Three months ago, our heading for this newsletter was called “Global Pandemic Spares Few Internet and Digital Media Stocks.” We then noted that the S&P 500 fell by 20% in the first quarter of 2020, while the four internet and digital media indices we monitor each fell as well, including ad tech (-28%), social media (-19%), digital media (-10%) and marketing tech (-7%) stocks.
Three months later the damage from Covid-19 on the stocks in these sectors doesn’t look so bad after all. Those with strong stomachs to invest at the mid-to-late March lows likely have been rewarded handsomely. In the second quarter the S&P 500 increased by 20%, while stocks in Noble’s digital media (+24%), social media (+37%); marketing tech (+48%) and ad tech (+94%) all significantly outperformed the market. In fact, not a single stock in the four sectors we monitor was down in the second quarter.
Not only did no stock in this universe decline in the second quarter, but many saw double digital returns. Including the Leaf Group (LEAF, +173%), Inuvo (INUV, +126%), Spotify (SPOT, +113%), The Trade Desk (TTD, +111%), and Cardlytics (CDLX, +100%). Snapchat (SNAP, +97%) nearly doubled as well.
Through the first half of the year, the S&P 500 finished down 4%, while the larger cap but more narrowly focused Dow Jones Industrial Index decreased by 10%. However, the FAANG stocks all finished up in the first half of the year: the stocks of Facebook, Apple, Amazon, Netflix and Google finished +11%, +24%, +49%, +41%, and +6%, respectively.
Not surprisingly, marketing tech stocks, with their recurring revenue business models fared best in the first quarter and first half of the year. Of the 11 stocks in our marketing tech sector, 9 of these stocks finished up in the first half of the year, led by Hubspot (HUBS, +42%), Adobe (ADBE, +32%) and SVMK Inc. (a.k.a. Survey Monkey (SVMK, +32%). We expect this group to post the strongest year over year revenue results compared to the advertising-based businesses that make up the ad tech, social media and digital media sectors.
OUTLOOK – INTERNET AND DIGITAL MEDIA
INTERNET AND DIGITAL MEDIA COMMENTARY
On the other end of the spectrum, 7 of 12 ad tech stocks finished down in the first half of the year. Investors are likely weary of the growth prospects for companies whose business are based on ad spend. Channel checks indicate that digital advertising declines in the 30%-40% range were common in the month of April, slightly better than traditional media advertising declines. However, it would appear that digital advertising trends improved significantly in May and June, far better than the advertising improvements at traditional media companies. We have had several conversations with digital advertising companies whose revenues in June were flat to down only single digits.
Despite significantly improving operating trends in digital media, we do not expect many companies to provide guidance for the third quarter given the uncertainty surrounding state by state reopening differences. While investors have had to “fly blind” heading into 2Q earnings results, we expect few companies to provide guidance given continued uncertainty ahead.
Sequential Decline in M&A Could Prove to be Temporary
According to Mergermarket's Global & Regional M&A Report, the number of global M&A deals fell by 39% sequentially to 2,630 deals in 2Q20 from 4,308 deals in 1Q20, and deal values fell by 48% to $308.9B in 2Q20 from $592.6B in 1Q20. This is not too surprising given the onslaught of the Covid-19 pandemic which caused most companies to focus on preserving cash rather than spending it. M&A is a tricky proposition in any economic environment, but especially so in one where there is very little visibility.
For the first half of the year, MergerMarket noted that deal volume fell by 32% to 6,938 transactions vs. 101,155 transactions in 1H19, while deal value fell by 53% to $901.6B from $1,907.5B in 1H 2019. In the United States, total M&A deal values in the first half of 2020 fell to their lowest activity levels since the first half of 2003. Complicating the effort to get M&A transactions across the finish line were the cancellations of site visits and in-person meetings, especially in March and April when the first lockdowns went into effect. U.S. M&A activity decreased by 33% in 1H20 to 2,139 deals vs. 3,174 deals in 1H 19. Deal values in the U.S. also decreased by 72% to $274.5B from $996.0B in 1H19. These results also reflected 53 deals that were terminated in 1H20, as deal terminations rose through May, but decreased in June. If there is a silver lining, deal activity appears to have picked up in May and June, particularly in the technology sector.
On a sequential basis, U.S. M&A deal volume fell by 68% to 668 deals in 2Q20, down from 2,077 deals in 1Q20, according to MergerMarket. Noble Capital Markets tracks M&A deal values in the digital advertising and marketing services sectors, and not surprisingly, deal volume also fell in 2Q20 compared to 1Q20. Noble tracked 251 deals in 1H 2020, with 151 deals tracked in 1Q 2020 vs. 100 deals in 2Q 2020, indicating a 34% sequential decrease in the number of M&A transactions.
While deal volume fell considerably, it is interesting to note that M&A deal value actually increased in 2Q 2020 despite significantly fewer deals where purchase price information was available. Noble tracked 36 deals in 1Q 2020 with purchase prices available compared to only 15 deals where purchase prices were available in 2Q 2020. However, there were significantly larger deals in 2Q 2020 than in 1Q 2020: total deal value in 2Q 2020 was $12.9B vs. $6.4B in 1Q 2020. More than half of the deal value in 2Q 2020 was attributable to the $7.5B acquisition of GrubHub by Just Eat Takeaway. Other large deals included Zynga’s $1.9B acquisition of Peak Games, and The Stagwell Group’s $1.6B acquisition of ad agency MDC Partners. Noble did not track any deals greater than $1B in 1Q 2020.
As shown in the chart in the PDF, of the 100 deals we tracked in 2Q 2020, 35 of them were in the digital content category, while the marketing technology trailed with 28 deals, followed by the always active advertising agency deals with 22. These three sectors were also the most active sectors in 1Q 2020.
In their second quarter commentary on broader U.S. M&A activity, MergerMarket noted that M&A in the technology sector started to rebound in May and June. We expect mergers and acquisitions to increase in the second half of 2020. We believe the biggest impediment to deal activity in the second quarter was visibility. At the onset of Covid-19, most businesses with an advertising business model witnessed heavy cancellations.
While traditional media businesses have seen modestly improved trends in recent months, we believe digital media businesses are witnessing a much stronger return in business trends. We believe this likely has to do with traditional media being more heavily weighted to brand advertising, whereas digital advertising businesses are more focused on direct response advertising. As sectors such as restaurants and travel begin reopening, it will be important for them to remind consumers that they are open for business, and platforms that are built to generate leads or maximize a return on investment will continue to see incremental improvements in ad trends. As visibility improves, so too should M&A. If visibility doesn’t improve and fundamentals remain tepid, it may accelerate consolidation trends, as companies realize they need to get bigger to compete with the walled gardens of Google, Facebook and Amazon.
OUTLOOK - TRADITIONAL MEDIA
Are Media Investors Too Pessimistic
Covid hit the advertising industry especially hard as businesses shut down to combat the pandemic. The second quarter will bear the brunt of the advertising fall out, with core advertising expected to be down in the range of 40% to as much as 60%. We believe that the second quarter results will be downcast with very few positive upside surprises. The media stocks quickly reacted to the effects of the pandemic, down on average 44.2% in the first quarter. Notably, the stocks have yet to recover, even as the economy is reopening. Media stocks on average are up 15.3% in the second quarter. Investors appear to have concerns regarding the recent spike in Covid cases, particularly in southern states, Texas, Arizona, Florida, and in California. The fear is that those states will reimpose restrictions on businesses, sending a trepid advertising recovery spiraling downward. For this reason, media managements are cautious about the advertising recovery. Notably, California recently reimposed restrictions on restaurants, movie theaters, and other indoor businesses. In our view, it will be hard to put the “genie back in the bottle.” Once states begin to reopen, we believe that people will not be willing to go back to “stay at home” rules. Consequently, we believe that advertising is on the mend, even in the troubled states where Covid is spiking.
Advertising trends in the third quarter are improving nicely from the second quarter disaster. We believe that core advertising in the third quarter will be down in the range of 30% to 35%, significantly better than the down 40% to 60% revenue expected in the second quarter. Encouragingly, Political advertising is starting to be booked, particularly for the Presidential campaign. Managements appear to be sanguine about Political advertising, but that optimism does not appear to be spread evenly. Some media companies located in battleground states such as Florida, Arizona, Michigan, and Ohio, appear to be very optimistic, while some companies that are located in less contested markets appear to be cautious. Consequently, investors should be prepared that not all boats will rise with the influx of Political advertising.
Many media stocks are still hovering around 52-week lows as investors weigh the reality of a resurgence of Covid 19 and some states’ rolling back reopening the economy. In our view, media stocks near current levels appear to have baked in dire advertising and cash flow expectations. The big fear in the industry nearly 3 months earlier was that high debt levered companies may not be able to survive the cash flow crunch. We believe that many of these companies are breathing a sigh of relief that advertising is bouncing back and that cash flow has significantly improved. Investors have yet to hear that message. As such, we believe that investors will become more interested in media stocks, once the second quarter is in the rear-view mirror and that there is a more optimistic tone on advertising in the second half.
Encouraging Early Signs On Political
Second quarter revenue is likely to turn out as bad to slightly worse than expected. As such, we are not anticipating that there will be much in terms of positive upside revenue surprises. Core advertising is expected to be down 38% to as high as down 55%, depending upon 1) the size of the markets, with larger markets likely to be down at the higher end of the range, 2) whether the stations are located in states that have had aggressive “stay at home” orders and/or 3) in states that have reopened the economy. Q2 cash flow results could be a wild card too, given aggressive cost reduction efforts and/or the participation in government employment relief programs. With a wide disparity in estimates, we believe that there will be some hits and misses on cash flow expectations. Overall, we anticipate that the quarter will be as ugly as feared.
As we look toward Q3, we believe that there are improving advertising trends. Core television advertising is expected to be down in the range of 28% to 36%. Notably, the advertising picture has been improving sequentially every month and forecasts are still fluid. The outlook will depend upon how some states manage through the recent spikes in Covid. Recently, California rolled back some business openings and forced the closing of Bars, Restaurants, and other indoor venues. Not surprisingly, managements appear cautious regarding how states such as Texas, Arizona and Florida will react to the spike in Covid cases there.
Importantly, some broadcasters remain optimistic about Political advertising, given indications of strong demand from the Presidential race. The Trump campaign appears to be aggressive in booking advertising and is currently leading in terms of spending at this point, particularly in swing states including Florida, Ohio, Michigan, Nevada and Arizona. We expect that there will be strong spending in many House and Senate races as well, but that money is typically booked later. We do not believe that the spending thus far is related to Facebook’s consideration of blocking Political ads on its social media platform in days before the election. Furthermore, not all broadcasters are optimistic about the Political dollars at this point. The Presidential dollars have been targeted in swing states and has not been spread evenly. As such, there is a lot yet to unfold regarding Political advertising. So far, E.W. Scripps has increased its Political advertising estimate, expected to be above $200 million for the year. The company has a large TV footprint in swing states.
The Television stocks performed in line with the general market, as measured by the S&P 500 Index, up roughly 20%. The shares of E.W. Scripps somewhat lagged that performance, up 16.0% for the quarter. We view the SSP shares as among our favorites in the sector given its strong footprint in swing states. In addition, the company recently announced the sale of its podcasting business, Stitcher, for $325 million and a New York TV station for $75 million. We believe that proceeds from the sales will assuage investor concerns over its high debt leverage. In addition to SSP, we view the shares of Entravision as among our favorites given its strong cash rich financial position.
Who’s Better or Worse?
The Radio industry is gaging how it is faring in the second quarter relative to the recent release of Beasley’s second quarter revenue expectation. Beasley reported in an 8K filing, which prefaced a refinancing, that second quarter revenues are expected to be down a significant 54% to 57%. Interestingly, many radio companies appear more sanguine about their second quarter performance compared with Beasley. Why? We believe that there is a disparity among small market versus large market Radio, with the small markets performing better. In addition, National advertising seems to have performed better than Local. So, companies that have Network Radio business, may perform better. It is likely that there was a very weak performance in Beasley’s Boston and Philly markets, which may have accounted for a significant portion of the company’s revenues and cash flow. In addition, many Radio companies have diversified revenue streams, which may be performing better than Radio.
To that end, comparatively, we believe that Salem Media and Townsquare Media will likely have much better second quarter revenue performance relative to Beasley. Salem’s Radio revenues, for instance, is expected to be down in the 25% range. For Salem, half of the company’s radio revenues come from block programming, which is much more stable. For Townsquare, we expect second quarter total company revenues to be down in the 35% to 40% range. Townsquare has a significant and growing Digital business. Digital now accounts for 40% of total company revenues. Notably, Townsquare Interactive is expected to grow double-digits in the second quarter. Even Cumulus Media is expected to do better than Beasley in the second quarter, with revenues expected to be down in the range of 45% to 50%. Cumulus is expected to benefit from its Network business and other diversified revenue streams, such as podcasting, that should allow the company to perform better than some of its peers.
So, what is on tap for the third quarter? We believe that Radio managements are cautious, given the trepid reopening of the U.S. economy. Nonetheless, Radio advertising trends appear to sequentially improve month to month. For the third quarter, we expect that industry revenue trends will be down roughly 30% to 35%. But, again, some diversified Radio groups may perform much better than that. A “V” shape recovery, which was hoped, now appears very unlikely. As such, some in the industry have begun permanent job cuts, including those recently announced by Cumulus Media. That company recently announce 3% cut in its work force.
The Noble Radio Index has recovered somewhat from the disastrous 48.1% drop in the first quarter, but not by much, up a modest 11.5%. The stock with the strongest second quarter performance has been Salem Media, which benefited from strong trading volumes. For the most part, most Radio stocks had a poor second quarter performance and traded to new lows in the quarter, including Cumulus Media, Entercom and Townsquare. We are constructive on the Radio stocks as a play on the economies reopening. Our favorite is Townsquare, which is expected to report results better than industry averages given what is expected to be favorable revenue growth for its Townsquare Interactive business.
Doing Better than Many
The Publishing stocks performed better in the first quarter and the second quarter than many media stocks. While Publishing stocks were down on average 37.7% in the first quarter, that performance was better than TV (down 46.9%) and Radio (down 48.1%). We believe that Publishers were accustomed to weak advertising trends and had cost reduction efforts in place based on the revenue outlook. In addition, Publishers appeared to be uniquely positioned with its Digital businesses to take advantage of the influx of Internet users, potentially seeking information on Covid and other geo-political developments.
Publishing stocks had a good second quarter, with the average increase 13.6%. The Publishing stocks under-performed the general market as measured by the S&P 500 Index, which was up 20.0%. But, there were notable performances such as the shares of The New York Times up 37.9% and Tribune up 23.2%. In the case of Tribune, there was news that the company added another board member from its activist shareholder, The Alden Group, and that Alden agreed to an extension of a standstill ownership agreement.
While the publishing industry is not immune to the expected weak Q3 advertising trends, we believe that there are significant cost mitigation efforts that should soften the drop in revenues. In our view, investors have yet to appreciate the digital transition of the industry, save the New York Times. Our favorite in the industry is Tribune Media (TPCO) given its favorable cash rich financial position, attractive assets like BestReviews (which may be sold), transition toward a digital future, and strong cash flow generation.