Communication Services: Digital Advertising Demand Has Some Firms Flush with Cash

Digital advertising remains red hot, with the bulk of incremental demand accruing to Meta Platforms META, Alphabet GOOGL/GOOG, and Amazon AMZN. Strong ad pricing has largely offset decelerating user growth. Google’s revenue per click has increased about 8% year over year over the past several quarters, while volumes have steadily grown at a mid-single-digit pace. Revenue per ad impression at Meta increased by 11% in the third quarter, the fastest rate in three years.

Meta and Alphabet Continue to Power Communications Services Higher

The ad giants continue to pour money into R&D and infrastructure to support the development of artificial intelligence. While the payoff from these investments is still highly uncertain, we’ve seen signs of clear progress, especially at Alphabet. The search giant released Gemini 2.0 in December, demonstrating continued feature improvements, such as the ability to ingest and produce text and images. OpenAI may have a first-mover advantage in AI, but we believe Alphabet’s ability to distribute and monetize applications built on AI across its advertising, content creation, productivity tools, and cloud services gives it an edge.

We See Opportunities in Telecom, Especially in Canada and Latin America

Meta has also seen benefits from new AI tools, but we expect most gains will remain confined to its core social media and advertising business. The firm claims that more than 1 million firms have used its AI tools to create ads, and we expect AI-enabled ad targeting will improve effectiveness. AI tools also help content creators and allow Meta to surface content to users. However, advertising budgets are ultimately finite. One of the reasons we prefer Alphabet to Meta is the former’s ability to monetize AI investments through its cloud business in addition to ad-supported services.

Ad Pricing Remains Very Strong as Click and Impression Volume Growth Slows

In the telecom world, fiber expansion remains a key theme. Following Verizon Communications’ VZ plan to expand its broadband fiber network with the acquisition of Frontier Communications FYBR, AT&T T announced that it will increase network investment to 50 million locations, nearly double the size of its fiber network, by the end of the decade. Despite these plans, we expect cable companies will remain the primary broadband provider in many locations. We also expect broadband price competition will remain rational, given the high cost to deploy fiber.

Cable's Network Reach Remains Well Ahead of the Phone Companies

Top Communication Services Sector Picks

Alphabet

• Fair Value Estimate: $220.00
• Morningstar Rating: ★★★★
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: Medium

We believe investors are overly pessimistic when it comes to antitrust concerns around Alphabet, as well as its competitive positioning in AI. On antitrust issues, we think the worst-case scenario—a breakup of the firm—is highly unlikely, and that the company will be able to navigate remedies without materially damaging its core business. We also see Alphabet as one of three credible leaders in the public cloud and believe it is well-positioned to benefit from surging interest in generative AI. We think Alphabet’s Gemini model and the variety of products that it powers, including a chatbot and productivity tools, can stand toe to toe with solutions from other industry leaders.

Paramount Global

• Fair Value Estimate: $20.00
• Morningstar Rating: ★★★★
• Morningstar Economic Moat Rating: None
• Morningstar Uncertainty Rating: Very High

We think Paramount PARA is too hated, and that its declining business overshadows the value of its content franchises and production capabilities. We also see catalysts that should drive the stock higher in the first half of 2025. Skydance is set to acquire Paramount, offering shareholders the opportunity to submit at least half of their shares for $15. While the amount is below our fair value estimate, submitting shares would ensure a quick return. Fundamentally, we expect Paramount to make significant strides on the profitability front in 2025. The company has already begun a sizable cost-savings program. We also expect streaming to move closer to durable profitability in 2025.

Comcast

• Fair Value Estimate: $54.00
• Morningstar Rating: ★★★★
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: Medium

We still favor Comcast CMCSA over other cable companies for its stronger balance sheet. We expect Comcast’s network will let it maintain the size of its broadband customer base over time while a rational competitive environment allows broadband prices to rise. The cable companies, including Comcast, will need to increase network spending in the coming years to keep pace with the phone companies’ fiber network capabilities, but we expect cable cash flow to still grow modestly over the coming years. In our view, the NBCUniversal business isn’t as strong, but it remains an important media asset.