Our Outlook for the Media Sector
There was plenty of M&A activity in the second quarter.
Stock Strategist
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Most of the media companies that we cover derive a significant amount of their revenue from advertising, and the first quarter extended a trend we've observed for some time and expect to continue--a shift in ad dollars from traditional media to digital media. In fact, ad expenditures for network television, newspapers, and radio were lower in the first quarter of 2007 than in the same period a year ago, down 7%, 5%, and 2%, respectively, while ad spending on the Internet grew by 17%, according to TNS Media Intelligence. What's even more remarkable about the Internet-spending figure is that it doesn't include dollars related to search.
This trend certainly hasn't gone unnoticed by major players in the industry, evidenced by the significant amount of merger-and-acquisition activity recently announced. Quite a few looked to improve their competitive positions to capture the influx of online ad dollars. Google (GOOG) made the first move when it agreed to pay $3.1 billion for online advertising agency DoubleClick. Not to be outdone by its larger competitor, Yahoo agreed to acquire the remaining 80% of Right Media that it didn't already own for $680 million. Subsequently, Microsoft (MSFT) agreed to the largest acquisition in its history when it announced it was buying aQuantive for $6 billion at a hefty 85% premium.
But the flurry of M&A activity wasn't just limited to purely online plays. Two other significant deals were Thomson's bid for Reuters and News Corp.'s bid for Dow Jones . Thomson's offer represented a hefty 43% premium to where Reuters was trading prior to news of the potential takeover. We think this deal makes sense strategically as the combined entity would be able to compete more effectively against industry-leader Bloomberg. News Corp.'s offer of $60 per share for Dow Jones represented a 65% premium to the prior closing price. This generous offer shows both how badly Rupert Murdoch wants Dow Jones and how expensive it can be to take over a media property that is family-controlled (the Bancroft family, in this case). Murdoch's offer has not been accepted as Dow Jones is seeking out other potential buyers.
Valuations by Industry
Our average star rating for the media industry is 2.72, which means we think the overall industry is a just a bit overvalued. We currently think radio is the most overvalued sector, while most of our undervalued names are in the media conglomerates segment.
| Media Industry Valuations | |||
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| Segment | Average | Median Price/Fair Value | Stocks Covered |
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| Broadcast TV | 2.50 | 0.96 | 4 |
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| Cable TV | 2.66 | 1.05 | 12 |
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| Film and TV Production | 3.00 | 1.10 | 2 |
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| Media Conglomerates | 3.05 | 0.97 | 22 |
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| Publishing | 2.63 | 1.11 | 16 |
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| Radio | 2.39 | 1.06 | 13 |
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| Data as of 06-15-07. |
We are bearish on the radio industry as we see limited long-term growth prospects and heightened competition for local advertising. Time spent listening to radio has been in a slow decline for several reasons, with listeners' resistance to an abundance of commercials and the rapid adoption of portable music players and satellite radio service topping the list.
Media Stocks for Your Radar
Although we don't see an abundance of undervalued media companies at this time, listed below are three of our favorite companies that may offer investors a compelling buying opportunity. We think all three of these companies have sustainable competitive advantages that will allow them to thrive in an ever-changing media landscape.
| Stocks to Watch--Media | |||||
| | | | | |
| Company | Star Rating | Fair Value Estimate | Economic Moat | Risk | P/FV |
| |||||
| Time Warner |  | $25 | Wide | Below Avg | 0.86 |
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| Disney | | $40 | Wide | Below Avg | 0.85 |
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| Yahoo | | $34 | Narrow | Average | 0.81 |
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| Data as of 06-22-07. |
Time Warner
Time Warner controls some of the most prominent assets in media, including Time Warner Cable, Warner Bros., HBO, AOL, and Time Inc. Most of these businesses are leaders in their respective industries and possess formidable competitive advantages. Although Time Warner's "old" media assets--film, television, and print--may not have high growth prospects, they do provide the company with generous amounts of cash. With the influx of cash, Time Warner has invested in higher-growth areas including its cable operations, online publishing, and AOL's advertising platform.
Disney (DIS)
Walt Disney has developed some of the most popular and enduring animated franchises of all time. In addition to creating this great content, Disney has been very successful in exploiting its content through box office and home video sales, licensing to television networks, sequels, theme park attendance, and merchandising. However, as content migrates to digital platforms, Disney must find new ways to attract and retain customers. To that end, Disney has been very aggressive in distributing its content through its own Web site and third parties such as iTunes. Disney also owns ESPN, another powerful brand that generates ample profits through multiple cable channels, restaurants, a magazine, and ESPN.com.
Yahoo
In recent quarters, Yahoo's revenue growth has slowed, profitability is down, and talent continues to walk out the door. Despite its struggles, Yahoo remains the most popular destination on the Web, with 500 million unique users per month. Products with high switching costs--such as e-mail and stock portfolios--should help retain a large portion of these users, while newer products such as Flickr and Yahoo Answers should help attract new users. In addition, Yahoo's new advertising platform is increasing its search monetization, and advertising partnerships with Comcast (CMCSA), Viacom , and a consortium of newspapers are indications that Yahoo is still a dominant player in Internet advertising. Although we don't view the appointment of co-founder Jerry Yang to CEO as a panacea to Yahoo's problems, we do think Terry Semel's resignation was in the best interest of shareholders. Semel lacked technical expertise and his grand vision of marrying Yahoo and Hollywood had failed. This left Semel out of place and ineffective, at best.
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