Sunday, September 13, 2009

Stocks to Buy in a Cyclical Advertising Recovery

In 2Q09, advertising spend in the U.S. declined in the high teens according to most estimates, with all advertising media, except theater advertising, declining year-over-year. Yes, even Internet advertising declined y/y due to weak branded advertising and less than robust search growth. According to my calculations, Google’s domestic search business actually declined y/y by approximately 1-2%. Therefore, even overall search advertising declined y/y given that Google has a lion share of the domestic search market and exhibits the strongest search fundamentals.

At a series of conferences this past week, several companies reported that advertising is still challenging but is however firming, with month-over-month improvement in national and local advertising and improvements in auto advertising.

U.S. advertising has historically tracked GDP growth but has lagged behind other categories in a recovery. On that basis, I would look to less advertising dependent sectors within the TMT universe for stocks worth owning early-on in an economic recovery, particularly technology stocks. However, there are advertising related stocks that are trading at attractive multiples that are not secularly challenged and with relatively balanced risk/reward scenarios – indeed, the best stocks to own in a recovery are the ones operating in advertising sectors free of secular challenges. Further, 4Q09 and 1Q2010 offer easy compares given the harsh experiences in the prior year with the Winter Olympics in February, World Cup Soccer in June, China World Expo in the summer, and political advertising in the fall setting the stage for mild improvements in advertising growth rates.

I’ll go through the sub-sectors to uncover those gems.

I’ll start with the Internet advertising stocks first, which along with cable programming network advertising has performed better than any of the other advertising categories in the first half of 2009, with Internet advertising edging out cable networks by a slim margin.

Google (GOOG) is my long-term favorite and is the best stock to own in this sector due to its huge exposure to search advertising, which is not facing secular challenges. Search queries have held up well in the recession but pricing (CPCs) has not, which is partially why Google’s y/y growth rates have plummeted from close to 60% in 3Q07 to 3% in 2Q09. However, pricing is cyclically based, in my view, and when/if the economy recovers pricing is likely to rebound with it, leading to a reacceleration of growth for Google. Add to that, improving allocation of ad budgets to search, improving monetization of search queries, mobile search growth, and monetization of YouTube videos and an eventual drive to profitability for the online video site, and finally, improving company wide margins and free cash flow growth as the new CEO has reigned in costs, we have what is the most attractive stock in the media sector. The stock trades at 10.5x 2010 EBITDA, way below its five year historical average of 20x and at a PE of 19x 2010 EPS below the 36x historical average.

IAC/InterActiveCorp (IAC) is another attractive play within the sector. The company has $13 per share in cash, about 70% of the stock’s value, and is an active share repurchaser, having repurchased 16 million shares in the first half of 2009 and has a new authorization for 20 million shares. It appears that share buybacks are the primary use of cash at the moment. IAC has a nice mix of assets that are growing nicely. Plus it is a derivative play on Google given’s search relationship with the search giant. The shares are trading at 5x 2010 EBITDA, in-line with Yahoo, but largely free of Yahoo’s secular issues. My sum-of-the-parts valuation values the company at $25, about 30% upside from current trading levels.

I would stay on the sidelines with Yahoo! (YHOO) for now because of its dependence of branded advertising as a core function now that it has decided to essentially exit the search business. Unlike search advertising, branded advertising is facing secular pressures such as unlimited inventory which is depressing CPM pricing, an advertiser mix shift from higher price guaranteed inventory to lower priced non-guaranteed inventory, and CPM pricing pressure due to inventory being purchased through lower priced sales channels. I do not foresee those challenges abating anytime soon, even in an economic recovery. Branded advertising declined 12% for Yahoo! in the first half of 2009, in-line with the broadcast networks and slightly better than outdoor advertising. Domestic search was down 5% y/y in the first half 2009 but down 13% in 2Q09, so clearly no offset there. The shares are trading at 5x 2010 EBITDA and could be an attractive stock for value investors given that it is no longer a value trap. The Microsoft search deal should lift margins and free cash flow substantially but that’s an event that is 24 months out. A Taobao IPO could be a positive catalyst for the shares but the timing is uncertain. And I am not buying the analogy to DELL – Yahoo has lost a competitive advantage by giving up search. Street sentiment has improved with several upgrades to buy in the past two months but I am not convinced yet. Yahoo is a turnaround story but there are too many “ifs” and uncertain catalysts layered on top secular challenges in its now core display business for me to buy this stock.

For the same reasons I would stay clear of AOL when the company goes public in 4Q09. Its branded advertising business was down 19% in the first half of 2009 and its third-party network advertising, which it reports separately, was down harder at 27% in the first half of 2009, rivaling newspaper advertising growth rates. Tim Armstrong will have a hard time selling this story to investors.

Next is newspapers, which are facing secular challenges brought about by declining sales and shift of classified advertising dollars to the Internet, coupled with a high fixed cost structure, and highly levered capital structures.

Newspaper advertising has been battered and is down 30% y/y in the first half of 2009, the worst of any advertising category. The key stocks in this sector are Gannett (GCI), and The New York Times (NYT). Classified advertising at these companies were down 40-45% in 2Q09 due to declining real estate, employment (down 60%+), and auto advertising. NYT stated on their 2Q09 conference call that they expect the newspaper advertising environment to remain challenged but believe the rate of decline will moderate in the third quarter from the second quarter. That has provided some relief to investors that things won’t worsen. Nonetheless, those revenue growth rates are horrible.

In my opinion, newspapers stocks aren’t worth holding for the longer-term because there is a strong likelihood that these companies head towards bankruptcy even if the economy recovers. However, due to the high short interest in these stocks (12% of NYT’s float was sold short at last reported date) investors can make money by trading around the earnings reports because of the likelihood of earnings beat due to the cost cutting. A few of the newspaper companies own broadcasting stations, which are not faring any better. Longer-term, I would avoid stocks in this sector because the equities in this media category could eventually disappear due to the secular challenges.

Moving on to radio, whose stock prices have been decimated due to massive audience erosion and secular challenges from the iPod in the car, satellite radio, WiMax development that could put Internet radio like Pandora in the car. The latter is years away from having a negative impact on radio, in my view. Radio did suffer from massive audience erosion over the past decade but that has largely abated with the remaining radio listeners likely to stay with the medium. Radio advertising is down 22% in the first half of 2009, faring better than newspapers, magazines, and local cable advertising, but is still bad.

Stocks in this sector include Clear Channel (CCMO) which last traded for $1.20 on the OTC, Entercom (ETM) last traded at $4.79, Emmis (EMMS) lasted traded at $0.68, Cumulus (CMLS) last traded for $1.41, Beasley (BBGI) last traded at $3.29, Radio One (ROIA) last traded for $0.85, and Sirius XM (SIRI) which last changed hands at $0.66. Unlike my view of the newspaper equities, I believe the radio stocks could survive but I am not recommending anyone of them, except Sirius XM purely for the reason that John Malone is behind that company. His company Liberty Media owns 40% of the shares but will not buy in the full company in the next two years due to their inability to use the NOLs. Over 50% of Liberty Capital’s (LCAPA) value is tied to its stake in Sirius XM and for that reason I believe that Malone will ensure that the company does not go into bankruptcy.

Overall, if you want exposure to radio, then CBS (CBS) is the best bet. The company noted on their 2Q09 conference call that they are seeing improving sales trends in the quarter.

Outdoor advertising is down about 16% in the first half led by companies such as CBS Outdoor (CBS), Clear Channel Outdoor (CCO), and Lamar Advertising (LAMR). That sector is likely to remain challenging due to over capacity of billboards, pricing pressures, declining utilization rates, and intensifying competition. Those are not secular issues in my opinion, thus outdoor advertising is likely to be an attractive sector in an ad recovery. The companies are taking down billboards to address the overcapacity issue and pulling back on capital expenditures, which should have the effect of improving free cash flow and improving ROIs. Pricing and utilization rates should come back in a recovery so no concern there. In addition, outdoor advertising is relatively insulated from secular threats from the Internet.

CBS is the best pick overall for a play on this ad category given its more attractive relative valuation. I personally think CBS is one of the most attractive stocks in the media sector and is the one media stock worth owning for the longer-term. Lamar is the most expensive of the group haven already gapped up almost 300% in the past six months due to short covering. It is trading at 11x 2010 EBITDA compared to 9x for Clear Channel, and 7x for CBS.

Magazine advertising is down about 25% in the first half of 2009 and is facing the same secular issues that newspapers are facing. There are some signs of stabilization in this medium but I think the spate of magazines going out of business will likely continue even in a recovery. The survivors will need to live in a world with less ad pages, less readership, but with costs that remain the same, hence profits will continue to erode.
Time Warner (TWX) is the behemoth in this sector but others like Martha Stewart (MSO) and Meredith (MDP) are interesting. Meredith is the one interesting play here that is worth taking a harder look at.

Cable Networks
Advertising on cable network advertising was down in the low single digits in the first half of 2009 slightly outperformed by Internet, however, a recent report by Sanford Bernstein has cable networking advertising edging out Internet advertising in 2Q09. The media is free of secular challenges and is taking viewership share from broadcast TV. The pure play stocks to own here are Scripts Networks (SCNI) and Discovery (DISCA) and are attractive long-terms buys.

My favorite of the two is Discovery, which has shown impressive numbers in 1H09 with flat revenues and 11% EBITDA growth. While the stock is not cheap, trading at 10x 2010 EBITDA and 18x 2010 earnings, the long-term trajectory looks compelling given solid ratings, expansion internationally, and driving the Oprah Network and others like Animal Planet to profitability. Plus, DISCA has ample liquidity, with $300 million-plus in cash on the balance sheet, consensus at $650 million in free cash flow in 2010, and is underlevered at just 2.5x. Management can use cash to repurchase shares and to fund internal expansion of cable channels. Further, the company looks attractive as a take-out by one of the conglomerates like Time Warner (TWX), who has stated their interest in cable programming assets.

Time Warner (TWX) and Viacom (VIA) provide good exposure to this sub sector.

TV Stations / Broadcast Networks / Local Cable
TV station and local cable advertising are both down in the 20% range in the first half of 2009 and broadcast networks was down in the mid-teens.

Time Warner Cable (TWC), Cablevision (CVC) and Comcast (CMCSA) are the stocks most exposed to the declining advertising trends on local cable. However, the dynamics of the cable sector overall are extremely attractive leading me to be positive on the cable stocks. I will report on the cable sector on a later post but I would be buyers of these stocks.

The plays in broadcasting networks are CBS (CBS), which again I am a buyer of the shares and Newscorp (NWSA), which I am not. NewsCorp’s shares have doubled since the March lows but the company is facing issues on many fronts including challenges at MySpace, the film business, newspapers, and Sky Italia. If you must invest in a media conglomerate then Disney (DIS), Viacom (VIA), and Time Warner (TWX) offer a more attractive asset mix at their respective valuations.

I am staying on the sidelines on the pure play TV stations but if you are inclined to venture, the stocks to look at are Belo Corp (BLC, $4.25) and Sinclair Broadcasting (SBGI, $3.12). Both stocks have rebounded quite nicely from penny stock status in March but I am not convinced that there is much upside left.

Advertising Agencies
Ad agencies lag in a recovery so there is no reason to chase the stocks – Omnicom (OMC), Interpublic (IPG), WPP Group (traded in the U.K.), Publicis (traded in France).

Emerging New Media
I am considering FaceBook, Hulu, YouTube and MySpace in this category. FaceBook could likely go public in 2010 but even with its massive growth I think the company is burning through cash. See a previous post. When YouTube turns a profit, Google could consider spinning it off into a separate publicly traded company. NewsCorp should do the same for MySpace. Hulu, which is owned by the media conglomerates, could head down that path as well. All of these companies are dependent on the secularly challenged branded advertising to generate revenues, but online search, paid subscriptions, and other paid content/transactions offer means to support revenue growth in the future.

To recap, the most attractive ad mediums in a recovery are Internet, Cable Networks, and Outdoor, and the most attractive stocks in the media space are Google, IAC, Discovery, CBS, Scripts Network, Disney and Time Warner.


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