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October 26, 2005

The Impact of Internet Advertising on Media Stocks

In my recent reading of Street research on traditional media companies I have noticed two trends. First, analysts are beginning to adjust their multiples downward in their sum of the parts valuation multiples, finally reflecting the actual trading multiples of media stocks in the current market environment. Analysts are really just catching up to the multiple compression that has been going on all year and accelerating recently...

Second, I've noticed increasing discussion of the impact of the internet on the growth rates of traditional advertising-supported media such as newspapers, television, magazines, and radio. I am not being critical of traditional media analysts, rather just noting that the volume of discussion of traditional media vs. the internet has kicked up a level.

In that vein, I wanted to mention something that hit me as I was reading this weekend. According to reports on Google (GOOG) and Yahoo (YHOO) written by ThinkEquity analyst John Tinker, internet advertising (search and branded) should grow 30% in 2006 to $16 billion. This means absolute growth will be about $3.7 billion. John's work on the internet stocks appeals to me because earlier in his career he was a well-regarded media analyst.

Even in the good times, advertiser-supported traditional media is a GDP plus growth business. This year the traditional media businesses of newspapers ($47 billion), magazines ($13 billion), television ($63 billion), and radio ($20 billion) will generate about $143 billion in advertising revenue. Direct mail is another $55 billion and Yellow Pages around $14 billion. Add in over $50 billion in miscellaneous advertising and excluding the internet you have around $270 billion in total advertising.

Certainly, some internet advertising budgets are incremental to traditional media ad budgets. However, internet advertising clearly is stealing a decent percentage of its total volume from these traditional media sources. Focusing on just newspapers, magazines, television, and radio, if they had 2006 advertising growth tracking nominal GDP of say 6%, they would enjoy around $8 billion on incremental revenue.

This means that if 25% of the $3.7 billion in incremental growth comes from budgets that otherwise would have been dedicated to newspapers, magazines, television, and radio, the growth rate in these traditional advertising categories is reduced by 1%. Look backwards at disappointing growth rates for traditional advertising and you get a better feel for the impact of the internet. Look forward and even if you assume slower growth for internet advertising you've got a 1-2% reduction in the growth rate of traditional advertising relative to its historical trend.

On Wall Street, multiples are directly related to growth. Is it any wonder that multiples for traditional advertising supported stocks have compressed?

Posted by Steve Birenberg at October 26, 2005 09:36 AM