Our Outlook for the Media Sector
Microsoft is making a bold move to catch Google in the search business.
Quarter-End Insights
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In our previous article about media stocks in December, we suggested that Google's (GOOG) competitors would continue to look for potential acquisitions and partnerships to chip away at Google's dominance in the search business. As it turned out, the big story in the media sector in the first quarter was Microsoft's (MSFT) hostile offer for Yahoo of $31 per share, a 62% premium to Yahoo's previous closing price and a 19% premium to our $26 fair value estimate. Our take on the proposed tie-up is that it is great for Yahoo shareholders; however, we are skeptical that the acquisition will create value for Microsoft shareholders.
As we pen this article in mid-March, Yahoo and Microsoft are still bickering about the offer on the table. Yahoo has floated several ideas for potential partnerships in lieu of a tie-up with Microsoft, which has stood firm with its initial offer. We think the posturing between these two heavyweights could go on for some time, but we expect the deal will eventually be consummated.
As Yahoo and Microsoft contemplate their future, Google continues to gain market share in the lucrative Internet search business (90% of Google's net revenue). We think the company benefits from its vast resources (financial and human) and a strong brand. Most people assume that Google's search engine is superior, so it would take a significantly improved offering from a competitor to convince people to switch to a different engine. Due to Google's resources, we think it is unlikely that a competitor would be able to develop a vastly superior technology. For these reasons, we recently increased our economic moat rating for Google to wide from narrow and raised our fair value estimate as well. We think the shares are undervalued, but the stock price has not yet fallen into 5-star territory.
Valuations by Industry
Our average star rating for the entire media industry is 3.44, indicating that we think the overall industry is slightly undervalued. We think some of the most attractively priced stocks are in the media conglomerates segment.
| Media Industry Valuations | |||
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| Segment | Current Median Price/Fair Value | Three Months Prior | Change (%) |
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| Broadcast TV | 0.97 | 0.81 | 20% |
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| Cable TV | 0.83 | 0.91 | -9% |
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| Media Conglom | 0.81 | 0.93 | -13% |
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| Publishing | 0.96 | 0.92 | 4% |
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| Radio | 0.97 | 0.97 | 0% |
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| Data as of 3-14-08. |
Media Stocks for Your Radar
We see compelling investment opportunities in three wide-moat media conglomerates, an online recruiting company, and a holding company with a dominant shopping brand.
| Stocks to Watch--Media | |||||
| | | | | |
| Company | Star Rating | Fair Value Estimate | Economic Moat | Risk | P/FV |
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| News Corp. |  | $25 | Wide | Below Avg | 0.74 |
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| Time Warner | | $25 | Wide | Below Avg | 0.58 |
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| Disney | | $40 | Wide | Below Avg | 0.79 |
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| Monster Worldwide | | $41 | Narrow | Average | 0.63 |
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| Liberty Interactive | | $27 | Narrow | Average | 0.61 |
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| Data as of 3-18-08. |
News Corp.
With its suite of diversified media properties around the world, News Corp. appears to be well-positioned for the foreseeable future. Its largest business segment, Fox Entertainment Group, owns a vast library of motion pictures and television shows including "The Sound of Music," "Star Wars," and "The Simpsons." Besides the proven ability to create great content, News Corp. can also distribute its content around the world through its theatrical film-distribution capabilities, television networks, and satellite television providers. The company also owns one of the premier online distribution channels via its purchase of MySpace.
Time Warner
We believe Time Warner owns some of the best assets in media, including Time Warner Cable, Warner Bros., HBO, and Time Inc. Most of these businesses are leaders in their respective industries and possess formidable competitive advantages. We're optimistic that the intrinsic value of these assets will eventually be realized under the leadership of CEO Jeff Bewkes, who took over in January. For example, we're encouraged by his intention to realign Time Warner's ownership structure of Time Warner Cable , as we think the shares are considerably undervalued.
Disney (DIS)
The strength of the Disney brand has allowed the company to exploit its characters and franchises through box office and home video sales, theme park and resort attendance, and merchandising. The company has also aggressively built out its online presence, allowing its customers to consume additional content, play games, and buy more merchandise. However, the company's largest profit generator is its media networks, including ESPN, ABC, and the Disney Channel. While we anticipate solid performance in filmed entertainment, theme parks, and merchandising, we expect the media networks to account for the majority of the company's profit growth for years to come.
Monster Worldwide
We believe that Monster is positioned well to take advantage of the long-term trends of the online-recruiting industry. In our opinion, Monster's shares are attractively priced, even after we forecast a near-term slowdown in sales growth for its North American careers unit. We think most of its growth opportunity lies in its international careers business, which now accounts for about 41% of Monster's total revenue. We expect its international business will continue to generate lofty revenue growth and increased profitability.
Liberty Interactive (LINTA)
Liberty Interactive holds a great asset in QVC. Consumers view QVC as a high-quality TV network, largely because of agreements it has with programming distributors that provide QVC with high-visibility channel placement. In fact, according to the company, about 85% of all basic cable subscribers receive QVC below channel 36. Its TV network dominates the home-shopping airwaves, but we're also impressed with its online operations. QVC.com (22% of domestic revenue) gives consumers access to many more products at any point in time than the TV network can. Also, sales made through QVC.com are more profitable because Internet sales require fewer commissions to be paid to programming distributors.
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