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December 30, 2008

Media: 2008 Year In Review

It's been a rough year for investors. My own performance has been mediocre with most Northlake clients plus or minus a couple of percent relative to the S&P 500. I think I could have done better but I use a fully invested strategy so it was a very tough to make much progress.

Further complicating matters was that it was a terrible year for media stocks. SNL Kagan's Media and Entertainment Index is down almost 53% this year, far worse than the 41% decline for the S&P 500. Kagan has 13 sub indices for Media and Entertainment and ever single one was down more than the S&P 500. Keeping in mind there is some overlap in these indices since companies are included in more than one index (e.g. TWX is in Diversified entertainment and Cable Networks), here is the ugly numbers:

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The damage was worst among small cap media companies. The SNL Kagan Small Cap Media index fell an amazing 86% while the Large Cap index dropped 48%. The complete collapse in radio stocks, most of which now trade for less than $1, led the decline in small caps.

Northlake's stock picking in media was mixed in 2008. I made one very good decision, a few very bad ones, and a bunch that were not terrible on a relative basis but that I wish I could have back....

....My best move was to sell client positions in Disney and News Corporation in late May. Both stocks collapsed since then, with NWS dropping 52% and DIS falling 36%. I made these sales following Viacom's May announcement that it had witnessed a rapid deterioration in advertising sales. This weakness occurred before the economy completely succumbed to the deep recession and was definitely prior to Wall Street's total acceptance of the weak economy thesis.

I eventually reinvested the proceeds of these sales in Discovery Communications, Dreamworks Animation, and Time Warner. These purchases were made in September, August, and November, respectively. The stocks held up fairly well relative to the market but with the market collapsing in October, declines were still steep, in the range of 25-35%. The consistent theme in these reinvestment choices was reduced exposure to advertising and where the exposure was going to exist to skew it heavily toward cable networks which were holding best and still may be down just low single digits in 2009 against a drop of 10% in overall advertising.

My poor investment decisions were in Apple and Central European Media Enterprises. I stubbornly held both and rode them down. In each case, my view of the fundamentals turned out to be rosier than reality. However, the big thing I missed was the collapse in valuation. Both stocks were big winners for many years and had high multiples relative to their peers. This left a lot of room for multiple compression, which was also accompanied by lower estimates. The results for the stocks were ugly with AAPL falling 56% and CETV dropping 82%.

There is a good lesson in the action of AAPL and CETV. While estimates for both stocks did come in as the year progressed, both companies will still have far superior organic growth compared to their peers. I assumed that superior relative growth would allow the premium valuations to be sustained. This was poor analysis. High growth, momentum stocks have little ability to withstand any slowing in fundamental operating momentum even if the fundamentals deteriorate less than other comparable companies.

One other decision I made hurt my relative performance materially. At the very end of 2007, I threw in the towel on Northlake's position in Comcast. The stock had performed poorly in 2007, falling about 30% from my purchase in late 2006. As it turned out Comcast was a good stock to own in 2008, falling just 15%. The stock benefited due to its recession resistant business and excellent operating and financial management which focused on free cash flow and balance sheet strength. I have since moved back into an investment with a similar profile by opening a position in AT&T in early December.

Looking ahead to 2009, I expect media stocks to remain a difficult area for investment. Advertising remains under severe pressure and consumer spend is falling on media such as DVDs and advanced services from cable and satellite companies.

Northlake's investment strategy is to always own some media stocks so I am sticking with my approach of limiting exposure to advertising, especially in the US, and owning stocks exposed to the highest possible revenue growth opportunities, cable networks and emerging markets.

CETV is pure emerging markets advertising in Central and Eastern Europe. Currency will likely dictate near-term performance but I remain confident that in local currency advertising will be in positive territory for each of the companies major markets.

DISCA gets over one-third of its revenue outside the US just half of its revenue form advertising. Almost 100% of revenue is from cable networks.

DWA is pure content with zero advertising exposure. 2009 estimates have upside and 2010 is a big year with three films in theaters including Shrek 4.

TWX will get 40% of its revenue from cable networks after the spin-off of Time Warner Cable is completed. TWX also will benefit from additional internal restructuring including the possibility that AOL will be jettisoned. The company will also be in a position to reward shareholders after it receives $9 billion form the TWX spin-off.

Posted by Steve Birenberg at December 30, 2008 10:37 AM in Media