDS COMPANIES THAT EARN ECONOMIC PROFITS. That's right. Companies with high returns on capital. Companies with pricing power. Companies with low cost structures. And most importantly - companies that are selling for a tremendous discount in relation to what they're really worth.

That's why we recommended K-Swiss at $17.50 per share and sold it at $30.80. Or Timberland, which we recommended at $53.50 and is now selling for over $70. Or Comcast, which we purchased at $27.65 and is now selling in the mid-30's.

And there's plenty more where that came from.