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March 29, 2007
Prudential Midwest Media Day 2007
I spent Tuesday at Prudential Securities Midwest Media Day. This is a great conference using a unique format combining very small group discussions with one-on-one meetings. Over the course of the day I met with CBS (CBS), Lee Enterprises (LEE), DreamWorks Animation (DWA), EW Scripps (SSP), Omnicom (OMC), Moody's (MCO), and Disney (DIS). Special thanks to Prudential media analyst Kathy Styponias and my institutional salesperson Michael Callahan for inviting me to the conference. Customer service is a hallmark of both of their efforts.
The only company at the conference that is presently owned broadly in Northlake client accounts is Disney (DIS). Nevertheless, I am positn gthis summary here instead of at Media Talk because broader conclusions about the media environment that impact actual Northlake holdings couldbe drawn.
I did not come away the conference with any new buy or sell ideas. However, I am incrementally more positive on CBS and SSP. I have been bearish on both stocks and don’t feel they are buys but I learned new information that challenges my core long-term bearish thesis on each stock.
On DIS, which I have been long on behalf of Northlake clients for a couple of years, I gained increased confidence in the upcoming March quarter earnings report. DIS is not included in this report but look for a separate note in the next couple of days.
Read on for individual company comments....
CBS: I have been bearish on CBS because of my concern that faltering ratings performance at the CBS Television Network, particularly on Thursday nights, could be the cusp of a multiyear decline in the network's financial performance amounting to hundreds of millions of dollars. In the past the swing from networks going from #1 to #3 or #4 has been of this magnitude. The reason I am less negative about CBS is because the management team of Les Moonves and Fred Reynolds explained to me how the economics of the network business have changed for the better, which should reduce volatility of financial results relative to ratings. There are three factors at work. First, a large portion of the fixed cost base in the form of affiliate compensation has been eliminated (fees that CBS used to pay to local TV stations to bribe them into being a network affiliate). Second, CBS owns 75% of its primetime schedule enabling it to make a lot more money off a successful show. In the old days, all the network received was advertising revenue from an initial showing and a rerun. Now they can earn money on syndication (selling the show to local TV stations and cable networks) and through developing digital distribution channels. Finally, the advent of high def TV is improving the quality of primetime TV, particularly in dramas. The production value of TV is the highest it has ever been which is helping to keep viewers and advertisers interested. I still don’t think CBS is cheap enough to buy but if the shares pulled back 10-15% I am now more inclined to consider it as a buy idea.
SSP: My bearishness on SSP has been linked to concerns that the cable TV network business was maturing rapidly and the premium valuation previously accorded operating income from this segment would contract rapidly. SSP management made a strong case that it can outperform its industry and has new levers to pull to sustain growth. Specifically noted was that $75 million of 2006's $840 in cable network revenues was earned online. This figure grew 50% last year and seems likely to sustain 25-50% growth for several years. Simple math suggests that this revenue stream alone can add 2-4% to the overall segment revenue growth rate making the likelihood of 10% annual operating income growth quite high. HGTV and Food Network have very popular and interactive websites with big traffic numbers. So far management appears to be doing a good job of monetizing the traffic with at least 80% of the revenue considered incremental. A setback in SSP's Interactive segement (Shopzilla.com) and continued poor performance of the Newspaper segment along with a valuation that is still at a premium to other diversified entertainment conglomerates like DIS keeps me on the sidelines at SSP. All else equal, I'd consider buying the shares in the upper $30s.
LEE: LEE remains an outperformer among newspapers companies due to a sales oriented corporate culture and a small market focus where the broad reach of the paper and associated website can sustain value to advertisers more easily. I don't think the stock can overcome the headwinds facing the newspaper industry however. I think newspapers are headed toward valuations 5-6 times EBITDA. At that level, LEE would be interesting.
MCO: My overwhelming takeaway was that this is purely and simply a macro story. if debt issuance remains in a growth mode then MCO will work again, if not then the story is over until debt issuance resumes growth. For the short-term, in the current environment with fears of a credit contraction paramount, it is hard to see how MCO works. The meeting also reminded me how complicated and diverse the various structures in the bond market have become. this makes me think that there is no real way of knowing how much stress many of these structures can take. I don't fear liability on the part of the rating agencies but rather that deals will unexpectedly blow up and the spillover impact will be credit contraction.
OMC: In blogosphere terms this was a meta discussion. Lots of talk about trends in advertising budgets and lots of talk about digital. OMC pitches the story that their ability to offer any marketing service including advertising, investor relations, public relations, promotion, etc in any medium gives them a competitive advantage in winning and retaining clients. They also think that movement away from TV is beneficial as they go from capturing 10-15% of the client spend to 80-90% in some cases. Costs are correspondingly higher but they said margins were similar. I got the impression that they really think that margins are "at least" equal. In any event, a 10% margin on $10 million is $1 million, while a 10% margin on $80 million is $8 million. On a side note I asked about cinema advertising and found that OMC believes it is a worthwhile medium and a growth business.
DWA: Everything rides on Shrek 3 in the near-term quickly followed by the Bee Movie. Shrek 3 cost around $160 million all in and the marketing spend will be around $150 million. Shrek 2 had an opening weekend of $108 million and a domestic gross of $441 million. International gross was slightly higher. they believe analysts have $300-325 million in their models for domestic box office on Shrek 3. I think anything short of almost $400 million will be bad news for the stock regardless of how it impacts analyst estimates. They also discussed the DVD market. they feel that things have stabilized enough and they learned some lessons on Shrek 2 so that there won't be any screw-ups for Shrek 3. one other interesting item was that in the future all movies be made as 3-D and then turned to 2-D in post production. The theatres are adding thousands of 3-D screens over the next few years so that they can charge a higher price for tickets to these screenings and differentiate from the home theatre experience. Costs are not significantly higher to produce in 3-D and piracy is a lot harder. Finally, we discussed what they will do with the excess cash on the balance sheet. There is really no need to invest in the business or pay down debt. Share buybacks make sense but float is an issue as there are only 50 million shares in the float and 80% is held by the top 15 shareholders. Special dividends were discounted (that was my idea) as setting an expectation bar that couldn't always be met. The bottom line is that DWA should be private or part of a large conglomerate. I have no opinion on the shares at current prices.
Posted by Steve Birenberg at March 29, 2007 11:59 AM in Media
