Newsletter Media sector review January 2017
Is the Post-Election Rally Justified?
A wave of optimism swept the investment community following the Presidential elections, with media stocks significantly outperforming the major indices which hit record highs. Media stocks in general were up a strong 12,6% versus a 4,6% gain as measured by the S&P 500 following the elections on November 8th to near current levels.
In our view, the gains were largely a reflection of the prospects of lower taxes, a possible lifting of regulations, and an acceleration of economic activity. While these prospects may be a hopeful future, the present, in our view, still reflects a lackluster economy. As such, we wonder if the euphoria will, at some point, be grounded by reality. We remain constructive on media stocks, but caution investors that the fourth quarter and, possibly, the first quarter fundamentals appear to be lackluster. As such, we encourage investors to take an accumulation approach to media investing and look for more aggressive buying opportunities on possible weakness.
OUTLOOK - TRADITIONAL MEDIA
Television stocks increased a strong 43% from the day after the general election to near current levels, strongly outperforming the general market. The TV stocks were due for a bounce given that the stocks were oversold and underperformed for much of the year. The underperformance earlier in the year was in spite of the fact that the industry had a "good" nine months, with the help of Political and Olympic advertising and a reasonably strong core advertising market, which was up roughly 1%. While Political advertising fell short of original expectations, 2016 was still a good year. Looking forward toward 2017, the stocks are likely to struggle early in the year with the prospect of lackluster fundamentals. But, we believe that there are bright spots. Spectrum Auctions seem to be winding down, which may lead to heightened M&A activity, which appears possible in the first quarter 2017. Retransmission revenue continues to be strong, which is shifting the fundamental dynamic of the industry away from economic sensitive advertising. We encourage investors to buy opportunistically, especially on weakness related to possible near term fundamental disappointments. We believe that the TV stocks should reflect 1) heightened Political advertising in 2018, strong Retransmission revenue growth, & increased M&A activity, which could be further fueled by lifting of ownership caps in a new "deregulatory" minded administration.
Many radio stocks struggled to gain much traction, save our favorites, which include, Entercom, Salem Communications, and Townsquare. These stocks were up 19%, 23% and 17%, respectively, following the Presidential election to near current levels. The highly-leveraged play, Cumulus Media struggled to gain traction. While the Radio group underperformed the Television stocks in the comparable time frame, the radio stocks significantly outperformed the general market. We believe that many radio investors focused on the prospect of an improved domestic economy, but we also believe that investors have in mind a Radio deal, whether it be an IPO or a large radio merger, which may include CBS Radio. The latest attempt for Cumulus to de-lever through a debt for equity swap could play into that prospect as well. Much like the TV industry, we do not believe that the very near term fundamentals have caught up to the stock prices in many cases. But, deal activity appears in the air as many radio broadcasters have lowered debt leverage. While stock valuations appear attractive, we encourage investors to take an accumulation approach when investing in the group.
The Publishing stocks did not participate in the rally that other economic sensitive advertising mediums did. Most Publishing stocks are near or slightly below trading ranges as of the Presidential election. This under performance is despite some positive developments. For instance, McClatchy sold a significant amount of real estate, very near the asking price, in the amount of $68 million, or $6.50 per share. The proceeds are to be used to pare down debt. Furthermore, the company still has its 15% stake in CareerBuilder that is currently on the block. In our view, many of the Publishers are getting debt levels into a manageable range as most companies have been very diligent in managing cash flow. In our view, the under performance of the Publishing stocks is reflective of the lack of interest in the group following Gannett's failed bid to buy Tronc. While deal oriented investors are likely out of the Publishing stocks, we believe that cash flow oriented investors should take note of the significant debt pare down in the industry. In our view, this sets up the prospect of heightened M&A activity in the near to intermediate future. In our view, Publishing stocks offer some of the best values in the media landscape at this time.
OUTLOOK - INTERNET AND DIGITAL MEDIA
In late-December, the Internet Advertising Bureau (IAB) reported that internet advertising increased by 20% in 3Q 2016. Through the first three quarters of 2016, internet advertising grew by 19%. As we noted in our 1Q 2016 newsletter, Google and Facebook account for the lion's share of the industry's growth. Google's revenues through the first three quarters of 2016 increased by 23% while Facebook's revenues increased by 50%. As shown in the chart below, this implies that Google and Facebook accounted for $7.8B of the industry's $8.1B increase, or roughly 97% of each dollar of incremental internet ad spend.
Fortunately, a deeper dive into third quarter results, shows that the industry as a whole is healthier than the above chart suggests. For example, in analyzing the 3Q results of publicly traded ad tech companies including Google and Facebook shows industry revenues grew 24.9%, while results excluding Google and Facebook, shows industry revenues decreased by 3.1%. However, Yahoo!'s results account for more than 100% of the decline. In fact, 6 of the remaining 7 publicly traded ad tech companies posted strong revenue growth including The Trade Desk (+84%), Criteo (+27%) and Social Reality (+29%).
The industry's strong revenue growth likely continued in Q4 2016. Recently, Magna Global reported that digital advertising increased by 18% in 2016 to $70.3B. Driving the growth was mobile (+54%), social (+48%) and digital video (+19%) advertising. Desktop advertising declined by 2%. Stocks in the digital media, social media, ad tech and marketing tech sectors underperformed the S&P 500, posting 2016 returns of 2.7%, 7.9%, -9.2% and 0.1%, respectively, versus a 9.5% return for the S&P 500. Interestingly, unlike the rally we saw in traditional media stocks, three of the four sectors decreased following the November election, with only the ad tech sector increasing modestly (+2.1%) following the election. Finally, the outlook for 2017 continues to look promising for internet ad spend. Total internet advertising is projected to grow by 14%, driven by mobile ad spend (+35%), social (+26%) and search (+14%). Desktop advertising is expected to decline by 5%.