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August 26, 2010

Macro Concerns Still Dominating Media Stocks

Trading volumes on Wall Street are seasonally low in late August until Labor Day passes. But that has not led to a lack of movement. Stock prices are under severe pressure having given up most of the gain off the July yearly lows. The major concern continues to be the economic outlook. Data remains weaker than expected and the risks of a double-dip recession have risen in reality and in the eyes of investors. The stock market discounts the future so sellers are ahead of the economy. What makes investing so hard, particularly for shorter time horizons is that we won't know the economic facts for a few months.

I've written regularly that the macro concerns are overwhelming individual company fundamentals. This is true whether the stock market is rallying or selling off. Another way to say this is that correlation among individual stocks, industries, and economic sectors is unusually high. In media, this means, sell all the stocks when economic concerns intensify and buy all the stocks when the economic outlook improves. It does not matter if third quarter guidance for advertising growth is better than expected when the sentiment toward the economy is negative. No one believes the advertising dollars will actually be sent. Instead, the assumption is that late 2010 and 2011 earnings estimates are too high.

For the time being, I expect this macro driven market to remain dominant. However, other than day traders, we can't ignore micro level fundamental developments, and despite the late August lull, there have been a few items worth noting.

The biggest news was Netflix buying the streaming rights to Paramount, Lionsgate, and MGM films from EPIX. Netflix is betting its future on streaming hoping to finance expensive content purchases by attracting new subscribers and buying and shipping fewer DVDs. I understand Netflix approach and I give them credit for going all in but I am uncertain how this will play out. The only obvious winner appears to be Liberty Starz (LSTZA), which controls the streaming rights for Disney and Sony films to be produced and released through 2015. Starz has sold this content to Netflix for several years at a huge discount to the price paid to EPIX. Furthermore, Disney and Sony are more valuable than Paramount et al especially when considering scarcity since most of the rest of studio output is controlled by HBO.

The studios (Time Warner, News Corporation, Viacom, and soon to be Comcast) might be winners as the streaming rights are suddenly worth big money. This is a nice development given the collapse in DVD sales. However, the risk of substitution to box office, rental, VOD, and more DVD sales is high. The fight over windows for availability of studio content is what is really at stake, however. Windows have driven profits, so elevated uncertainty about future windows leaves the Netflix-EPI deal as mixed for studios.

Cable, satellite, and telco TV distributors seem like losers as a robust Netflix option threatens video subscriptions and premium purchases such as movie channels, VOD and DVRs. The timing could not have been worse for cable as 2Q10 subscriber counts showed a decline in video subs for the first time ever. In last week's column for SNL Kagan, I mentioned that I was surprised the year-over-year drop in subs had not gotten more attention. That is no longer the case: the Wall Street Journal and Business Insider wrote about the drop in subs.

I still think that over-the-top-video is a much smaller threat than feared but in a market deep in negative sentiment, the combination of the Netflix-EPIX deal and declining subs came at a bad time. Despite the risks to cable and poor action in the stocks I remain long a lot of cable stocks at the Entermedia hedge fund as I feel the over top risk plays out very gradually over many years while declining capital intensity and rising free cash flow on still low to mid single digit revenue and operating cash flow growth is here today and for the foreseeable future. Domestic cable stocks are less attractive than the advertising driven stocks held in Northlake client accounts.

Disclosure: LSTZA is widely held by clients of Northlake Capital Management, LLC , including in Steve Birenberg's personal accounts. LSTZA is also a long position in the Entermedia Funds. Steve Birenberg is sole proprietor of Northlake, an SEC registered investment advisor. Steve Birenberg is co-manager of the Entermedia Funds, long/short hedge funds focused on media and communications stocks. Steve also owns a portion of the Entermedia Funds' investment management company and has personal monies invested in the Funds.

Posted by Steve Birenberg at August 26, 2010 09:54 AM in Media