Newsletter Media Sector Review October 2016

Getting Through The Election!

The political elections have been a focus for investors over the past quarter, with the unconventional Presidential election in the spotlight. The open seat Presidential race and the battle over the control over the Senate and the House was a perfect set up for a very strong political advertising cycle It appears now that this will not happen.

Whether it was lack of support from the Republican establishment, a novice Republican nominee that was ill prepared for fundraising efforts, or belief by the candidate that conventional television advertising was not needed; this election has broken the string of roughly 30% growth in the political advertising spend cycle. Based on our current estimates, it appears likely that political advertising may be below that of 2012. Important for investors, we believe that this lackluster political spend will be an anomaly, given the unconventional Republican candidate and lack of political Action Committee (PAC) money. As such, we encourage investors to look beyond this election, (which likely will be analyzed for years to come), and focus on the next election battle. In our view, political advertising is likely to remain a growth driver in future elections.


Investors were first tipped off that political advertising was not shaping up to be the barn burner that was earlier predicted by E.W. Scripps
in its second quarter conference call on 8/05/2016. The company lowered its political advertising expectations at that time. The rest of
the industry appeared to be holding out hope, but relented nearly a month later and lowered the political advertising forecast. We believe that the industry may be in for yet another wave of lowered expectations in the fourth quarter, with reports that the Republican nominee cancelled advertising in some key swing States. Political advertising aside, we believe that there are some bright spots to the Television industry: 1) Retransmission revenue fees continue to escalate, with $2 per subscriber in sight, 2) Spectrum Auctions are moving forward, and 3) M&A discussions are heating up. As a result, we believe that the TV stocks should have a nice finish to the year as the elections are over and investors once again focus on the value proposition of the broadcasters. We are constructive on the TV stocks and recommend an overweight, but would recommend an accumulation approach given the prospect of very near term political advertising disappointments.

Radio was never a big political advertising play. As such, the issues that have weighed on the television group are not at play in this sector. In addition, we believe that industry wide efforts to illustrate the favorable attributes of the industry, including stable listenership, has resonated with advertisers with this "value" medium and with investors alike. The radio sector has outperformed the traditional media stocks and the general stock market as measured by the S&P 500, up 16.8% since the beginning of the year versus a 6% increase for the market. We believe that the stock outperformance can also be attributed to several factors, which we believe will be evident for the balance of the year as well, including favorable fundamental environment for many in the industry, building M&A environment, and further debt refinancing's and/or equity offerings to shore up balance sheets. In our view, the prospect of an IPO or spin off of CBS Radio certainly has heightened investor interest in the sector. We recommend an overweight in the sector given compelling valuations, heightened investor interest in the sector and a favorable fundamental tailwind.

There has been a disparate stock performance among Publishing stocks from the beginning of the year to date with the leading industry consolidator, Gannett (GCI: Rated Buy) underperforming, and the rest of the industry performing very well. The year to date performance has the average newspaper stock up a strong 33%, despite a 28% decline in the Gannett shares on a comparable basis. It is clear that Gannett's rapid industry roll-up strategy is lost on investors that may be confused or skeptical of the potential value creation from its moves. Certainly, we believe that Gannett has some explaining to do to the investment community, especially given its recent lackluster fundamental performance, which has cast a pall over its most recent acquisitions' performance. In our view, investors seem to be speculating on Gannett's next take-over target or potentially sweetened offer for those it has already targeted and not focusing on the value proposition of each stock in the industry. Nonetheless, we believe that there is investment merit in the space and that the stocks are undervalued. As such, we recommend that investors overweight the sector.


In mid-September, eMarketer reported that digital advertising in the U.S. is likely to surpass TV ad spending this year. As recently as March, eMarketer had forecast that the shift would happen in 2017. U.S. digital ad spending is now projected to reach $72.1B in 2016 while TV advertising is projected to reach $71.3B. It is important to note that the shift is not occurring due to a slowdown in TV spending. In fact, eMarketer raised its forecast for TV spending due to strong Olympic spending and a strong scatter market. However, this uptick in TV spending is not enough to keep pace with strong online spending, particularly in the mobile and video sectors.

Mobile advertising is now projected to grow by 45% in 2016 to reach $46.0B. Online video ad spending is projected to reach $10.3B in 2016. Mobile and video are benefiting from a substantial increase in programmatic advertising which is making significantly more inventory available to national/large and local/small advertisers alike.

Within the internet and digital media sector, we focus on four primary sub-sectors: digital media, social media, advertising technology and marketing technology. As shown in the chart above, year-to-date, stocks in the social media sector (+18%) outperformed the S&P 500 Index (+6%), while digital media stocks (+5%) performed in-line while stocks in the marketing technology (+3)% and advertising technology (-17)% sectors underperformed the broader market.

Driving the significant outperformance in the social media sector is Facebook, whose shares were up 23% YTD. Facebook continues to exceed Street expectations: revenues and EBITDA exceeded Street consensus estimates by 7% and 14%, respectively, last quarter. The digital media sector's outperformance is driven by shares of Yahoo, which increased by 30% despite exceptionally weak operating results thanks to Verizon's $4.8B bid to acquire the company.

While stocks in the marketing technology sector failed to outperform the market, stellar contributors included Marketo (+23%, after being taken private by Vista Equity Partners for $35 per share), and Brightcove (+110% YTD; which returned to double digit revenue growth after cycling through the loss of a major customer in 2015.

Through September, half of the stocks in our ad tech sector increased while half decreased. Outperformers include ReachLocal (+175%), which was acquired in September by Gannett for $4.60. On the other end of the spectrum, stocks such as Rubicon Project (-50%), TubeMogul (-31%), RocketFuel (-24%) and Criteo (-11%) underperformed the market. Two issues appear to have weighed on the sector: 1) a decline in desktop advertising as dollars migrate to mobile ad campaigns; and 2) header bidding, the process by which publishers use a programmatic technique to offer their inventory to multiple ad exchanges simultaneously before making calls to their ad server. By making multiple demand sources bid on the same inventory at the same time, publishers can increase their yield. Rubicon Project and Criteo both noted header bidding as having impacted their businesses.

What must frustrate ad tech investors is the fact that operating results have been quite good. For example, in Rubicon Project's most recent quarter, revenues and EBITDA increased by 33% and 177%, respectively, while Criteo's revenue and EBITDA increased by 36% and 66%, respectively. Nevertheless, each company's 3Q guidance fell shy of consensus estimates.

On a brighter note, the ad tech sector received a boost when The Trade Desk priced its IPO at $18.00 per share on September 21st, and shares finished the day at $30 (+67%). Trade Desk shares trade at a significant premium to its peers, which likely reflects exceptionally strong organic growth (revenues and EBITDA growth of 93% and 112%, respectively) and attractive EBITDA margins (33%). It will be interesting to see how many other ad tech companies look to follow in The Trade Desk's wake.

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