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Media stocks with moxie
Advertising spending is booming in some quarters, and along with it, the prospects of select media companies. Here's how we tuned in to the likely winning performers among television, radio, Internet and newspaper issues.
By Michael Brush
Conventional wisdom holds that business has clamped down on spending so hard, theres no growth anywhere. But look closer and youll see one bright spot where money flows freely: advertising.
Thanks in part to intense competition for wallet-share, spending on TV and radio advertising has jumped an impressive 10% to 20% since August.
At a time when its hard to find any budget growth, that makes an investor sit up and take notice. And if the economy actually begins to recover -- which isnt too far fetched -- ad spending will grow even more next year.
This bodes well for media stocks that control ad space and airtime, of course. But knowing which ones to buy is a lot trickier than you might think.
Television shares seem like an obvious play. But its actually better to avoid these companies, in part because next year there will be no election campaigns or Olympics to provide follow-through on this years strength.
Advertising agencies? Nope, because their business is likely to remain weak. Advertisers are reluctant to pony up for new campaigns now, preferring instead to make the most of the material they already have in hand.
Instead, its safer to turn to radio companies like Clear Channel Communications (CCU, news, msgs), Cumulus Media (CMLS, news, msgs), Radio One (ROIA, news, msgs) and Salem Communications (SALM, news, msgs), or newspaper chains like Knight Ridder (KRI, news, msgs), because many of them have more reliable earnings growth. Meantime, a tiny survivor of the Internet bubble called LookSmart (LOOK, news, msgs) is also quietly turning in strong revenue growth.
Before we get to more details, heres a closer look at whats behind the growth in ad spending.
Cutthroat battles for market share
First of all, the growth were seeing now looks bigger than it really is because ad spending was so weak last year following the terror strikes. However, there is real demand from several sources.
With all that zero percent financing in the auto sector, for instance, car dealers are eager to crow about the bargains theyre offering. Low interest rates have finance companies scrambling for mortgage-refinancing clients. And retailers have to tell the world about all the discounts meant to steal customers.
Everyone is either trying to grow market share or to stop the loss of market share, and I dont know how you do that without advertising, says Billy Farina, the head of advertising at Cox Communications (COX, news, msgs), a cable company.
A big push came from politicians who spent nearly $1 billion trying to win over voters this year. Thatll go away next year. But many media insiders are still bullish about 2003 ad spending trends because current demand is so strong. For instance, several radio execs say off the record -- because they havent yet issued public guidance -- that they expect a slow and steady buildup in ad revenue next year. From what I see, I think it will continue, says Grant Bowers, a media stock analyst with Franklin Templeton Investments.
Overall, ad spending should be up 5.3% next years, predicts Leo Kivijarv, the director of research at Veronis Suhler Stevenson, a New York investment-banking boutique that specializes in media deals.
That may not sound like much. But the estimate includes everything from leading segments like radio (where gains of 8% to 10% are possible) to slower ones like the Internet and billboards. And its certainly a lot better than the overall 2.9% growth in advertising expected for 2002. An added bonus: Media companies have cut back on costs so much, ad revenue gains drop right down to earnings.
Many investors, of course, have already noticed these trends. Since the start of the quarter, media and broadcasting stocks are generally up between 10% and 35%, depending on their size. With valuations ratcheted up, its especially important to be selective. Heres a sector-by-sector guide.
Avoid television stocks
Some television companies have other things going on that will boost earnings. CBS, a division of Viacom (VIA, news, msgs), appears to be making progress because it did so well in the recent sweeps. But dont look to ad spending growth to juice earnings at most TV companies. The reason: TV advertising runs the hottest in the even numbered years -- when we have election campaigns and Olympic events. So TV is gong to have a tougher time in 2003, says Ed Platt, a media and entertainment analyst with Dreyfus.
Another problem is that investors have bid up the shares of television stocks in anticipation of a likely easing of the rules on newspaper-TV links and station-ownership limits. Investors are betting that a rule change would spark a bidding war among newspaper companies and the large broadcasting groups for smaller TV companies like LIN TV (TVL, news, msgs), Sinclair Broadcast Group (SBGI, news, msgs), Hearst-Argyle Television (HTV, news, msgs) and ACME Communications (ACME, news, msgs), says Franklin Templetons Bowers. Betting on possible takeovers is risky business. Television company valuations are high already, leaving plenty of room to fall if there are disappointments.
Keep in mind that these problems dont apply to cable TV companies. Theres no takeover speculation, and they get far less of the lumpy political advertising revenue. There is no sign that what we experienced in 2002 would diminish in 2003, says Cox Communications advertising chief Farina.
Avoid the ad agencies
Yes, theres a persistent reluctance to fund new campaigns at a time when potential global conflict is in the air. But thats not the only drag on this group.
Ad agencies like Omnicom Group (OMC, news, msgs) and Interpublic Group (IPG, news, msgs) typically ink deals using fixed 12-month contracts. That means if the economy picks up, theyll still be working under deals priced during the depth of the downturn.
Go with radio stocks
Radio advertising has several characteristics that explain why it should hold up well even if there is a downturn, says Ed Platt, the media and entertainment analyst with Dreyfus.
For starters, radio ads are cheaper to produce and radio time costs less.
Next, radio companies tend to run a lot of local advertising. Why does this matter? While national campaigns are meant to accomplish more nebulous objectives like building brand awareness, local ads are run by businesses like grocers who have goods to move immediately. Since sales for local companies are more directly linked to commercials, these companies are less likely to pull ads if the economy weakens, or if war breaks out. Clear Channel Communications is the largest and most liquid radio stock with lots of local market exposure.
Finally, advertisers like radio because its more direct. People often listen to radio in their cars, for example, where they arent distracted by the media clutter in their homes.
Radio also lets advertisers reach targeted audiences. Radio One offers exposure to black audiences, for instance, Hispanic Broadcasting (HSP, news, msgs) can help advertisers reach Latino populations, and Salem Communications emphasizes religious and conservative themes.
All of these factors help explain why radio advertising is taking market share from other media. We feel very good about radios opportunity to continue to take share from competing media, says Lewis Dickey, president and CEO of Cumulus Media.
While the radio group is expensive, Clear Channel and Cumulus still trade somewhat cheaply. Clear Channel has a slower growth billboard division. Both companies have snapped up a lot of stations, and investors are still a little suspicious of acquisitive companies because of the potential for creative accounting in takeovers.
Go with newspaper stocks
Companies still arent hiring aggressively, so help wanted ads are slumping. Thats one reason newspaper stocks remain weak, excluding those like Tribune (TRB, news, msgs) that own TV outlets. If the economy picks up, newspaper stocks should get a boost from an increase in recruitment advertising.
Among the newspaper companies, Knight Ridder is one of the few without an ownership structure thats controlled by a family or small group. This should make it more attractive to investors as advertising picks up.
One way to play the Internet stocks
Demand for banner ads remains sluggish. But companies -- both national and local -- are willing to pay handsomely to reach buyers by having their ads pop up in search engines used by consumers.
This helps explain the impressive 20% quarter-over-quarter revenue growth at LookSmart. The company manages search engines for about 100 Web sites, including About.com and Microsoft (MSFT, news, msgs), which owns MSN Money. LookSmart provides the search engine, and then takes payments from other companies in exchange for assuring their sites come up in relevant searches.
Risks
Many media companies have grown by snapping up lots of other properties. Theres nothing inherently wrong with this. But the strategy remains under a cloud due to the accounting scandals that surfaced at Tyco (TYC, news, msgs), which was also an aggressive acquirer. If another accounting scandal surfaces at a serial acquirer, media stocks will suffer.
And keep in mind that to buy radio stocks now, you have to be convinced that an economic recovery is on the way to support more ad spending growth. That is not too far-fetched. Economic policy makers earlier this fall finally moved beyond interest rate cuts to bring about growth. Government deficit spending, a weaker dollar (which spurs exports), and lower long-term market rates are now lined up to produce more growth. Given the valuations on radio stocks, however, if economic growth slips youre bound to hear more than a little static.
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