Old Media, Through an ETF

For the past few years, taking an investment in the beleaguered traditional media space has been the very definition of a contrarian view.

"Old media" companies have ridden a roller coaster in recent years as investors first questioned their competitive positions, their high levels of debt in some cases, and ultimately some firms' very survival. Investors then saw many of these names come roaring back in 2009 and, in some cases, 2010 as well.

Whether debt-laden newspaper publishers who have seen their ad revenues siphoned away by the Internet, radio station operators who find their businesses under siege both by the Internet and by satellite radio, or even TV station owners who have lost viewers to fragmentation, cable, and the Internet, traditional media companies clearly have required a view vastly different from the masses. Investors also have needed nerves of steel. A perfect example is the newspaper publisher McClatchy MNI, which has ridden a roller coaster in recent years, with its stock price plunging 98.8% from the end of 2004 through the end of 2008, and then--after advertising trends stabilized some, and investors realized that the company wasn't yet headed to oblivion--surging 354% in 2009 and rising another 31.9% in 2010.

For investors interested in investing in media but understandably wary of single-stock risk, the ETF structure would seem to be an ideal option. However, in the ETF universe, there are surprisingly few options for investors interested in owning a diverse set of media companies--particularly involving old media. Here, we will spell out the current dynamic for traditional media companies and then discuss what ETF options investors have to invest in the space.

Despite recent rebounds, old media companies aren't out of the woods by a long shot, with secular trends continuing to favor migration to digitally oriented media--particularly from newspapers--and clear questions remaining over what the level of digital advertising will look like for such firms and whether any lost revenue can be supplemented by pay walls. My colleague Joscelyn MacKay recently noted that despite an improving economy, newspapers' year-over-year revenue growth remains negative, even as TV and online ads have sharply recovered. She called attention to the vicious cycle that publishers are facing: U.S. newspaper circulation has fallen during each of the past 15 years, and newspapers' share of ad spending decreased to 23% in 2009 from 31% in 2002.

Can digital advertising growth save traditional newspapers? Morningstar's equity analysts do not believe so. Joscelyn predicted that publishers will be unable to cut costs as rapidly as long-term revenue declines take place and expressed skepticism about publishers' abilities to monetize digital content, noting that the USA Today and New York Times websites and iPhone apps all receive high traffic but remain free. She also questioned whether any meaningful revenue ultimately will be generated from subscriptions to websites and apps. For all those reasons, Joscelyn argued that the shares of publishers Gannett GCI and New York Times Co. NYT are currently overvalued.PAGEBREAK

Meanwhile, on the broadcasting side, TV stations and networks continue to wrestle with how to deliver content in an environment where cable networks have been producing more and more compelling content, and increasingly savvy viewers prefer watching shows when they want, through the use of digital video recorders and on-demand services. That said, several TV broadcasters have posted especially impressive numbers in recent quarters, the result of strong political advertising in 2010 and a local and national spot advertising recovery. CBS CBS, which Morningstar's equity analysts believe is overvalued, has done a great job generating strong audience ratings relative to its peers and owns valuable content that is tough to build from scratch, while Sinclair Broadcast Group SBGI, which owns, operates, or provides sales services for 58 TV stations, recently reported very strong results, owing to significant political revenues but also strong ad spending from a wide variety of other sectors. The recent results of other broadcasters like Belo Corp. BLC, which owns 20 TV stations, and Meredith Corporation MDP, whose 12 TV stations account for about 20% of revenues, have been more mixed, but nonetheless have been buoyed by strong political spending and an ad rebound. (Publicly traded, pure-play radio station owners are rare--solely micro- and small-cap companies like Entercom ETM, Emmis Communications EMMS, Spanish Broadcasting System SBSA, and Cumulus Media CMLS, which are held in very few ETFs.)

Media conglomerates--Walt Disney DIS, Time Warner TWX and News Corporation NWSA--have been doing well. Disney, which owns ABC, has seen great growth in its cable networks (far outpacing its broadcasting growth), owing to strong affiliate fee growth and ad revenue growth at ESPN, demonstrating the power of live sports programming when time-shifted viewing continues to proliferate. Time Warner's cable networks, which generate more than 70% of operating profit, have grown rapidly from similar growth in affiliate fees and strong demand in the up-front ad market, and its filmed entertainment revenue group has enjoyed nice growth as it has continued supplying important TV content to both broadcast and cable networks. And News Corporation, which owns FOX and cable networks like Fox Sports, Fox News, Fuel TV, and FX Network, is being fueled by similar trends as its peers--strong cable networks growth (60% of operating profit) and less-compelling results in its other segments, including filmed entertainment (tough comparisons with Avatar).