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January 06, 2006

Newspapers Flounder As Web Ads Flourish

So far the positive news out of Dow Jones (DJ) that 4Q05 guidance was being raised has done little to rally the newspaper group. I think several factors are at work that reflect the unique mix of businesses at DJ vs. its newspaper peers:

# DJ has very heavy exposure to B2B advertising from technology and financial firms. These categories were extremely depressed for the past year and a small improvement has allowed double-digit declines to turn into positive growth.

# DJ also has less exposure to help-wanted advertising. This has hurt the company relative to its peers over the past year but the year-over-year gains in help wanted are moderating so DJ looks better.

# Finally, DJ has less exposure to auto advertising. Auto is a big category for local media including newspapers and TV stations....

Web Ads for Cars Are Hot

A recent article on AdAge.com noted that the auto companies have already purchased 80% of the inventory available in 2006 at the major independent auto web sites. A year ago the sell-out rate was just 50%. The web sites are dramatically raising prices in the face of strong demand with CPMs (cost per thousand impressions) up 20%-30% at many sites. Ford (F) is leading the way in the shift to online advertising.

AdAge.com quoted a Ford executive as saying that the company will sharply increase its online ad budget but its overall budget will be flat. By definition, this means the traditional ad budget is down. An ad buyer from British media company WPP notes that he is advising auto clients to shift 10% of their ad budget to the web this year. It is thus not surprising that Merrill Lynch media analyst Jessica Reif is looking for a down year in auto advertising, something that has occurred only once in the last decade.

Online Research Attracts Car Buyers

Most of the other automakers are planning a similar approach in 2006 with big increases in web advertising and a decline in traditional media. The auto companies are finally responding aggressively to studies that show more than 70% of the people who buy a car conduct online research first. Another interesting tidbit from the AdAge.com article is that despite tight inventory and rising CPMs at the web sites, the auto companies are not shifting ad purchases back to traditional media. Instead, they are bidding up prices of online inventory further.

Meanwhile, Newspapers Annoy Advertisers

While auto advertising may be the most significant headwind for newspapers this year, there are a few other problems. The latest circulation survey for the six months ending Sept. 30 showed a decline of 2.6%, the largest drop since 1991. I think a big part of that is the cleaning up of bulk subscriptions, so the trendline of circulation drops may not be steepening as much as perceived. However, I find it surprising that coming off these numbers and the bad publicity and advertiser anger they elicited, newspapers plan to increase ad rates between 3% and 6% in 2006 (DJ is an exception as it is trying to broaden its advertiser base to consumer companies). I suppose managements don't have much choice, but this seems like a risky way to reach for higher revenue.

Bid for KRI Could Spark a Rally

The Knight-Ridder (KRI) sale could be the salvation of the stocks if a fancy price is paid. CSFB is reporting that presentations to the KRI board will begin next week and final bids are due at the end of February. The group currently trades at around 8.5 times 2006 estimated EBITDA. A $70 price for KRI equates to 10 times EBITDA. I think that would protect against further downside in the stocks but I'd note that Comcast (CMCSK/A) trades at under 7 times EBITDA with better growth prospects, albeit much higher capital spending requirements.

Bottom-Line: What's Good for Online Media Is Bad for Print Media

The outlook for newspaper stocks in 2006 is drab, since the fundamentals remain challenging and valuations are not cheap enough yet. An upturn in advertising can be better played elsewhere, and waiting on takeovers is pure luck if it works in your favor. Meanwhile, investors in online media have secular winds at their back and would still benefit from an upturn in ad spending. These are some of the reasons that I have recently purchased shares of Yahoo! (YHOO) for myself and Northlake clients.

Posted by Steve Birenberg at January 6, 2006 10:30 AM in Newspapers