• Speaking of box office, it was another strong weekend with a gain of 25% vs. a year ago. RGC's quarter ends this Thursday and the box office is tracking to be up 7%. I think this is far ahead of current analyst estimates which are stale due to restrictions related to the NCMI IPO. Comparisons toughen for a few weeks before focus shifts to the enormous potential in May when Shrek 3, Spiderman 3, and Pirates 3 all hit theatres.
• Keep on eye on the Vonage (VZ) blow-up from the perspective of the cable industry. My first reaction was to wonder whether the Verizon (VZ) patents may be applicable to the cable industry. I've asked the question and so far I hear mixed results. In general, the expectation is that the cable companies don’t have to worry about violating VZ's patents. However, one contact indicates that VZ thinks that based on how the judge ruled the cable companies may be in violation. Another thing to keep an eye on is what happens to VON's current customers, who will get the customers that Vonage would have won in next year, and will pricing firm up now that the low price competitor is leaving the market. In general, the answers to these questions are positive for cable as long as they don’t get caught up in VZ's patents.

Media Madness

A few small items in the media world that are cluttering up my desk:

• Last week FCC Chairman Kevin Martin appeared before Congress for the first time since the Democrats took control. The questioning made it very clear that the FCC will face much different Congressional oversight until at least January 2009. Fortunately, the agenda for media companies is not that heavy but pending and rumored mergers are likely to find a much tougher road to approval.
• Martin's testimony revealed that the FCC will consider reestablishing the 30% ownership cap for any multichannel service provider, cable or satellite. This should not create much of an obstacle to further industry consolidation. Presently, a DirecTV-Echostar merger would just barely slide in under the proposed cap. Additionally, either Time Warner Cable (TWC) or Comcast (CMCSA/K) could acquire Cablevision (CVC).
• According to a Reuters article, 40% of all sub prime loans were made to Hispanics. There are already some signs that Hispanic advertising growth is slowing from its historical rate. I wonder how much Hispanic radio and TV advertising was from sub prime lenders. I also wonder if the sub prime meltdown could cause damage specifically to the Hispanic economy that could impact general advertising trends to the important population. Negative implications might exist for Spanish Broadcasting (SBSA) and Entravision (EVC).....

• As theatres upgrade to digital projection, expect a big expansion in 3-D enabled screens. I read an article that said currently there are 700 3-D enable theatres and that number is expected to grow to 6,000 to 8,000 by 2009. The upcoming Disney (DIS) release Meet The Robinsons will get a lot of 3-D distribution which is being supported by Disney's marketing campaign. More 3-D films is a benefit for theatre operators like Regal Entertainment (RGC) as 3-D is not presently replicable in a home theater.
• The box office was up 3.3% this past weekend according to BoxOfficeMojo.com. Year to date the box office is up 4.2%. RGC's 1Q07 includes the final weekend of 2006 and wraps a week from Thursday. On this basis, the box office is up over 5% so far this quarter. Comparisons toughen considerably in April but investors will look ahead to the guaranteed record breaking May when the third films in the Shrek, Spiderman and Pirates of the Caribbean franchises hit theatres.
• Speaking of Pirates, the theatrical trailer for the Pirates of the Caribbean: At World's End had its world premiere Monday night on Disney.com. Here is a link.

UBS Media Conference 2006

Every year I attend the UBS Media Conference in NY to get a face-to-face update with many companies in the media industry. My goals are to find new ideas for client accounts, gain a better understanding of major industry trends, and connect with other money managers focused on the media sector. Below is a lengthy providing one paragraph summaries of all the presentations I saw during my four days in NY.

Overview and 2007 Advertising Forecasts

Sir Martin Sorrell, CEO of WPP Group noted is his keynote presentation at the 34th Annual UBS Global Media & Communications Conference that "if you compete on price, you create commodities, not brands." Usually we think of price competition on products and services purchased by end users. However, Sorrell made his comment in the context of a discussion of what is going on in the global economy for all things advertising related.

I think what Sorrell was getting at is that changes in media consumption due to digital technologies will be tricky to navigate. On the one hand, the digital technologies are opening new avenues for consumption of content supported by advertising. On the other hand, these same digital technologies could serve to depress profitability across all advertising-related industries because there is a major risk that the transition to digital/broadband delivery of content could depress pricing on the content, and in turn, the advertising.

The first day of the UBS conference was largely devoted to advertising forecasts and big picture, meta thinking about the future of the global media industries. I'd classify the news as mixed. 2007 advertising forecasts revealed by Universal McCann and Zenith Optimedia called for U.S. growth of 4.8% and 4.1%, respectively, and international growth of around 6%. International growth is boosted by continued double digit growth in many emerging markets with Central and Eastern Europe and Asia being the strongest geographies.

These growth rates overstate the outlook for traditional media as they include another year of 20% plus growth in internet advertising. Internet is contributing about 2% of the growth rate, leaving traditional media advertising growth at just 3-4%, or about inline with real GDP growth rates. Historically, advertising has been a considered a cyclical growth industry because it tracked nominal GDP growth. The loss of pricing power that Sir Martin noted in his comments reflects the new reality.

It is not pricing alone that is causing problems for traditional ad supported media. Newspapers, magazines, radio, and TV are all losing time spent using to alternative forms of entertainment including the internet. In fact, a study noted by Zenith Optimedia CEO Steve King concluded that the internet now represented 22% of our media consumption but just 7% of the total advertising pie. The cost to reach consumers on the internet is far lower than in traditional media so even if media companies can keep the lion's share of their users as the online transition continues, prices and profitability could compress.

Fortunately, this viewpoint is readily accepted by investors, analysts, and the companies themselves. Consequently, the upside is that most companies and industries are fighting back and are willing to risk new trying new distribution methods to reach consumers. Furthermore, when perception becomes reality and conventional wisdom, stock prices ought to reflect the news. In other words, whether it is the depressed stock prices of local media such as newspapers and radio or the outperforming prices of the big entertainment conglomerates and multichannel TV distributors, it is probably fair to say that the stocks reflect the tricky fundamental environment. This leaves it to investors to find opportunities where companies are meeting the challenges and thriving.

With that in mind, here are a few observations on other presentations I attended during the conference which ran from December 4th through December 7th.....

Monday, December 4th

Modern Times Group (MTG) is a Swedish company with leading free and pay TV positions in Scandinavia, Central and Eastern Europe (CEE), and Russia. There is no US listing for the shares. However, the company's commentary was very constructive for other companies operating in these regions including Central European Media Enterprises (CETV) and CTC Media (CTCM). News Corp (NWS) also has a growing presence in CEE markets.

My interest in CETV, long my favorite stock, always has me listening for commentary on CEE media markets. I believe I can state objectively that this conference represents the mainstreaming of the CEE opportunity. King of Zenith Optimedia, Sorrell of WPP, and Peter Chernin of News Corp all highlighted the CEE opportunity, often multiple times. King was unusually enthusiastic, noting that 15% 2007 advertising growth in this region was the highlight of Zenith's 2007 forecast. If my assessment is correct, it bodes very well for shares of CETV.

Additionally, MTG responded to several questions about their #2 station in the Czech Republic by noting that the would follow CETV's lead and attempt to raise TV advertising prices by 10-15% in 2007. CETV remains my #1 pick in all of media with 20% revenue growth and margin expansion driving margin expansion and a $90-100 target on the shares.

I would also recommend investors add to positions in NWS. Chernin and UBS Media analyst held a "fireside chat" that supported the bullish estimates and sentiment surrounding NWS. I've done very well with Disney (DIS) by riding the synchronized growth of the media networks, theme parks, and filmed entertainment that had led to a multiyear run of double digit EBOTDA growth. NWS is about to embark on its own multiyear run of double digit growth starting with guidance for 14-16% growth in 2007. NWS is benefiting from synchronized growth in its US and international cable networks, Sky Italia, digital and broadband efforts led by MySpace, and emerging markets exposure in CEE, India, and Asia. A massive share buyback triggered by the swap of NWS's Direct TV stake with Liberty Capital (LCAPA) would be icing on the cake.

One other company that impressed me was NII Holdings (NIHD). NIHD is not a media company. It is a leading provider of mobile phone services in Brazil, Argentina, Peru, and Mexico. This was my first exposure to the company and I was very impressed by the corporate strategy, execution, and CEO Steve Shindler. The stock looks expensive at 12-13 times EBITDA but the company has a 3 year growth record of 34% in subscribers, 34% in revenue, and 40% in EBITDA. And Shindler noted numerous times that growth is poised to accelerate in Brazil and Mexico. Additionally, free cash flow should surge as the company completes the expansion of footprint across all of Mexico in mid-2007. I have more work to do but this might be a case of you get what you pay for. Being new to this stock, I'd welcome any input form contributors or subscribers.

Tuesday, December 5th

New Media Economics Panel: This panel discussion attempted to explain the economics of ad supported content distribution on the internet focusing on video content that would be supplied by traditional suppliers like Disney, News Corp, Time Warner, and others. There were two conclusions. First, subscription based models would not likely produce enough revenue create profitable models especially considering the potential that online video might replace traditional viewing on TV. The reason for this conclusion is that a historical look at quadruple play household spending in the US shows stability indicating the consumer is not willing to allocate a larger portion of the monthly budget for subscription based video. Second, advertising supported models will work but current projections calling for a multi billion revenue stream from ads preceding "free" online TV shows would take longer to develop than currently forecast. The panel laid out a series of required advertising infrastructure such a critical mass of unique users and uniform technological standards and concluded that the infrastructure wasn't anywhere near ready. If the panel is correct the recent more positive sentiment toward the big entertainment conglomerates may be overly optimistic.

Evolution of Monetization Panel: This panel consisted of a half dozen start-ups that are trying to improve ad buying efficiency using internet tools. The presenters focused on everything form ad creation through ad placement. Much of the commentary went over my head but there was one interesting moment. UBS Internet Ben Schachter analyst asked the panelists to raise their hands if they were worried about Microsoft as a competitor. Two hands went up. Schachter then asked about Yahoo. Three hands went up. Finally, Schachter asked about Google. All six hands went up. My takeaway was that Google's strategic plan appears to be reaching the entire advertising economy from end-to-end.

Sundance Channel: Larry Aidem, President and CEO of the Sundance Channel, provided an overview of the company's strategy. Sundance is primarily a movie channel featuring independently produced and financed films. Sundance is privately held with ownership spilt among NBC, CBS, and Robert Redford. The channel appears in premium tiers of Dish and DirecTV and on digital tiers of cable operators. The present subscriber base is 25 million. Another 9 million subscribers have access to Sundance via a VOD channel. Like many cable channels, Sundance is trying to increase its originally produced content. Sundance is also looking to increase its sponsorship revenue. Presently, the channel sells no traditional commercial time. The promotion model is similar to what you see on local publlc TV channels. Sundance appears to be a valuable niche asset for NBC and CBS and either would likely want to add the channel to its stable of cable of networks. However, Redford doesn't sound like a seller. Sundance's value comes from the fact that it has 70% brand awareness (likely due to the success of the Sundance Film Fesitival) in the U.S. and its viewership is affluent. Given its status as a private company, there is no direct investment takeaway from the Sundance presentation. However, the presentation does reinforce the desire of many newer channels to be very niche oriented. Additionally, Sundance is another reminder that cable networks face increasing program costs as the growth in affiliate fees is moderating.

JC Decaux: This French company is one of the world's leading outdoor advertising companies with unusually large exposure to street furniture and transportation (buses, airports). I attended to learn more about the outdoor advertising market, which is one part of traditional advertising I know least. The presentation noted that worldwide outdoor advertising growth is around 7% and stable, far better than most other traditional media. Outdoor's competitive advantage is that people are more mobile allowing outdoor ads to reach consumers who are fragmenting time spent with other traditional media. There seems to be plenty of room to grow as outdoor represents just 5% of total worldwide advertising market and the three major players, Clear Channel, JC Decaux, and CBS, have market shares of just 12%, 10%, and 9%, respectively. JC Decaux indicated very firmly that it would bid for Clear Channel Outdoor (CCO), if the new private equity firms are sellers. This presentation was bullish for CBS and Lamar Advertising (LAMR).

Cable Networks: David Zaslav, currently in charge of NBC Universal's cable networks but on his way to become CEO of Discovery Communications discussed broad trends in the cable network industry. This was the first presentation I have seen which acknowledged this formerly double digit growth engine for entertainment companies was maturing. Industry revenues have been driven by subscriber growth, affiliate fee inflation, ratings growth, and CPM growth. Zaslav indicated that each of these revenue streams was slowing to low mid single digits. Offsetting positives are greater inventory sellout ratios and development of ancillary revenue streams such as VOD and online. International efforts are also beginning to mature. However, digital initiatives come with added costs and protecting current networks requires a greater investment in programming. Realization that cable networks are now an upper single digit growth business is a negative for Disney, Time Warner, News Corp, Viacom, and EW Scripps. However, I'd still much rather be a cable networks company than a newspaper, radio, or broadcast TV company.

Rogers Communications (RG): RG is the largest wireless company in Canada with a 37% market share. RG is also the largest cable company with a 29% share. For comparison, Verizon and Cingular each have about 25% of the US wireless market and Comcast has about 44% of US cable subscribers, but less than 30% of total multichannel TV subscribers. RG has been growing rapidly. Wireless in Canada is closely tracking the US adoption curve but got started several years later. Penetration is just 54% and is likely to growth by 5% per year for several more years. RG is unusually well positioned as it operates the only GSM network in Canada. RG's cable business is closely paralleling the strong growth in US cable with a mix heavier in high speed data but much lower in VOIP telephony. I was very impressed by this presentation, as I expected to be. I plan to buy RG on a modest pullback and may decide not to wait.

Grupo Televisa (TV): I have written favorably about TV before and deeply regret not having bought the shares despite my bullish outlook. TV dominates Mexican TV with its four channels garnering a steady low 70% share for many years. The company also supplies its TV content all over the world including as the dominant supplier to Univision. Over half of TV's revenue and EBITDA comes from TV Broadcasting, while an additional 20% comes from Sky Mexico, a satellite platform comparable to DirecTV. These core businesses should continue to drive solid double digit growth and margin expansion after a lull in 2007 when growth will be held back by the 2006 boomlet driven by the World Cup and Mexico's Presidential election. Promising new growth initiatives include 40% ownership of a new free-to-air TV channel in Spain and launch of a gambling business in Mexico encompassing bingo parlors, sports betting a second national lottery. The next time emerging markets sell-off and drag TV shares down, I plan to take a long-term position in this very high quality company. I hope that the shares won’t have moved up too much more before that happens. Take a look at a chart of the stock form last May and June to give yourself an idea of what might happen.

Disney (DIS): DIS shares hit a new 52 week high yesterday following comments by CFO Tom Staggs at the UBS and Credit Suisse conferences. While still cautioning investors that there are many headwinds for FY07 ending September, Staggs offered plenty of positive comments that increased investor confidence in the outlook for another year of double digit growth. Notable positive comments included (1) DVD sales of Cars are tracking equal to The Incredibles, (2) the ad market for ABC and ESPN is solid but not spectacular, and (3) the current quarter attendance and hotel occupancy at the domestic theme parks is holding up well against the toughest comparison of the year. Tough comps, loss of tax benefits, Pixar dilution, and other factors still present a growth challenge in 2007 for DIS, especially on the EPS line. However, on the operating income line, the outlook appears to be firming assuming the economy holds together. DIS also gets a boost from the weak dollar which helps foreign travel to the US parks. I remain long DIS and added positions in new accounts in the last two weeks.

Wednesday, December 6th

Verizon Communications: I sat it in on the VZ presentation to get an update on its FiOS deployment, the rebuild of its twisted pair copper network with fiber to the home. Despite the heavy dilution from FiOS, I think it is the correct strategy if VZ if going to hope to remain competitive with the cable industry in providing broadband and telephony to the home. While cable companies dispute VZ's statements, VZ claims it has achieved 14% penetration where it has rolled out FiOS. With a 2010 target of 6-7 million customer households, FiOS will begin to bite the cable industry in a few years. However, I think cable remains in a very strong position for 2007. Regarding VZ shares, broadband, business, and wireless are nice growth engines but investors have low confidence in VZ's forecast that FiOS dilution will peak in 1Q07. Were that to change or if additional dilution were the results of substantially greater than expected subscriber growth, VZ shares would likely be good performers again.

AT&T: T has shown great earnings growth as a result of synergies achieved in a series of mergers including Cingular/AT&T Wireless and SBC/T. The next big deal is the BellSouth merger which is stuck at the FCC. Assuming the deal closes, merger savings and additional cost cutting will drive earnings and likely lead T shares higher. However, I think T is making a big mistake by using a fiber to the node instead of fiber to the home strategy. T will have an inferior product and will not garner the massive cost savings from an all-fiber network. I think the decision to go fiber to the home will ultimately lead to the acquisition of Dish Network. Synergies won't be as high in that merger. T shares offer nice upside if the BLS deal is approved but I won’t be along for the ride because of my view that in the long-term the company will be in a weak competitive position.

Economics of Film: I sat in on a fascinating panel discussing the recent trend for movies to be financed by hedge funds. A representative from Creative Arts Agency and another firm that helps to validate the deals explained the history of film financing, how the current deals are structured, and why the financing of films is changing. Basically, the idea is to use capital markets theory so that film financing drives a more efficient production and marketing process for movies. Presumably, returns will be more stable, benefiting all parties. I suspect this won’t work in the long run because too much money will flood into film financing and investors will gradually reduce the hurdle rates for deals. Ultimately, it will produce a bubble in production much like Wall Street IPOs produce bubbles in other industries. That said, for movie studios, the new financing strategy might make their results more predictable as they trade upside for predictability and effectively become marketers and distributors while leaving equity mostly in the hands of the financiers. The exception to this would be when a studio owns its own intellectual property (Pirates of the Caribbean for Disney is a great example) or proactively decides it wants to develop the intellectual property. No immediate investment ramifications from this panel but if the new financing strategies actually improve the predictability and stability of the studio's filmed entertainment businesses, a higher multiple could be awarded to this operating income.

Time Warner (TWX): Jeffery Bewkes held a bullish fireside chat with UBS Media analyst Aryeh Bourkoff in front of a full ballroom. Bewkes is normally a good speaker but I thought he showed an unusually high level of self-confidence. I mentioned this fact to several big-time buysiders in the media world who all agreed with my assessment. I think this is actionable as it indicates TWX is going to report a strong fourth quarter and provide solid 2007 guidance. Notable among Bewkes comments were: (1) AOL's advertisng business is performing very strongly in 4Q, likely showing another quarter of 40% plus growth, (2) the recent trend of slower than expected VOIP telephony adds at Time Warner Cable is likely to reverse, and (3) there is no margin pressure in 2007 in almost all of TWX's businesses. If my feeling on 4Q06 and 2007 guidance proves accurate, I think TWX shares could trade up to $22-24 over the next few months. This is a more bullish outlook than I had previously expected and is largely the result of an unexpected highly positive vibe emanating from AOL. I totally whiffed on AOL so far, expecting the new strategy to fail.

NTL Incorporated (NTLI): NTLI announced before its presentation that it would be dropping its pursuit of ITV. Surprisingly, this did not result in a pop for the stock. I think the reason why is that in its attempts to explain to investors why the ITV was a good idea, the company endorsed the bear case that the competitive environment in the UK creates a headwind that even the Virgin rebranding and execution of merger synergies and NTL operational upgrades will not be able to overcome. Furthermore, in response to a question, management said that it "had better opportunities" than to buyback stock. Given that the company was willing to massively increase leverage to buy ITV but is not willing to increase leverage to buyback stock, a poor signal was sent. All that said, If NTLI shares traded lower ahead of the expected improvement in operational and financial metrics in 2007, valuation could get attractive enough to entice me back into the shares.

Liberty Global (LBTYA/LBTYK): Liberty is a large international cable operator with 13 million customers in 17 countries. Run rate revenues and EBITDA are $6.3 billion and $2.3 billion, respectively. The company is most focused on Europe but has significant exposure in Latin America and Japan. Recently, the company has been selling and buying cable assets which has mostly shifted its asset base in favor of higher growth markets, particularly in Central and Eastern Europe. An astute investor asked why the company wasn't growing faster (11% revenue, 15% EBITDA last quarter) given its heavy capital spending (almost twice as high as a percent of sales than US cable companies). The gist of the question was that Liberty wasn't earning a good return on its spending, while foregoing free cash flow that could be returned to shareholders. Management effectively responded by noting that today's heavy spending was extending the double digit growth profile many years into the future. Management also noted that despite the heavy spending and lack of free cash flow it was in the process of completing its third dutch auction share repurchase this year without pushing debt levels anywhere near the danger zone. I think management won the argument and have no intention of selling the shares I have owned in my personal account for many years. I guess that is a recommendation to buy the shares at current prices.

Charter Communications (CHTR): Aryeh Bourkoff introduced CHTR by noting that based on the massive dollars in private equity, CHTR's lousy balance sheet with a 9:1 ratio of debt to EBITDA was obviously the envy of companies everywhere. Given that cable stocks trade at less than 9 times EBITDA, I still see CHTR equity as effectively worthless. However, the CHTR shares have tripled and yesterday Aryeh raised his target to $4.50 while another analyst launched coverage with a $4.50 target. I see four reasons why CHTR shares have been rising and each could justify the new targets. First, restructuring of debt has pushed maturities out several years dramatically increasing the time value of CHTR's optionality. Second, a strong high yield market might be opening opportunities for further debt restructuring. Third, the sharp rise in value of Comcast shares has increased subscriber values to the point that CHTR's equity might have actual, not theoretical value, at current valuations. If that is the case each move up in Comcast increases the value of CHTR's tiny equity value geometrically. Fourth, the pending creation of a publicly traded Time Warner Cable that is likely to acquisitive, along with Comcast's willingness to expand its footprint, suggests that CHTR has greater options to fix its balance sheet through assets sales should it so desire. I like cable and I don’t mind leverage but I'll settle for Liberty Global and Comcast where upside exists but the risk profile is much lower. CHTR is just a bit too aggressive for me.

Thursday, December 7th

Mark Cuban, HD Net: Mark believes that TV will continue to dominate video delivery. His rationale is as follow. First, he sees HDTV's on the same price performance curve as PCs' meaning that the more and more households will have HD capabilities over the next few years. Second, all the studies show that once consumers have HD, their viewing habits change in that they immediately seek out HD channels at the expense of analog channels. Third, there are bottlenecks in the broadband networks that will prevent massive downloading of HD video programming. The files are just too big. Fourth, put the first three factors together and viewers will not be satisfied with the experience of watching TV on their PCs or in analog form if an iTV device does allow transfer of files on the PC to the TV. Cuban's view is bullish for multichannel TV providers such as Comcast and DirecTV. As usual Cuban addressed lots of other topics including his view that Google should not have bought YouTube, his bullish trading call on Yahoo for 2007, and the massive contracts filling up the roster of the NY Knicks.

Insight Communications: Insight is a private cable company, 50% owned by Carlyle and 50% owned by Comcast. Insight is the 8th largest cable operator in the U.S. with 1.4 million customer relationships in Indiana, Illinois, and Ohio. I sat in on this presentation to get a sense for what Comcast's intentions are toward Insight. Insight CEO Michael Willner pretty much admitted that the company would not exist in its current form within two to three years. Both sides are currently allowed to trigger an event that would rationalize the ownership structure. Despite lots of prodding from UBS Media analyst Aryeh Bourkoff, Willner refused to say whether a transaction was imminent. One other takeaway form this presentation is that the triple play bundle of TV, broadband, and phone works just fine in small and mid-size markets where population densities are lower and satellite TV penetration is higher. I'd expect Comcast to own 100% of Insight soon but don’t see it as something that will move Comcast shares.

Mediacom Communications (MCCC): MCCC is a smaller cable operator passing 2.8 million homes, mostly in markets sized from 50-100. MCCC is heavily leveraged. The company is producing double digit revenue and EBITDA growth but its growth rates significantly lag the industry. This is likely due to stiff competition from satellite companies in the smaller markets the company serves. I see little upside in MCCC shares because of relatively weak operating momentum and lack of free cash flow to pay down debt. Additionally, the resolution of MCCC's dispute with Sinclair Broadcasting (SBGI) over retransmissions fees will pressure margins next year as programming expenses, already at a premium to other larger cable operators, rise further. If I were interested in a highly leveraged play on cable, I'd go with Charter Communications.

Craigslist: Jim Buckmaster, CEO of Craigslist, gave a very interesting presentation in Q&A format with UBS Internet analyst Ben Schachter. Buckmaster stated that Craigslist puts the needs and wants of its users ahead of corporate goals. Craigslist is more interested in doing what it views is good for society than in maximizing profits. While this viewpoint was met with snickers and laughter by the audience, it was also clear that the company is growing rapidly and producing plenty of profits. Overall, I found the discussion refreshing as it led me to question conventional wisdom. As an investor, I found the discussion troubling for newspaper companies, whose classified ads are under direct attack by Craigslist. Growth at Craigslist could also limit the opportunity for Yahoo, Google, and other internet companies to capitalize on the local classified business.

Comcast (CMCSK/CMCSA): Comcast made a bullish presentation emphasizing its "accelerating revenue and operating cash flow growth." The gist of the presentation was that for the next few years, the trends driving this year's mid-teens growth are likely to remain in place. Furthermore, no significant rebuild of the networks is required to drive growth residential growth at least through 2007 and probably 2008. Capital spending will rise as more and more customers take the triple play but the returns on this variable, success based spending are very high, Comcast says north of 30%. There will also be a boost in capital spending of up to $250 million in 2007 as Comcast prepares to more aggressively enter the small and mid size business market. Expect to hear more about this opportunity in the next few months when it is positioned as almost as large as the current residential business with the ability to drive growth in 2008 and beyond. Comcast was trading at $26 at the 2005 conference when I was a lonely bull. I am a lot less comfortable with the shares at $42 and the bull side of the trade very crowded with portfolio managers and analysts. Howeve,r I think Comcast's operating results will surprise to the upside in 4Q06 and estiatmes for 2007 will head higher. This should be enough to drive the shares toward new analyst targets in the upper $40s. That is enough to keep me bullish on the shares.

I hope you enjoyed my coverage of the conference. I want to thank UBS and their analyst team, including Aryeh Bourkoff (media), Ben Schachter (internet), John Holdulik (telecom), Brian Shipman (publishing), and Matthieu Coppet (media strategy) for putting on another fine conference and welcoming Northlake Capital Management.

Bud Latest Company To Shift Advertising Mix

Advertising Age is reporting that Anhueser-Busch (BUD) "2007 media plans call for significant increases in marketing spending." However, not surprisingly, the company plans to shift its mix in favor of digital advertising. This is good news for internet advertising driven stocks, most likely those with strong positions in branded advertising such as Yahoo (YHOO). On the flip side, the losers appear to the broadcast television networks.

BUD's Chief Financial Officer, Randy Baker, told an investor meeting that the total advertising spend was going to rise significantly but the mix of media purchased would change "to reflect the viewing habits of our consumers." Baker noted two key mix shifts. First, more money will be spent on cable TV networks and less on broadcast TV networks. Since Baker noted that BUD's massive spending on sports would unaffected, this implies that prime time network TV would bear the brunt of the mix shift. ABC is owned by Disney (DIS), CBS is owned by CBS Corporation (CBS), FOX is owned by News Corp (NWSA), and NBC is owned by General Electric (GE). Fortunately, DIS, FOX, and GE also own a broad array of cable networks so the loss at the broadcast networks will be softened. CBS has extremely limited exposure to cable networks. The numbers here aren’t huge, BUD spent under $300 million on network TV in 2005, but given the high operating leverage in the network TV business, this is still a meaningful shift.....

The second shift is from traditional media to internet. This is old news. BUD made its intentions clear several months ago, while other large TV advertisers like Procter and Gamble (PG) have announced similar moves. In this case, only NWS through MySpace has any real hope of recapturing lost network TV dollars.

Yesterday, I discussed how advancing technology benefits content producers like DIS, NWS, CBS, GE, and Viacom (VIA). The news out of BUD reminds us that closely related technology changes are also working against these same companies.

I continue to believe that due to the momentum of its major operating businesses DIS is the best positioned entertainment conglomerates. NWS should enjoy a similar syncing of its major operating units beginning in 2007, while also benefiting from MySpace. Consequently, these are top two choices for current investment.

And I you are wondering why BUD feels the need to significantly up its marketing spend, look no further than shipment growth of just 2% for the first three quarters of 2006. #2 and #3 brewers, Coors and Miller are faring no better, with Coors up less than 2% and Miller seeing a 2% decline in shipments. Traditional media may face secular challenges, but apparently they aren’t alone.

Technology Advances Assist Media Growth

Rob Martorana, my editor at StreetInsight.com, and I had an email exchange the other day surrounding the advances in digital technology for media playback. Rob was discussing his new 30GB iPod with accessories, his new high def cable set top box, and his first experience watching a DVD in the new blu-ray format. The gist of our conversation was that new technology can drive the business for content producers, especially the ability to exploit a quality library of media.

Yesterday,I received another reminder of this when Bernstein Research put out a research report on Corning (GLW) discussing the high likelihood that 70 inch flat screen TVs will be on sale in the next few years. According to Bernstein, an 80 inch flat panel LCD TV would weight the same as a 36 inch CRT TV. Bernstein's pricing model indicates that by 2010 a 70-80 inch flat panel LCD TV might retail for $3,000, which would be "roughly the same percentage of US average disposable income as a PC in 1996." Furthermore in 1996, PCs had a "40% household penetration."

Now I suppose not everyone has wall space for a 70-80 inch TV, but the mere possibility supports the idea that producers of high quality video content stand to benefit as technology advances lead consumers to upgrade their equipment and refresh their libraries.

The winners would be video content creators like Viacom, Time Warner, Disney, News Corp, CBS, and Lionsgate. Multichannel TV distributors like Comcast, Echostar, DirecTV, and Time Warner Cable would also be indirect beneficiaries as consumers opt for broader packages of services that are delivered through advanced set top boxes. Distributors of User Generated content like Google's You Tube also would benefit.

I'll be attending the UBS Media Conference in NY next week where I hope to here more about the impact of new technologies on the media business.

NBC's Strategic Changes: The Future of Network TV?

I think the money quote from last Thursday's widely discussed article on steep cost cutting at NBC Universal came from Bob Wright: “As we reprioritize ourselves toward digital, we’ve got to be as efficient in our current business as possible.” The reality is that analog is under pressure due to continuing moderate viewership declines, alternative distribution channels like the internet and iPods, and ad-skipping friendly digital video recorders. The big TV networks have long been able to offset sliding ratings with prices increases but recent trends suggest that the additional challenges of digital technologies has finally restored balance to the pricing battle and CPM growth has stalled....

NBC’s response is a massive cost cutting program design t save $750 million against projected 2006 revenue and operating profits of $16.5 billion and $3 billion, respectively. The cost cutting is supposed to be across the board but it appears that primetime programming expenses, particularly in the first hour, and news will bear the brunt.

As far as saving money on programming, NBC wants to have more reality type programming in the opening hour of prime time. The Peacock network trails its rivals at CBS, ABC, and Fox in this regard, so I’d view this partially as a catch-up move and not a groundbreaking announcement. That said, entertainment executives do seem to recognize that the economics of content production breakdown as talent and other production costs soar while pricing power dissipates.

On news, there have been cutbacks for years and rumors of massive changes such as a joint venture between CNN and the news divisions of ABC, CBS, or NBC. The reality is that the internet handles news better than TV except for breaking news on big stories. Maintaining a huge news gathering and content distribution system just doesn’t make sense as consumers increasingly turn to the internet for timely and accurate reporting.

This story is likely to reignite the debate about how TV is headed the way of music, newspapers, and radio. The acquisition of YouTube by Google (GOOG) merely reinforces this view. However, I maintain that TV viewing habits are much more deeply ingrained and that the alternatives are much worse substitutes that is the case for these other traditional media. Consequently, I expect the erosion of TV economics be much more gradual than has been the case for newspapers and radio, especially the recent acceleration in challenges faced by those industries.

Additionally, the TV networks are owned by the same companies that are the content suppliers so unlike radio or newspapers, the transition to new distribution channels opens up a revenue opportunity. I don’t think selling ads on ABC.com of selling shows on iTunes for $1.99 can make up for the loss of pricing power on network TV, but it does provide a growing revenue stream against the slow erosion in network TV economics. You can’t say the same thing for newspapers or radio.

When the YouTube generation ages by 10 or 15 years, the economics of TV might breakdown more rapidly. For now, it will be periodic shifts in sentiment that hurt the stocks. But sentiment swings widely on Wall Street so don’t get overly concerned if the death of TV becomes a big story again for a few months.

Updated Advertising Forecast For 2007

Yesterday, Merrill Lynch analyst Lauren Fine lowered her 2006 and 2007 forecasts for U.S. advertising. Lauren has been ahead of the curve this year with below consensus forecasts for advertising growth so this is a call worth paying attention to, particularly for 2007.

Based upon Merrill’s forecast for nominal GDP growth of 4.5% and real GDP growth of 1.8%, Lauren is now calling for 2007 U.S. advertising of $298 billion, a gain of 2.8% vs. her prior forecast for a gain of 3.5%. Lauren lowered her forecasted growth for all the major traditional media categories but slightly raised her estimate for internet advertising growth.

In fact, excluding the $3 billion, or 22% gain for internet advertising, Lauren’s estimate for 2007 U.S advertising growth would be just 1.8%. Internet advertising represents $3 billion of the projected $8 billion gain for total advertising, or 41% of the incremental growth....

Looking at the traditional advertising media, Lauren lowered her forecast for newspapers to -1.5% from a prior forecast of 1.1%. I think this is the low estimate on the street. It also includes online classifieds so the negative growth in print advertising is even larger.

For broadcast TV, Lauren’s estimate is for growth of -1.2% pulled down by fact that 2007 is not a political year. Cable TV ad growth will be the healthiest among traditional media sectors at a gain of 5.8%. Nevertheless, this forecast is lowered from a previous estimate of 7.2%.

Radio and Magazines are each projected to grow by 1% in 2007, down from previous estimates of 2.2% and 2%, respectively.

Historically, advertising has been a cyclical growth industry, tracking nominal GDP when economic growth is rising. The current ad cycle has seen traditional media advertising track well below nominal GDP largely as a result of share loss to the internet. In turn, traditional advertising has suffered a loss of pricing power.

Right now, with the stock market apparently buying into a soft landing scenario, lowered advertising forecasts have little impact on media stocks. However, if Lauren’s below consensus view proves accurate and investors begin to fear a hard landing, the ramifications for media stock performance could become significant.

At a minimum, what appears to be a structural slowdown in advertising growth for traditional media should keep the pressure on public and private multiples of media stocks, rendering historical valuation levels irrelevant and sustaining the secular headwinds faced by the sector.

Cruise-Paramount Split, Part 2

Here are some further thoughts on the Cruise-Paramount split (Part 1). This post takes to look at Tom Cruise as a business by comparing the profitability of his two most recent films.

Cruise's last film prior to Mission: Impossible 3, (MI3) was War of the Worlds (WOTW) which grossed $594 million worldwide. MI3 grossed $393 million. According to BoxOfficeMojo.com, WOTW had a production cost of $132 million and MI3 had a production cost of $150 million. It is probably safe to assume that marketing expenditures on both films were similar and recent press reports use a figure of $100 million for MI3. Press reports also indicate that Cruise's production company had a deal with Paramount giving it 10%-20% of the worldwide box office gross before theatre splits. A good rule of thumb for DVD revenue is 1 times the domestic box office. For WOTW, domestic box office was $234 million, while MI3 pulled in $132 million. Another good rule of thumb is that TV rights are sold for 35% of domestic box office.

Let's look at the theoretical profits on each film assuming Cruise gets a 15% cut of the gross:

On WOTW, Cruise's production company would have pulled in $90 million. Paramount's take of the box office would be 55% of $594 million, or $327 million. Steven Spielberg directed WOTW and it is probalby fair to assume that he had a similar gross participation deal to Crusie. Subtract Cruise adn Spielberg's takes, and Paramount is left with $146 million, leading to a loss of $85 million on the theatrical run against production and marketing costs of $232 million. DVD revenue of $234 million could have had an operating margin to Paramount as high as 60% (Paramount's DVD costs likely included a participation for Cruise adn Spielberg). That is $140 million in operating profits to Paramount from home video. TV rights including domestic network, domestic cable, domestic pay TV and all international is another $80 million to Paramount at a margin that could be as high 80%. Add another $65 million in operating profits to Paramount. So before merchandise sales, on WOTW, Paramount might have had an operating profit of $120 million against production and marketing investment of $232 million. Not too bad.

On MI3, the numbers aren't quite so good for Paramount but are still pretty darn good for Cruise. 15% of worldwide box office brings Cruise and his production company $59 million. Paramount's take of the $393 million box office is $216 million. Deduct Cruise's cut and Paramount is left with a loss of $93 million on the theatrical run after production and marketing costs of $250 million (I've read on a usually reliable blog it could be as high as $280 million). Since the DVD market has weakened considerably over the past year and MI3 wasn't a smash hit, let's say DVD revenue is 80% of domestic box office at a 50% margin reflecting higher marketing and distribution costs. That still leaves around $50 million in profits from the home video window for Paramount. Again, let's adjust TV rights downward to account for the lower popularity of MI3, say 25% of domestic box office still at an 80% margin. That is another $25 million in profits to Paramount. So all in, MI3 will probably lose $10 million or $20 million, maybe as much as $50 million if the production budget really was as high as $180 million.

Now let's turn to negotiations over Cruise's new deal....

Paramount figures Cruise is broken goods, suffering a permanent lowering of his appeal. They baseline the MI3 results and decide to take a hard line in negotiations on a new deal. Cruise is insulted and has advisors whispering in his ear that hedge funds will pony up $100 million if he self produces. Despite his bad press, in Hollywood Cruise is known as a hard worker when it comes to promoting his films, even if he is increasingly difficult to work with on the set because of his religious beliefs and star treatment requirements.

What makes the most sense for all concerned? Cruise and Paramount go their separate ways. Cruise banks on his enduring popularity and gains a greater degree of control. Redstone spouts off about how Cruise's erratic behavior reflects poorly on Paramount and Viacom (VIA). Redstone has an excuse if Cruise hangs his shingle with another studio and produces a few more $500 million plus global blockbusters. Everything works out fine for all concerned.

Except that if I were a Viacom shareholder, I'd sure be hoping that Sumner is right about Cruise's future. Cruise was the only bankable star on the Paramount lot prior to the arrival of Spielberg, Dreamworks and Brad Pitt. Pitt has brought in $1.4 billion domestically on 22 pictures, or $64 million per film. Cruise has brought in $2.7 billion on 27 films, or $100 million per picture. Spielberg has brought in $3.4 billion on 23 pictures, or $150 million per film. Sumner thinks Cruise has peaked but since 1998 Cruise has grossed $1.3 billion, while Spielberg and Pitt have each grossed $700 million.

Cruise-Paramount Split, Part 1

Given all the publicty created by the split between Tom Cruise and Paramount, I thought I'd offer some impressons from the perpsective of the stock market. The following post is my first impressions, while a second post due to go up later this week provides greater detail on the economics of Tom Cruise as a "subsidiary" of Paramount's owner, Viacom (VIA, VIA.b).

It is hard to say much that is relevant to stock prices as far as the Tom Cruise-Paramount split is concerned. I do think that this is much more about money than Tom Cruise's behavior. The two are linked, apparently tightly linked in the mind of Viacom (VIA, VIA-B) chairman and controlling shareholder Sumner Redstone. Redstone and many others think that Cruise's bad press led the latest Mission Impossible film to fall short of box office expectations. It is hard not to agree with that assumption. The bigger question is whether future Cruise films were likely to suffer the same fate. And that is important because despite his hefty paydays, prior to this film Cruise has been a huge money maker -- arguably the only huge money maker -- for Paramount.

Cruise appears to have had a very generous deal at Paramount, providing his production company funds for overhead and a percentage of the worldwide box office gross. Importantly, the gross points came whether Paramount made a profit on the film or not. Consequently, the real problem here is not Cruise's behavior but the fact that production and marketing costs have gotten completely out of control. Mission Impossible III grossed $400 million worldwide at the box office and is likely to bring another $150 million to $200 million plus in DVD revenue and TV rights. A project with up to $600 million in revenue likely won't make any money for Paramount because the studio allowed the production budget to go over $150 million and spent another $100 million on marketing....

Remember studios only collect about 55% of each box office dollar. So for Mission Impossible III , Paramount's share might be around $215 million. Subtract the off-the-top take of Cruise's production company (rumored at anywhere from 10%-20% of total box office), and Paramount is left with $155 million against a production and marketing expense of $250 million plus. Oops. And with a slowdown in the DVD profits due to higher marketing and distribution expenses and a falling ratio of DVD revenue to box office revenue, Paramount's hopes of making decent profits on Mission Impossible III look bleak, while Cruise's production company walks away with $60 million or more.

Thus, despite press reports playing up Cruise's "behavior," I think the split was a business decision by both sides. The contract between Paramount and Cruise was up. Paramount wanted a better deal. Cruise felt the deal being offered wasn't good enough. End of story -- except that Redstone took it to another level with his aggressive comments about the split.

Does this episode represent a change in how studios will deal with stars? Maybe. Will Cruise's new, self-financing strategy represent the future? Maybe. Will studios finally attempt to better control budgets so that $500 million or more in worldwide gross isn't break-even? Maybe.

Is there a lesson for investors in stocks of companies that own movie studios? Yes. It's a tough business with erratic profits, high risks and impossible-to-analyze financials. So the next time you see an analyst report that puts a premium multiple on EBITDA produced by a studio, be skeptical.

Positive Sentiment Change For Media Stocks?

Breakup Time Warner! Univision for sale! Knight Ridder up for auction! Viacom splits in two! Clear Channel spins off its billboards and concert business! Cablevision is paying a special dividend – maybe not! Disney sells radio! Disney buys Pixar! Liberty Media splits off QVC! DirecTV is buying back $3 billion of its shares, Comcast is buying $5 billion, Disney is buying another $5 billion, Time Warner is buying $5 billion, Viacom is buying its shares, CBS is paying a decent dividend.

What the heck is going on? Obviously, big traditional media is under pressure and in some cases responding with asset sales, share buybacks, or dramatic corporate restructurings. I've been following media stocks for 20 years and one thing that has always been bullish has been merger and acquisition activity. Until recently, all the media M&A has been in Europe. Not coincidentally, European media stocks have performed much better than their U.S. peers.

So the question becomes will the flurry of M&A in the U.S. finally capture the attention of investors and lead to a rally in the shares or will overwhelming concern about future growth rates and the sustainability of free cash generation keep valuations depressed?

I mention this today because Wednesday was the first time in a long while that pretty much every media stock on my monitor, almost 50 of them, was up on the day. The stocks were up all day, even in the morning when breadth stunk and the major averages were barely up or underwater.

Yesterday morning marked the simultaneous reporting of the Icahn breakup plan for Time Warner and the potential sale of Univision. Did this represent the bottom? Will the shares see better performance in the months ahead?

I think the answer might be yes. Recent days also saw a great response to a good quarter by Disney and a nice bump for DirecTV after a decent quarter. Disney offers solid double digit growth. DirecTV is transitioning to a controllable growth strategy, trading subscriber growth for sustainability. Is the market's response to the quarters of these two companies a sign that a change in sentiment is at hand? I think so but the names that will lead are those that combine M&A potential, free cash flow dedicated to shrinking the capital base, and most importantly a growth profile over the next few years. DIS is the best of the big caps, while Central European Media Enterprises (CETV) is the best of the small and mid caps.

Thinking About The Movie Business

I wrote the following for StreetInsight.com while vacationing last week in chilly Bayfield, WI on the shores of Lake Superior:

I've been working "lightly" this week, spending time with my family at our place in Northern Wisconsin on the shores of Lake Superior. We have a blanket of snow about a foot deep and since there are only a few hundred people up here this time of year the environment is best described as pristine. Even better, we don’t have to go anywhere unless we want to, so commuting in the snow is not an issue.

The closest movie theatre is 25 miles away in Ashland, WI. It is an old theatre with a half dozen screens. Tickets are just $6 and popcorn and candy will only cost you $1 each. Our teenagers will actually go to the movies with us while we are up here since they don’t have to worry about bumping into their friends at the mall, so we decided to take in the two big blockbusters of the holiday season: King Kong and The Chronicles of Narnia: The Lion, The Witch, and The Wardrobe. Both films were very well reviewed and in our family both actually exceeded expectations. I think it was the simple stories with special effects that didn’t come across as technology. Each film reminded us of something that would have been made in Hollywood decades ago....

Of course, I can’t go to the movies without thinking about the movie business. Both these pictures have huge production and marketing budgets. I believe King Kong cost over $200 million to produce and Narnia around $150 million. Marketing budgets for each film will exceed $50 million. With this in mind, while sitting in the theatre, I began thinking again about movie industry accounting and remembered a post I recently found on a Yahoo! Finance Message board. I contacted the poster and got his permission to reproduce it, so here is the best explanation I've ever read about movie accounting with my clarifications in parentheses:

Say Box office of $100M (for Lions Gate Entertainment production Saw II). Theatres keep roughly half, plus or minus adjustments for co-op advertising, advertising credits, etc., leaving $50 million for LGF to divvy up as manager of the clearinghouse. LGF takes out a 30% (plus or minus) distribution fee, plus all out of pocket print and advertising (P&A) costs. Assuming $20 million P&A, this puts $15 million (net) in LGF pockets and leaves $15 million in the pot. There could be participations from this $15 million for producers, writers, directors, in front of the camera, behind the camera, under the executive producer, who knows. Say $5 million. LGF then would get its costs advanced for the negative costs, plus an interest factor. Say another $5 million. This leaves $5M to divvy up (with producers as "profits").

Next is DVD/ home video. This is where the industry is still in lala land. Even though it costs $2 max for the DVD production, packaging, and artwork, generally the contracts provide for a cost of sales allowance of 50% or more. Sometimes it is as little as 20% that goes to the profit split from the sale of DVD's.

Other ancillary revenue steams include say $5 million from cable (and broadcast TV) licensing. Right off the top to LGF is a 20% to 30% distribution fee. Then more allocated marketing costs, more participation costs, plus, of course, the residual deals with SAG (Screen Actors Guild). Wait until they start packaging Saw, Saw II with other films in marketing deals. Allocations have to be made to each film.

What is amazing to me is that some of these analysts say they can figure it out before hand. Right! All the contracts are confidential, unless it goes to court. Of course, they never go to court as the attorneys meet at The Ivy, cut a deal, and no one knows.

So there you have it. No wonder my major screw-up this year was LGF, a pure play movie and TV studio. Thanks to my Yahoo poster buddy who I can vouch for as someone who knows what he/she is talking about.

Media Stocks

I am a long-time investor and analyst in media stocks of all shapes and sizes. I like media stocks becuase the business is fairly simple, free cash flow capabilities are excellent, and US companies have an unrivavled global competitive position. Presently, Northlake's model portfolio contains two media stocks, Central European Media Enterprises and NTL, Inc. Those stocks have performed well in the last 18 months but most media stocks have not.

One of my key Wall Street contacts in the media sector is Lauren Fine, newspaper and ad agency analyst at Merrill Lynch. Lauren had a peice out last week from which I excerpted the following:

� Advertising Week in NYC has fueled a variety of discussions regarding the health of advertising, the growth of Internet advertising (up 43% in Q2), and the imminent changes in the network TV model due to increased penetration of broadband and PVRs.

� We maintain the view that advertising is still a vibrant field and believe that creativity is improving rather than worsening. A proliferation of media outlets combined with muted demand (stemming we believe from a combination of modest economic growth and questions regarding return on investment) are limiting the gains of traditional media relative to past cycles.

� On the margin, underlying demand for advertising is not improving, notwithstanding comments made by Unilever and Colgate that increased marketing is constraining their earnings performance or GM's accelerated advertising efforts to further its incentive program.

I agree with Lauren's assessment and this is the reason that Northlake is not presently using traditional large cap media stocks like Time Warner, Viacom, Clear Channel, Tribune, or Comcast. I am starting to look a little more carefully at these stocks, however. Traditional media stocks are trading at their lowest multiples of cash flows in years suggesting that Lauren's and my viewpoint is becoming widely held. The key to making money on Wall Street is to recognize when conventional wisdom is fully reflected in stock prices and taking the opposite side of the trade. We may be nearing that point on broadcast television, radio, and cable stocks so our antennae are up our research efforts increased.