Possibly the most challenging sector in IR
The first thing to know about the media sector is that it’s not as simple as it sounds. Only a decade ago, John Reidy was nurturing many of today’s media giants as little sprouts in Drexel’s high-yield greenhouse. Reidy then found himself at Smith Barney in 1990, single-handedly covering a range of companies today handled by six different analysts, their assistants and associates: cable, radio and TV, wireless, entertainment and publishing. ‘Media is an all-embracing term, but much too simplified,’ he says.
Now head of media and telecom investment banking at Salomon Smith Barney, Reidy sees yet more businesses converging on the sprawling world of media. First, there’s online media. At SSB’s global entertainment, media and telecom conference, an annual get-together in the high desert of California, internet companies such as Yahoo, CNet, Infoseek and Excite attended for the first time this year, while AOL made its second visit.
Mightier still is the encroaching force of telecom, signified by the ‘deal of deals’, as Reidy dubs AT&T’s acquisition of TCI. ‘That tells you almost anything can happen. It took a long time to get a mega-deal with such convergence as this, combining two industries that had stood separately. Now all of a sudden we have this great behemoth likely to be formed.’
Same difference
Remember the aborted Bell Atlantic/TCI merger in the early 1990s? Bell Atlantic prefers not to talk about it. Since then, cable companies like Cox Communications and TCI have been making moves into phone service, while the phone companies have made a lot of noise about video services and high-speed data. Reidy says that if – and it’s a big if – telcos can make money distributing video content as well as data, content companies could get roped into the telco M&A arena too. ‘Is telecom a totally different business or are we looking at the evolution of communications? As they all do video, voice and data, aren’t they more the same than they are different?’
Meanwhile, the traditional media companies are juggling the fruits of years of acquisitive labor. Investment bank Broadview International says the value of deals in the media sector grew 21 percent to $86 bn last year, with Europe shooting 95 percent to $36.8 bn. The US slipped to 867 deals and 5 percent less value, perhaps signifying a slowdown.
‘Analysts and investors are looking at the proliferation of choices available to viewers, making sure media companies capitalize on that broad diversity with strategic moves to get into cable and the internet,’ says Mark Begor, CFO of GE’s NBC and formerly award-winning IRO at GE. ‘The IR leaders in the media game have probably one of the toughest jobs out there because the product is changing so quickly.’
‘These are complicated companies,’ confirms Christopher Dixon, head of media research at PaineWebber. ‘When you talk about a News Corp, Disney, Time Warner or Viacom, you’re talking the economics and dynamics of businesses that are much broader than almost any other sector that analysts and portfolio managers cover. It’s a broad array dependent upon regulations, capital restrictions and technology.’
Take Viacom. Not only do investors need to understand Paramount’s motion picture and TV business, they must focus on Blockbuster video retailing, Simon & Schuster publishing, theme parks and UPN’s television businesses. ‘To try and understand those is not simple,’ says Dixon. ‘And that’s not even talking about capital structures. News Corp, for example, has over 27 separate layers of debt.’
‘The big are getting bigger and the small are getting bought out,’ sums up Paul Sweeney, senior media analyst at Salomon Smith Barney. ‘One of the challenges on the IR side is to keep people up-to-date with all the acquisitions and divestitures that are going on. It’s a consolidating industry brought about by regulatory changes, with TV and radio companies going on mass buying sprees.’ He adds that the TV networks are challenged by audience erosion to cable. One of the ways they have responded is to add more stations, which are still very profitable.
Complicating matters further, media company IROs today face a whole new audience of analysts and investors. Whether it’s CBS’s Marketwatch and Sportsline, NBC’s Snap, At Home’s $6.7 bn acquisition of Excite in January, Time Warner potentially relieving Compaq of its AltaVista search engine, or Disney/ABC’s 47 percent stake in Infoseek (acquired in June 1998) and their just-unveiled Go Network web site (spiking Disney’s languid stock up 8 percent in one day), the same internet pros interested in Yahoo and AOL are descending on the media sector.
Of course, Mark Begor has another group of analysts to educate about the media sector: those covering NBC’s parent GE. By contrast, they look at straight EPS for an industrial company like GE, while media analysts tend to look at Ebitda multiples. NBC, for example, had over $700 mn in net income in 1998 and Ebitda over $1.2 bn. Meanwhile, most internet businesses are getting a whole different valuation based on multiples of their revenue.
Integrated society
According to Salomon Smith Barney entertainment analyst Jill Krutick, the entertainment companies that are furthest along have integrated their acquisitions and are poised to ramp up investor returns. Time Warner and Viacom, for example, are in this position. At the other end of the spectrum are Walt Disney and Seagram, which have ‘languished since they are planting the seeds for future growth,’ says Krutick. Disney is now getting into cruises and regional entertainment, while Seagram is in the ‘throes of integrating its $10 bn PolyGram acquisition.’
A rebound in operating cash flow shows that companies are consolidating their acquisitions and achieving economies of scale, according to the annual Veronis Suhler & Associates Communications Industry Report. (VS&A is a New York buyout firm and investment bank specializing in media and communications which last month drafted JP Morgan’s media group head, James Rutherfurd, to lead its investment banking efforts.)
‘A lot of the M&A activity is behind us,’ says Dixon. ‘What’s unique about media companies is that they generate enormous levels of free cash flow and have spent the last ten years effectively restrengthening and rebuilding their balance sheets. At this point there’s much more focus on execution and the ability to hit business plans going forward. These companies aren’t going to be in the market raising equity or debt.’
Dixon expects more recapitalization in the media sector, just as last year saw CBS spin off Infinity and News Corp unload 19 percent of Fox for $2.8 bn – the largest ever media IPO. Now Viacom is expected to spin off Blockbuster in 1999, while Chancellor recently announced that it’s going to review strategic options for its group of radio stations.
Open access
M&A may be on the wane in the US, but Europe is still seething. Broadview sees the growing need for access to content and new forms of distribution continuing to drive media company deals in 1999. Even with Bertelsmann’s $200 mn stake in BarnesandNoble.com and a joint venture with AOL, Broadview says European media companies are behind the US in internet investments. Pearson and Reed International, for example, haven’t kept up with NBC or Disney.
Stock prices are thriving along with Europe’s deal environment. The Dow Jones Stoxx media index is back above its record highs of last July, and up 9 percent in the first three weeks of 1999 – well ahead of the market. The performance appears to be driven by the few and the strong – France’s Canal Plus, the Netherlands’ Wolters Kluwer and Italy’s Mediaset, for example. Reuters’ sales have been growing better than expected, helping it bounce back since cost-cutting and mergers in financial services sparked concern last October.
In Germany, new entertainment companies are drawing the spotlight on Frankfurt’s Neuer Markt – the German stock market for growth companies – satisfying investors starved of opportunities in the German media sector. Media and marketing firm EM.TV & Merchandising, for instance, has skyrocketed 5,500 percent since the company’s 1997 listing. Kinowelt Medien and Edel Music, which floated last September, have also climbed steadily. In January Senator Film raised over E60 mn with an IPO on the Neuer Markt that traded up fourfold on the first day.
Doing deals
Back at NBC, there’s no sign of a breather on the acquisition trail. ‘The internet in particular is still a very hot place for investments and acquisitions,’ says CFO Begor, who has almost daily meetings about how to get bigger on the internet. Last year saw the company invest in Cnet’s net portal Snap; and in January alone NBC landed three net deals, leaving it with a host of web properties and equity positions in about 25 different internet sites. And there are still some 30 deals in the pipeline.
That goes along with a lot of spending on cable in the last few years. NBC has CNBC and MSNBC, now reportedly doing well, as well as equity positions in the Arts & Entertainment and History cable channels.
All the deal-making has changed the job of broadcasting analysts. Salomon Smith Barney’s Sweeney points to radio in the US, which has evolved from a volatile mom-and-pop business to a larger cap, more diversified and more easily predictable industry. It used to be analysts would value companies based on the private market trading value of their stations. Now big companies, such as radio concern Clear Channel Communications, are consistently growing earnings – which Sweeney defines as after-tax cash flow – and valued just like stand-alone growth stocks.
Forecasting revenues for media companies is fairly straightforward no matter where in the world they’re located. The primary earnings driver for radio, TV and newspapers is advertising revenue, and advertising revenue reflects the overall economy – GDP growth and consumer spending, for example. This was demonstrated when Moody’s recently downgraded five of Brazil’s media giants in response to the gloomy macro outlook.
Another rule of thumb is that even-numbered years have more ad spending because of the Olympics (the ‘Olympic phenomenon’); NBC, for example, will get a $700-800 mn revenue boost for televising the games next year. Even-numbered years also feature huge spending on political ads in the US. Then there’s the millennium effect: many analysts predict incremental ad spending as companies position themselves around the big event.
Ironically, even as broadcasters battle competition from the internet, online media such as AOL and Yahoo make up one of the fastest growing categories in ads for radio, TV stations and outdoor properties.
Media bull
While Mario Gabelli told Barron’s in January there’s ‘no margin for safety’ in US stocks, he did deign to recommend some media companies: USA Networks, Liberty Media, Cablevision Systems and Viacom.
PaineWebber’s Dixon is also bullish. He points to advertising networks like Interpublic and Omnicom consolidating and developing internet capabilities. Emerging media will also play a role in the newspaper industry, both turning up the pressure as consumers figure out new ways to receive information, and prompting growth – 900 US newspapers already have web sites.
For television networks and stations, Dixon expects the second half of 1999 to be strong due to potential millennium advertising. Cable TV networks are thriving – Viacom’s MTV, Time Warner’s CNN and Liberty’s various properties, for example. The radio business is moving from ‘a consolidation to execution phase’, with companies like Chancellor focusing much more on the need to carry out their business strategy and integrate acquisition activity.
Overall, says Dixon, ‘There’s very stable top-line growth and advertising continues to do well given the high levels of economic activity in the consumer marketplace. Most of these companies have gone a long way to restructure their balance sheets, and continue to focus on bringing cost under control.’
For a sector in which IROs are challenged to tell the story of sprawling, complex businesses, Dixon concludes: ‘In sum, the media business looks to be pretty healthy.’