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March 12, 2009

We're Still Watching TV The Old-Fashioned Way

I have pointed out repeatedly that media stocks are suffering a two pronged assault from cyclical and secular challenges. Making matters worse is that the cyclical downturn in the economy might be accelerating secular trends. Investors certainly believe this as evidenced by the combination of falling near-term and long-term estimates and a drop in relative valuation of media stocks compared to other industries.

One of the events that established the cyclical-secular link was the fourth quarter conference call by Time Warner Cable (TWC). TWC is the second largest cable company in the U.S., behind Comcast (CMCSA), and the third largest provider of multichannel TV. DirecTV (DTV) is #2.

During the call, TWC President and CEO spooked investors when he said ""The reality is we are starting to see the beginnings of cord-cutting, where people — particularly young people — are saying, 'All I need is broadband, I don't need video, and obviously they're already saying they don't need a wireline phone."

The implication is that entire business model of the TV industry, from content development to broadcast and cable networks to cable and satellite TV providers, is going to change for the worse. That is a huge deal as TV is the primary driver of the media industry.

But does the data support Britt's dire warning? I don't think so. I am not saying TV does not face secular challenges. I am saying that fears of an imminent acceleration of the challenges that reach a tipping point are overblown. The challenges are coming but they are going to take longer to play out that investors currently expect. This means that the potential for snapback rally in many TV related stocks is significant once some stability in the economic outlook arrives.

Beneficiaries of such a rally would include Viacom (VIA), CBS (CBS), Time Warner (TWX), Disney (DIS), News Corporation (NWSA), Scripps Interactive (SNI), Discovery Communications (DISCA), Comcast (CMCSA), Time Warner Cable (TWC), Cablevision (CVC), DirecTV (DTV), Liberty Entertainment (LMDIA), and Dish Network (DISH).

One area of the TV business that I do not feel would benefit much from a countertrend rally is local TV stations. Local stations face secular challenges that are changing the business model today with little chance for an easing of the trends. In particular, the shrinking of the automobile industry is a crushing blow to local TV stations which rely heavily on local auto dealers for advertising on the local news. Hearst Argyle (HTV) and Sinclair Broadcasting (SBGI) are TV station groups that still have a decent amount of market cap. CBS is most exposed among diversified media companies with DIS and NWSA also vulnerable as they own and operate local TV stations in most of the ten largest cities.

As mentioned, I accept the cyclical and secular challenges facing TV. However, I think the risk are currently a bit overplayed. Investors are lumping all TV related stocks together even though the risks vary.

The reason I am more sanguine about the TV business is that TV viewing remains healthy. A Nielsen study released in late February revealed that Americans are watching 151 hours of hours per month in 4Q08, up about 3% from 4Q07. This occurred even as online and mobile video consumption grew strongly on a sequential basis. In other words, traditional TV faces competitive challenges that may alter business models negatively but the core underlying fundamental, viewing, is not under intense pressure yet.

Another way to look at this is to review trends in multichannel subscribers. SNL Kagan notes that the news here is not as bad as feared. In a February 26th article, Kagan quotes Bernstein Research analyst Craig Moffett who notes that despite Britt's worries during 4Q08 total cable, satellite, and telco TV subscriptions rose by 441,000. The 4Q08 increase was larger in absolute amounts than 4Q07 providing a further indication of health. Once again, I am not ignoring the challenges raised by the competitive dynamic, in this case telco and satellite gains at the expense of cable. However, the basic underlying fundamentals indicate that multichannel TV is still healthy despite the secular threats of cord cutting.

Finally, often lost in the debate over viewers moving online is that the cable and telco companies which provide multichannel TV subscriptions also provide the broadband connections that cord cutters need to watch TV online. High speed internet subscriptions are also still growing despite cyclical headwinds exacerbated by the housing contraction. Wireless bypass via Wimax is a plausible technology but even here cable companies are partners with the leader in Wimax, Clearwire (CLWR)

Media stocks have been a terrible to place invest as cyclical downturns in advertising and consumer spending are steep at the same time that secular changes to the media business model are rising. I am generally skeptical of the pace at which secular changes occur. For TV, I am especially skeptical because usage habits are so deeply ingrained. Changes are coming but just as broadcast network TV has remained resilient on a financial basis despite decades of share loss to cable networks, many feared changes to the TV business model will occur more slowly than currently expected.

TWX and DISCA are held in Northlake client accounts including my personal accounts.

Posted by Steve Birenberg at March 12, 2009 02:05 PM in Media