Our Outlook for Media & Telecom Stocks
Telecom offers relative stability, but old media is in big trouble.
The media and telecom sector is a tale of two extremes. At one end, we've seen relative stability among telecom service providers and cable companies, especially in the U.S. and other developed markets. While growth for most telecom and cable firms has slowed modestly recently and will likely continue to do so into 2009, margins and cash flow have generally held up very well. At the other end, "old media" companies that depend heavily on advertising spending are falling deeper into despair, and telecom-equipment vendors face a bleak outlook for 2009.
Several telecom and cable companies have noted recently that consumers are opting for cheaper rate plans or subscribing to fewer premium services. But a weak economy won't likely push households to disconnect television, Internet access, or wireless phone services in droves. These services, if not viewed as necessities, are fairly inexpensive relative to the typical customer's usage. The success of Apple's (AAPL) latest iPhone also demonstrates that a significant number of consumers remain willing to pay up for compelling products. About 2.4 million iPhones were sold in the U.S. during the third quarter, with each customer committing to spend at least $70 per month on AT&T (T) wireless service. Business customers have begun to pull back a bit on telecom spending and negotiate harder on price as contracts expire. But weaker industry players, such as PAETEC (PAET), have taken the biggest hit thus far. AT&T and Verizon (VZ), which dominate the business services industry, have seen growth slow, but we expect these giants to press their scale advantages to win back share that was lost over the last few years.
We do expect the fourth quarter and 2009 will be a bit more difficult for telecom and cable companies. Cable again dominated the high-speed Internet access market during the third quarter, claiming a far greater share of new customers. Comcast (CMCSA) alone added 40% more customers during the period than AT&T and Verizon combined. But we've seen the phone companies begin to fight back, using price as the primary weapon. Each of the major phone companies is currently offering basic Internet access service for around $15 per month and the cable companies have responded in many cases by promoting "economy" tiers as well. Although we still expect most cable companies will outperform their telecom peers over the long run, we recently lowered our margin expectations for several firms in the industry. For Charter Communications (CHTR), these changes, coupled with the firm's massive debt load, have pushed our fair value estimate near $0.
The current state of the capital markets has rattled few industries--outside of financials--as much as media. Over the past three months, we've assigned a $0 fair value estimate to 11 media firms, adding to the four zeros we had previously. We believe the combination of heavy debt loads, shifting consumer demands, and the cyclical drop in advertising spending is simply too much for several "old media" firms to overcome. In radio, we now believe the equity of seven of the nine firms we follow is worthless, including satellite pioneer Sirius XM (SIRI). In the newspaper business, we now expect McClatchy (MNI) and Lee (LEE) to eventually follow privately held peer Tribune into bankruptcy. Among television broadcasters, we've placed $0 fair value estimates on Entravision (EVC) and Gray Television (GTN). Finally, we've taken telephone directory publishers Idearc (IDAR) and R.H. Donnelley (RHD) to $0. Although we've maintained positive fair value estimates on a handful of newspaper, radio, and television broadcast companies, we don't believe any of these firms are compelling investments right now. However, we continue to believe shares of diversified media firms--such as Disney (DIS)--have been punished too severely amid the media mess.
The telecom equipment industry hasn't fared much better over the past quarter, and we expect 2009 will be even worse. Legacy vendors Nortel (NT) and Alcatel-Lucent (ALU) have seen revenue start to decline, and both continue to burn cash. Alcatel CEO Ben Verwaayen believes the telecom equipment market will see revenue decline 8%-12% during 2009, and AT&T's plan to cut capital spending doesn't bode well for equipment vendors. We have slashed our fair value estimates for Nortel and Alcatel, as both face bloated cost structures and need healthy carrier spending to aid their turnaround efforts. Cisco (CSCO) and Juniper (JNPR) have held up far better, propelled by double-digit third-quarter growth in the router market. However, we think demand fell precipitously in October, and we would not be surprised to see weak results over the next several quarters at either firm.
Valuations by Industry
While the market has dropped sharply over the past quarter, the radio and wireline equipment industries have both jumped sharply relative to our fair value estimates. As mentioned, this primarily reflects our belief that the majority of the equities in the radio industry are now worthless and that a slowdown in telecom capital spending will severely hinder turnaround efforts at the large, legacy telecom equipment vendors. A similar dynamic is at work in the publishing industry, where the newspapers reside. But this industry is much more diverse and includes healthy companies such as John Wiley & Sons (JW.A).
|Media & Telecom Valuations|
| Three Months |
| Change |
|Data as of 12-15-08. *Market-Weighted Harmonic Mean|
Communication Stocks for Your Radar
We continue to see compelling valuations across some of the strongest businesses in the media and telecom sector. Four of the five stocks listed below receive our wide moat rating and the remainder, NII Holdings (NIHD), is one of our favorite international stocks. NII replaces America Movil (AMX) this quarter, as shares of the latter have moved out of 5-star territory. We've also dropped Time Warner (TWX) from the list, as that firm plans to spin off its wide moat cable business in the near future.
|Stocks to Watch--Media & Telecom|
|Company||Star Rating||Fair Value Estimate|| Economic |
| Fair Value |
|Walt Disney Co.||$34||Wide||Low||0.67|
|Cisco Systems, Inc.||$31||Wide||Med||0.54|
|NII Holdings, Inc.||$58||Narrow||High||0.32|
Data as of 12-18-08.
Walt Disney (DIS)
We recently trimmed our Disney fair value estimate to reflect reduced expectations as a result of the weak economy, but we still believe the firm's long-term competitive advantages remain intact. The strength of the Disney brand allows the company to exploit its characters and franchises through box office and home video sales, theme park and resort attendance, and merchandising. The company also owns ESPN and its portfolio of assets, which include cable networks, magazine, and a popular Web site. In addition, Disney's cable networks are more dependent on affiliate fees and less dependent on advertising, which should help buoy the firm's financial results during these challenging economic times.
Although the business line that made eBay famous (online auctions) appears to be in decline, eBay is no longer a one-trick pony, as online auctions represent only about 32% of revenue. PayPal now generates about 27% of total revenue and continues to grow rapidly. We think PayPal is eBay's best opportunity for future growth. The total payment volume from merchant services now exceeds PayPal's payment volume on eBay, a testament to the ubiquity of PayPal across the Web.
The volatility in Comcast's shares over the past quarter belies the relative stability of the firm's business. Since late September, the shares have seen daily declines of 10% or more on five occasions and a 25% gain on a single day in October. Against this backdrop, the company itself continues to perform pretty much as expected, with free cash flow jumping sharply thus far in 2008. Revenues continue to grow, albeit at a slowing pace, while margins have held steady and capital spending has dropped. Despite a small reduction in our fair value estimate recently, we continue to believe the shares are compelling at current prices.
Cisco Systems (CSCO)
Although current market conditions are tough, network convergence, data-center consolidation, and increased global communications needs should drive relatively solid demand for Cisco's equipment through a depressed spending environment. We also expect Cisco to gain share at the expense of certain of its smaller, resource-constrained competitors during this economic downturn. At current levels, we believe the market is offering investors the opportunity to pick up a great long-term holding at a reasonable price.
NII Holdings (NIHD)
NII Holdings is a niche player in the Latin America wireless market, offering postpaid wireless plans (on Motorola's (MOT) iDEN platform) in a region where about 90% of subscribers are prepaid users. Despite solid performance through the first nine months of the year (40% revenue growth, 33% subscriber growth), 2008 has been a tough year for NII's share as economic conditions have deteriorated. While growth will likely slow in the fourth quarter and into 2009--mainly as a result of the steep declines in its operating currencies against the U.S. dollar--we think the long-term story for NII remains intact. The firm has built an extremely valuable customer base in the region and should be able to continue expanding that base as it enters into new markets. The shares currently place the firm's enterprise value at about 3.3 times operating income, excluding depreciation and amortization, the lowest since 2003.
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Michael Hodel does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.