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February 18, 2010

Quarterly Media Earnings Good But Stocks Trade Lower

The following commentary summarizes recent media company earnings reports including Discovery Communications (DISCA), which remains widely held by Northlake clients. Since I wrote these comments, it was announced that DISCA will be added to the S&P 500. This provided about a 10% pop in the stock price.

The past several weeks have witnessed a series of earnings reports from many major entertainment and media companies. Following the initial round of reports from communications companies I wrote the following:

"On a macro basis, the story so far this earnings season has been pretty solid earnings reports, but stocks have sold off as guidance commentary is being interpreted cautiously. Investors seem to be saying that the big run in stocks from March 2009 through early January already discounted the improved results being reported."

Unfortunately for long investors in media and communications those words exactly describe the reports and stock market reactions for entertainment and media stocks reporting in the past two weeks.

I had hoped that stock market correction that kicked off in mid-January, which deeply punished entertainment and media stocks, had lowered the bar enough for the stocks to react positively as long as companies did not miss on earnings or guidance. Sadly, that was not the case.

Obvious upside surprises, including the always rewarded "beat and raise," at best lifted a stock for a day or two before profit-taking began. News Corporation and Starwood Hotels belong in this category.

The plain, old inline report and guidance was generally met with selling. Comcast, Time Warner, Disney, Discovery Communications, and Viacom all reported in line to better than expected result for the fourth quarter of 2009 and provided guidance in line with current analyst estimates. The stocks all sold off.

Scripps Interactive reported a confusing quarter that missed some analyst estimates. Guidance for 2010 also fell short from some estimates. Confusion stemmed from the acquisition of the Travel Channel. The company also appeared to tone down extremely high expectations for affiliate fee growth, which I would argue management had previously supported. Scripps shares sold off sharply in a deserving reaction to missed results. The decline as compounded by the industry leading valuation multiple given the shares as of early January.

While I believe I have accurately characterized the response to quarterly earnings reports so far this quarter as "Sell the news," there have been a few exceptions. In an odd coincidence, all three companies with big positive reactions in their stocks reported on February 10th. Wyndham Worldwide was rewarded for its "beat and raise" quarter getting a further boost from a dividend increase. Millicom International bucked the trend of disappointing results from wireless companies with upside to its financial numbers and a blowout on subscriber additions. Millicom shares jumped 10% as investors found a growth vehicle again in wireless. Activision Blizzard reported in line results and guided slightly below street estimates. However, after every other video game company missed and guided lower, the expectations for Activision were quite low, so the results were good enough to separate the company from the pack. The stock jumped about 10%.

My comments so far have focused on investor reaction to the earnings. People who do not follow stocks for a living need to understand that short-term reactions are based on how results and guidance compare to expectations and what expectations are built into stock prices. However, most observers and many investors still focus on longer term trends.

On this front, for media stocks, the key takeaway from this quarter's reports and guidance is that advertising is improving sequentially but visibility for further gains remains low. First quarter 2010 ad trends look set to for further sequential acceleration. Other areas of focus for investors have been programming expenses (rising as expected) and affiliate fees (growing nicely despite the confusion at Scripps Interactive), and subscriber gains (slowing everywhere except for international cable TV networks). None of these secondary issues contained surprises.

Overall, investors remain concerned that the economy is not recovering strongly enough to meet current expectations for 2010. Management commentary was just cautious enough to leave an opening for the bears to argue that expectations are too high. In a market environment that has a newly bearish tone, the selling is not surprising.

Trading Activity Recap

Over the past two weeks, my trading activity for my long only and hedge clients has been on the quiet side. This is usually the case during quarterly earnings season as I tend to a patient investor and prefer to adjust positions after the dust settles. There have been a few trades of note, however, in my hedge fund.

I added to my long position in News Corporation and the News Corporation pair trade long NWSA/short NWS) after the company's outstanding earnings report. I also added to my long position in CBS which should have similarly good results to News Corporation. I took a bullish option position in Time Warner after the stock sold off following what I thought was a solid report and outlook. So far this trade is a loser but a small pop in the stock above $28 is in reach and would generate a nice profit. Finally, I took a new position in Adobe Systems as the stock has sold off due to controversy surrounding Flash and HTML5 ahead of a next upgrade of the company's flagship Creative Suite. The stock normally does well into new software releases and I believe there is pent up demand as the last upgrade hit when the economy was decelerating and company's were looking to cut costs and save cash.

Disclosures: News Corporation, CBS, Adobe Systems Time Warner, Comcast, Starwood Hotels, Discovery Communications, Wyndham Worldwide, Millicom, and Viacom are net long positions in the Entermedia Funds. Discovery Communications is a long position at Northlake Capital Management, LLC. Birenberg is co-owner and co-manager of Entermedia and has personal funds invested. Birenberg is sole proprietor of Northlake and has personal funds in Discovery Communications. Opinions expressed in this piece are solely those of the author and do not represent the views of SNL Kagan.

Posted by Steve Birenberg at February 18, 2010 11:09 AM in Media