Ad Forecast Cut is Not New News

I have been following advertising forecasts closely for many years. I have long thought that Zenith Optimedia provided some of the best forecasts and had the most insights into big picture trends. However, Zenith has been way behind the curve on this downturn. As a result, I find little value in their latest forecast cut which was outlined in Tuesday's Wall Street Journal.

Zenith now sees US ad spending at -8.7% vs. a prior forecast of -6.2%. The new global forecast is -6.9% vs. +0.2%. The prior forecasts were made at the UBS Media Conference in December 2008.

My thought reading this Journal article was "Zenith, tell me something I don't already know." I think that the lowered forecast contributed to lagging performance in ad-supported media stocks on Tuesday. If that is correct it is an overreaction and media stocks could rebound if the market turns up soon.

Beyond the daily movements, I think the recent big rally in media stocks assumes a stabilizing ad envrionment with improvement late this year. I think that might be a bit optimistic and would be careful putting new money in the group at current prices. In fact,. I trimmed my position in Discovery Communications (DISCA) last week even though DISCA has among the strngest advertising growth profiles for 2009.

P&G Still Spending

My daily email from All Things Digital had an interesting tidbit on the advertising market. Procter and Gamble is the largest US advertiser and CEO A.G. Lafley was quoted as follows from last week's earnings call:

"We have held our marketing spending, advertising spending and in fact what is really going on is the advertising markets are softening and for the same dollar we are buying more delivery… we have been shifting support in general to the store and the point of purchase… It is couponing in markets where couponing is a well established consumer habit and coupon redemptions go up in recessionary times. In markets like the U.S. we have clearly shifted dollars to coupons…Then depending on the market we are doing more digital and there are a number of categories that are doing quite well with the digital.”

On the one hand, this is positive for ad supported media as it reminds investors that there is a reason to keep spending to support brands, products, and services even as volumes soften. However, it seems quite clear that PG is able to get the same amount of exposure in traditional media like TV and radio by spending less because the price per spot they are paying has fallen. $100 million might have bought X minutes early in 2008. In 2009, the price of those spots might be down 10-20% so PG can spend $10-20 million less on the same campaign and still get X minutes and the same reach.

Those dollars appear to be getting redirected to coupons and digital campaigns. The shift to coupons is cyclical but the shift to digital is cyclical and secular. Overall, the picture for advertising remains bleak and still has not bottomed on a cyclical basis. The only thing an investor can do is look for pockets of relative strength. Digital (Google's decent report) and possibly cable networks (we hear from Disney, Time Warner, News Corporation, and Scripps Interactive this week) represent relative strength.

More Ad Forecasts Downgraded

Media stocks kept tumbling this week dropping to new recent lows yesterday in many cases after underperforming Tuesday's rally. Lehman's across the board downgrade of the big conglomerates got the latest drubbing started. Lehman's opinion was based a new, more negative view of the risk to content creators form the transition to digital distribution. I happen to think that the secular challenge form digital distribution won’t bite for several more years. In the meantime, the problem for the media stocks is slowing advertising growth.

That was reinforced yesterday when Bob Coen of Interpublic, the patriarch of advertising forecasting slashed his estimate of US ad growth in 2008. Bob is now expecting just 2% growth this year, down from his 3.7% prediction made at the start of the year. Bob's new forecast parallels a similar cut from Zenith Optimedia, the other major player in the ad forecast game.

Notable from Bob's new forecast is that he also sharply cut his forecast for internet advertising, now at 12% from a prior estimate of 16%....

12% is great if you are a newspaper, radio station, or local TV station but most forecasters have felt that internet advertising would still grow 20% this year. Another interesting point form Bob's new forecast is that he also slightly cut his global growth estimate. Like Zenith Optimedia, Bob did not cut his forecast for 15-20% growth in emerging markets but he sees weakness in Western Europe still taking a bite out of the global growth rate.

My sales of Disney and News Corp at the end of May were based on a belief that the "media recession" theme was gaining traction. Recent forecasts from Zenith, Coen, and several Wall Street analysts indicate that the media recession is reality not a theme. For the stocks, the silver lining is that estimates are coming down along with stock prices. I suspect that at least at the major conglomerates 2Q results will be as good or better than expected, though cautious commentary on 2H08 seems likely and will rule the day if it occurs. I think you should stay on the sidelines in most media names exposed to traditional sources of revenue.

As an aside, after the close yesterday I played a fast 18 holes (amazing how quickly you can go by yourself on an empty course). Coming up number 8 – along and tough dogleg par – sitting right in the middle of the fairway was a brand new Callaway ball. I couldn’t help but laugh when I picked it up and "The New York Times" was etched into the ball in its famous font. This on a day that NYT shares fell 7% to a level it traded at in 1987 before the October crash! A sleeve of those balls is going to be worth more than share soon!

US Ads Down, Emerging Markets Up

I want to make sure everyone saw that Zenith Optimedia reduced its forecast for 2008 US advertising growth. Zenith presents its year ahead forecast each December at the UBS Media and Communications Conference. I attend that conference most years and have always been impressed by the Zenith presentation.

The new forecast calls for a gain of 3.4%, down from its revised forecast of 3.7% in March. Zenith is seeing no slowdown in online ads which suggests that all of the reduction is in traditional media. In fact, excluding online, traditional media advertising is now projected to come in around flat. Zenith noted that auto, real estate, and financial continue to be weak but other typically more resilient categories are beginning to weaken Nevertheless, according to the article in the Wall Street Journal, Zenith is not seeing an abrupt slowdown, rather a spokesman characterized the situation as "a slow leaking balloon."

In an interesting twist, despite the drop in its forecast for the US, the world's largest ad market, Zenith actually revised its 2008 global forecast very slightly upward to 6.6% from 6.5%. Strength in developing markets like China and Russia were noted. Also supporting growth is Central and Eastern Europe where Zenith is forecasting 17% growth this year.

Previewing The TV Upfront

The upfront TV advertising market will kick off in May as usual despite dire protestations during the writer's strike that it would be a casualty of a new post-strike business model for broadcast and cable networks. NBC is saying it will not participate as usual but all the rest of the major broadcast and cable networks plan the usual lavish rollout of shows scheduled for the fall TV season followed by negotiations with advertisers and media buyers. Some of the major cable networks, including Time Warner's TBS and TNT, plan to rival ABC, CBS, FOCX, and NBC by matching the traditional broadcast approach to the upfront. With most cable channels increasingly relying on original productions and cable ratings still gaining on the big four networks, this is not surprising.

What might be surprising is that the upfront is generally expected to quite strong. Advertisers and TV networks both except a significantly higher level of spending this year than the past few years. This is expected to occur despite (1) another year of terrible ratings for the broadcast networks that was exacerbated by the writer's strike and (2) continuing controversy over the impact of DVRs.

A strong upfront is the result of a couple factors. First, advertisers are expected to buy a meaningfully higher percentage of inventory this year than the past two years. For two straight years, advertisers made fewer commitments in the upfront and then ended up paying big premiums, often as much as 20%, for similar advertising time one the season had started in what is known as the scatter market. The fact that scatter is receiving premium prices because advertisers are bidding aggressively to make up shortfalls in ratings is ironic but it is reality to the broadcast and cable networks which benefit. The impact of scatter can also be negative so if advertisers cancel upfront commitments or ratings are especially poor, it is possible that a weak scatter market will offset a strong upfront.

The second factor supporting the upfront is the shift in advertiser budgets toward national advertising at the expense of local advertising and the fact that TV remains the only and best place to reach a mass audience. The internet is clearly attracting the bulk of dollars shifting from local to national but TV remains an attractive buy for advertisers and its piece of the share shift is enough to keep broadcast TV advertising fundamentals healthy even as ratings suffer at the hands of cable networks and DVRs.

Before getting handle on which companies could benefit from a strong upfront, let's take a quick look at the growing influence and controversy over DVRs....

....According to SNL Kagan, more than 20% of all US households had DVRs at the end of 2007. Kagan expects penetration to rise to 45% by 2011. I have seen various estimates of how many DVR users skip commercials but 40-50% seems like a consensus. Obviously, this is a concern to advertisers. An equal concern is that many viewers watch shows on DVR up to seven days after their original airing. For example, in the final quarter of 2007, according to Nielsen Media Research, NBC hit Heroes had a 4.44 live rating in the 25-54 year old demographic but saw a 39% boost to a 6.15 rating on a live plus seven basis.

Last year the upfront settled on a Live plus 3 days of viewing as the basis for negotiations, however, there are still a significant number of deals done based on live only, live plus same day, or even live plus seven days. Eventually a standard must emerge but for this year, the controversy over DVRs will continue to plague the upfront.

All companies owning TV networks will benefit if the upfront is strong. The networks will have greater predictability of their advertising revenue. And while a song upfront is no guarantee, having a lot of inventory sold certainly offers hope that the fall TV season will enjoy a strong scatter market. Here's a look at how the leading TV network owners are situated ahead of the upfront:

Disney's two key ad supported TV assets are ABC and ESPN. ABC is in decent shape with modestly lower ratings this season. It has had some success with new shows and its hit shows are not that old. ESPN is a juggernaut and should enjoy strong demand as sports are DVR averse.

Ratings issues at the CBS network are a significant contributor to the very poor action in CBS shares. The current TV season has shown sharp ratings drops for CBS for the second consecutive year. Many of its hit shows like Survivor and CSI are beginning to age. A good upfront will insulate CBS for the time being but if ratings take another tumble next year the impact could be significant. As the leading network for several years, CBS could see a negative swing of several hundred million dollars if past history is any guide.

News Corporation owns FOX which has emerged as the leading network this season and is the only network enjoying higher ratings vs. a year ago. FOX has developed several hits besides American Idol (a good thing since Idol is off double digits this year). FOX also gets hit series 24 back next year. News Corp also owns several cable networks. Fox News should benefit from the Presidential election and recent ratings for it and CNN have been quite good. Others News Corp nets get very small ratings but would be carried along on a positive upfront tide.

NBC is owned by General Electric. NBC remains mired in last place in the ratings but has made some progress with a few hit shows. To GE, the upfront matters little outside of perception. But with ongoing strength at NBC owned cable nets like USA Network, a good vide form the upfront could help support GE valuation as NBC is a high profile asset.

Viacom has enjoyed a ratings turnaround at many of its cable networks, especially MTV. The turnaround has been in place for several quarters so the upfront will be the first real good chance to capitalize.

Time Warner owns only cable networks. As mentioned, TWX plan to turn things up a notch and treat the upfront for TNT and TBS as though they were broadcast nets. Cable network ad pricing remains at a sharp discount to broadcast network pricing. TWX may be able to close that gap with this strategy. If so, it could be a big benefit to all cable network owners.

EW Scripps is splitting off its cable networks into a separate company. HGTV and Food Network are the key assets. Ratings have been OK and scatter pricing has been solid. SSP is under a lot of pressure to perform well in the upfront due to the spin-off. I expect this management team, which has a superb record in cable networks, to execute again.

Discovery Holdings enjoyed a turnaround last year when ratings at its major networks reversed a multiyear downtrend. This year ratings at the major networks (Discovery, Animal Planet, TLC) have stalled but smaller networks including rebranded networks (Science, Military, Investigation Discovery) have picked up. I think the next leg in Discovery shares is related to the new networks which have great asset value but produce minimal cash flow.

Sub Prime Meltdown Advertising Impact

In yesterday's Media Madness post on the Northlake Capital Management home page, I mentioned that Reuters stated that 40% of sub prime loans had been made to Hispanics. This had me wondering whether sub prime lenders were substantial advertisers on Hispanic radio and TV stations and networks. I don’t watch or listen to Hispanic media so I have no idea but I've got to think the loss of sub prime lender advertising could be a significant headwind.

In a similar vein, I received a piece of research from Merrill Lynch discussing the potential impact of the sub prime meltdown on internet advertising.....

Merrill showed some data from the Internet Advertising Bureau revealing that financial services advertising represented about 12% of total internet advertising in 2005. The data also showed that mortgage lenders composed 16% of financial advertising. Based on this data, the risks to internet advertising from the sub prime meltdown seem low, as sub prime lenders would account for just 1-2% of total internet advertising at the maximum.

I think that may understate the risk, however. First, according to Merrill, total consumer advertising represents about 50% of internet advertising and of this amount, auto advertising, which has an interest rate financing component, represents 20%. For those scoring at home that suggests that auto advertising represents as much as 10% of total internet advertising. Seems high but no wonder newspapers are seeing consistent double digit declines in their own auto advertising. Second, while mortgage lenders represent just 16% of financial advertising, banks are another 12% and credit cards an additional 11%. Who knows how much overlap there is among advertising targeting sub prime borrowers from mortgage lenders, banks, and credit card companies but it seems plausible to assume it is significant.

I suspect that if the sub prime meltdown stays contained that there is not much to worry about in internet advertising. A greater fear would be a broader consumer led recession that was initiated by the sub prime problems. However, as Doug Kass has pointed out, the sub prime issues can easily morph into something worse and it appears that advertising is something to keep an eye.

With that in mind, I remember an awful of home equity loan and debt consolidation ads on the cable TV networks. I'll have to check that next.

Internet Continues To Take Advertising Share

The Wall Street Journal had an article reviewing the latest data from TNS Media Intelligence, a firm that tracks media spending patterns. TNS recently reported that spending on "measured media" among the top 50 advertisers fell by 1.5% in 2006 despite the fact that overall ad spending rose by 4.1%. The difference in the two figures represents internet advertising. I have highlighted in the past similar stats regarding specific ad categories or specific advertisers. This article notes some the same ideas. For example, Procter and Gamble is cutting TV advertising in favor paid search and other internet advertising. Johnson and Johnson (JNJ) sat out the upfront last year and according to TNS cut its national TV budget by 25% or $250 million. At the industry level, auto advertising continues to shift to the web aggressively. This is not too surprising given studies that show a very high percentage of auto buyers have searched the internet prior to heading to the dealer....

One new tidbit in the Journal article was that spending at cable networks such as CNN, TBS, and TNT rose only 3.4% last year. I have noted often how this advertising medium is seeing a sharp deceleration from many years of steady double digit growth. The weaker growth in 2006 was mainly at general interest channels as opposed to special interest channels like ESPN or HGTV. John Spiropoulos, vice president and group research director at Mediavest had an interesting comment regarding cable. He noted that advertisers looking for niche audiences "were the first to migrate to cable and now those advertisers are moving from cable and broadcast to the internet. You can take some money from cable and get a similar reach from the Internet."

I think this is a good point which along with close to maximum penetration of multichannel TV in US households and lack of new subscriber growth as most large channels are fully distributed is creating a headwind for cable network advertising relative to past history. There are some offsets such as the ability to increase ad inventory and less exposure to DVRs than broadcast TV but I remain of the opinion that slowing growth in cable network advertising is not fully incorporated into the valuation models for major cable network owners like Viacom (VIA) and Time Warner (TWX).

Overall, the TNS data on 2006 reinforces the fact that market share shifts in favor of internet advertising are limiting growth in all forms of traditional media. This means that historical valuation multiples are no longer applicable. Not only does that limit upside in stocks based on fundamentals but it also suggests takeout multiples by private equity won’t be at big premiums.

Why Are Network TV Ads Selling Well When Ratings Are Poor?

Bernstein Research was out yesterday with a really interesting piece of research noting the dichotomy between the poor ratings performance of the major broadcast television networks this season and the better than expected scatter advertising market. Scatter is jargon for TV ads purchased on the spot market as opposed to pre-bought last spring in the annual upfront market.

Their theory is that the combination of much lower than expected ratings and the lack of inventory purchased in the upfront market has left major advertisers well short of their goals for reaching consumers in the important holiday season. As a result, advertisers are bidding for more time, tightening the market and driving pricing of scatter inventory above upfront rates.

I have been cautious, especially toward CBS, because of poor ratings performance this year. Whether due to ABC and NBC's scheduling and programming decisions of the heavy use of DVRs for watching CBS hits like Survivor and CSI, there is no denying that in key demos, some of CBS long-time hits, especially in the critical Thursday prime time block, are under heavy ratings pressure. A similar argument could be made for shows on NBC and ABC but those networks aren’t as critical to the financial performance of their parent as CBS....

Bernstein goes on to note that this situation of strong scatter and weak ratings is not sustainable. I agree. It seems eventually that the networks could be in for a more substantial setback financially if ratings don’t firm.

This could come to a head at next May's upfront where the TV industry will also likely try to settle the debate over the value of ads in shows that are recorded on DVRs and watched over the next week. Many popular shows, almost exclusively on network television, are getting 10% or more of their viewers via DVRs.

Therefore, the next upfront could see dual pressure from advertisers complaining about weak ratings and the uncertain value of the ads appearing in shows watched via DVR that are highly likely to be skipped (and in the case of Thursday night depreciated further by the loss of timeliness for weekend driven advertising).

Additionally, cable networks are seeing more ratings stability partially due to the low level of DVR use on their original programming and they have plenty of ratings/viewers to sell and lots of unsold or undersold inventory. And no doubt, Doug Kass and others would remind us that if the economy slows more than expected next year, another major headwind for TV advertising will develop.

If a negative scenario were to develop for the broadcast networks next year, CBS and Disney would be most vulnerable. NBC resides at General Electric where it is overwhelmed in its parent's massiveness. Fox has actually had decent ratings performance this year and is about to get its two biggest hits back for this TV season, American Idol and 24. This would seem to protect Fox's parent, News Corporation, somewhat if the TV ad market suffers in 2007.

I am still long Disney but the stock's great performance is bringing the shares close to my stretch target. The idea of a swap to News Corp is looking increasingly attractive as NWS should take the mantle of synchronized growth among its major divisions from DIS next year. I remain very cautious on CBS despite the good performance of the shares and Cramer's vote of confidence.

Among cable network focused companies I prefer E.W. Scripps to Viacom. It is also useful to remember that any relative strength for cable networks gives a boost to DIS, NWS, and NBC/GE, which own many of the most popular channels. CBS has limited exposure to cable networks as those were given to Viacom when the company was split.