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July 20, 2009

Barron's Boosts Media Stocks Ahead of Earnings

Earnings season for media stocks begins in earnest next week but there is still news flow that is impacting the stocks.

Media stocks soared on Monday after leading last week's rally. Monday's move was the result of a bullish cover story (subscription required) on the sector in Barron's. The author, Michael Santoli, essentially reiterated my view that TV and movie related media stocks are too cheap given that changes in the TV business are happening more gradually than conventional wisdom. Investors are extrapolating cyclical issues to an accelerated secular decline in industry profitability. I do not deny that secular challenges exist but TV and movies are not the same as newspapers, radio and music it is the implosion of those businesses that have investors on edge toward all media. Major media companies will grow again with significant earnings and cash flow upside in the early part of the economic cycle thanks to material and permanent cost cuts in response to the current crisis. Stock prices assume no or negative growth creating an opportunity for investors in media stocks.

After it appeared that the upfront might break, it appears that negotiations have again stalled. The broadcast networks continue to hold for flat to low single digit pricing declines, while media buyers want upper single digit declines. The bid-ask spread has narrowed but no meaningful business is being written by broadcasters. There are some signs of thaw in the cable network upfront but not enough to gauge pricing and volume trends. The longer the upfront drags on, the more pressure on media stocks as estimate risk for 4Q09 and 1H10 rises. The stalled upfront becomes a problem for the stocks if investor sentiment toward the economy sours again.

I have been a little surprised that cable stocks have not performed better since Cablevision's early July win at the Supreme Court in the Network DVR case. This is a clear positive for the group as it should lead to lower capital expenditures, fewer truck rolls and operating expense savings, and higher free cash flow. Investors appear worried about weak 2Q subscriber trends as little help is expected from the digital transition. In addition, over the top video and cord cutting remain a big concern.

Finally, news broke last week that Disney had reached agreement on expansion of Hong Kong Disneyland. Three new gates accompanying 30 attractions are on the way and should help to better position the park which many have felt was too small. Disney will invest $465 million and convert its current debt in the park to equity. While this news could be a financial positive for Disney in several years if park attendance and spending climb, I think the better news is that it clears the way for a deal on a park in mainland China near Shanghai. A Shanghai park would probably not make the same mistakes as Hong Kong and could be a real boon to Disney directly and its attempts to more broadly build its brands and characters in China. I remain on the sidelines in Disney, especially not that I have added cyclical media exposure though CBS. I can see a bullish opportunity coming for Disney, however, as 2010 should see a return of the content generation engine led by the return of Toy Story. A cyclical improvement in advertising and theme parks would also help.

Posted by Steve Birenberg at July 20, 2009 03:05 PM in Media