Equity Research Report Release
Thursday, January 9, 2020
Media Industry Report
The Internet Takes Over The World
Michael Kupinski, DOR, Senior Research Analyst, Noble Capital Markets, Inc.
Refer to end of report for Analyst Certification & Disclosures
- Overview. In this quarterly Media Review, we look at the past 10 years, the past year, and quarter and what the future holds for media companies. This report highlights our favorite picks for 2020 by sector.
- Digital Media & Technology. Digital Media now accounts for more advertising than all traditional mediums combined. Have there been unintended consequences of privacy regulations?
- Broadcast Television. TV stocks outperformed the general market over the past decade, fueled by industry consolidation and a windfall from high margin Retransmission revenue. Looking beyond 2020, which is likely to be a good year, what will the next decade look like?
- Broadcast Radio. John Malone, the owner of Sirius XM and Pandora, signals his ongoing interest in iHeart Media by asking approval from the Justice Department to increase his ownership stake. What are the implications?
- Publishing. The sector had a good performance in 2019, but under-performed for the past 10 years. What drove the performance this year? How is the industry positioned for the next 10 years?
Click 'view previous report' for company specific disclosures on Noble covered companies.
The Internet Takes Over The World
As we start 2020 and a new decade, we take look back the past decade and look forward toward what the future may hold for Media companies. According to several advertising prognosticators, Internet Media accounted for roughly 50% of total US advertising spend in 2019, more than triple from 15% just 10 years earlier. Incredibly, in a short 10 years, the Internet accounts for more advertising than all of the traditional mediums combined! The media sectors that suffered the most from the growth of the Internet were Newspapers, Magazines, Radio, and, to a lesser extent, Television and Out-Of-Home. Newspapers declined from roughly 22% of total US advertising in 2009 to roughly 5% in 2019. Magazines share declined from 12% to 5% and Radio from 11% to 7%, respectively. And, for the first time, Television, the second largest medium behind the Internet, fell below 30% of total US advertising to 28%.
While it is difficult to determine with complete accuracy the performance of the sectors over the past 10 years, given mergers, spin-offs, and bankruptcies, the Television sector was the only traditional media sector to outperform the general market over the past decade. The TV stocks were up 736% from 2009 to 2019 versus 189% gain for the general market as measured by the S&P 500 Index over the comparable period. The TV companies benefited from a brand new and highly profitable revenue stream, Retransmission revenues, and significant industry consolidation. Many of the largest TV consolidators, including Nexstar (+2,783%), Sinclair (+723%), and Gray Television (view previous report)(+1,338%), outperformed the rest of the group. In contrast, there were very few Digital Media companies public 10 years ago and, as such, we do not have an Index to compare.
The significance of the stock performance for the past 10 years, as it was in 2019 for all media companies, including Digital Media, is that the stock valuations were influenced by M&A activity. This is true for the Publishing stocks in 2019 (discussed later in this report), which had one of its best performances in years. But, the momentum of the Internet and Digital Media appear to be hard to stop. In 2019, as Figure #1 illustrates, Nobleâ€™s Ad Tech (+75%), Social Media (+58%), and MarTech (+43%) Indices all significantly outperformed the S&P 500 (+29%) for the year, while Nobleâ€™s Digital Media Index (+26%) performed in-line with the broader market.
As we look into our crystal ball, there will be some favorable fundamental tailwinds in 2020, given the expected influx of Political advertising and the expectation of an expanding general economy. In addition, we expect many media companies to repair debt heavy balance sheets, which has been a result of recent acquisitions. As such, we anticipate that media stocks, in general, should have a favorable 2020. We encourage investors to be selective, however, given the late stage economic cycle and the secular headwinds from the Internet. This report highlights some of the challenges and opportunities by sector and some of our current favorites for 2020.
2019 Digital Media Performance
Internet, Digital Media & Technology
Unintended Consequences of Privacy Regulation
All four segments of Nobleâ€™s Internet and Digital Media sectors performed well in 2019. Nobleâ€™s Ad Tech (+75%), Social Media (+58%), and MarTech (+43%) Indices all significantly outperformed the S&P 500 (+29%) for the year, while Nobleâ€™s Digital Media Index (+26%) performed in-line with the broader market.
Despite the strong stock price performances across the board, we donâ€™t expect companies in the Internet and Digital Media sector to rest on their laurels. Change is the only constant in this industry. Whether to stay a step ahead or just to stay alive, M&A in the Internet and Digital Media sectors has remained healthy. While the Big Three (Google, Facebook and Amazon) may account for roughly 75% of the industryâ€™s revenues, in a $130B industry, that still leaves $30B+ marketplace growing at a double-digit rate. We expect continued consolidation in the Ad Tech sector as independent companies seek to build scale and acquire new capabilities in an era of mass personalization driven by access to first party (not just third party) data. The focus on first party data is likely to drive M&A in coming quarters. Consolidation will provide advertisers with alternatives to the Big Three, while also reducing the number of vendors they are partnered with, thus reducing the ad tech â€œtaxâ€? (numerous middlemen taking a percentage of an ad buy).
Digital Media, Fourth Quarter 2019 Performance
As tech giants have gotten bigger, politicians have begun to call for greater regulation on the tech â€œmonopoliesâ€?. While there appear to be increasing calls to â€œbreak them upâ€?, to date, efforts to ensure consumer protection and privacy by regulating the largest tech companies has resulted, unintentionally, in making them stronger. In May 2018, Europeâ€™s General Data Protection and Regulation (GDPR) went into effect, and on January 1st, 2020, the California Consumer Privacy Act (CCPA) went into effect. Companies such as Google and Facebook used GDPR as a reason to no longer share data with third parties. This provided them with more control over data and limited the effectiveness of the data third parties used to compete in the ad ecosystem.
In short, legislation that forces the systemic removal of digital profiles and identities (which have been used to prove attribution), is effectively ceding control to the walled gardens of Google, Facebook and Amazon. For example, pre-CCPA, a retailer might generate leads by buying data and audience models from third parties, but post-CCPA, the largest source of leads at scale are those brokered within the black boxes and walled gardens of Google, Facebook and Amazon.
Perhaps as a response to regain control over their data, 2019 was the first year that brands themselves began to make acquisitions in the ad tech or marketing tech sectors. For example, in March of 2019, McDonaldâ€™s bought audience personalization company Dynamic Yield for $300 million; Nike acquired analytics and inventory optimization company Celect in August 2019, and in October 2019, Mastercard acquired the customer data and loyalty marketing company Session M.
Connected TV M&A to Remain Healthy
M&A in the connected TV sector ramped up considerably in 2019, and in the fourth quarter in particular. When programmatic buying first began to take hold in the early 2010s, many industry execs opined that the lessons learned in online advertising would serve them well as programmatic or automated buying shifted to the biggest pot of gold: television. Of course, this was when TV advertising was 3x larger than online ad spend. But lessons learned in online advertising did not translate easily to TV, and in the years it took trying to figure out how to bring targeting and addressability to TV, online advertising surpassed TV advertising in size ($130B vs. $70B). Nevertheless, it is clear that M&A action has moved into the OTT or connected TV space, given the promise of marrying mass audiences with addressability. For example, in the month of October alone:
- Roku announced it would acquire DSP Dataxu for $150M to bring â€œdata-driven modeling focused on business outcomes for brandsâ€? to connected TV;
- AT&Tâ€™s Xandr acquired Clypd, a sell side platform (SSP) providing marketers the ability to buy both digital and linear ads with improved targeting; and
- LiveRamp acquired Data Plus Math for $150 million providing marketers the flexibility to marry â€œTV and digital to any real-world outcome online or offlineâ€œ and more accurately measure ad effectiveness.
Over-the-top (OTT) TV platforms were also in demand in 2019: in January, Viacom acquired Pluto TV for $340 million, and in April, Altice USA acquired Cheddar TV for $200 million.
While it is likely that M&A activity will drive stock performance in the sector going forward, our stock recommendations do not speculate on M&A to drive stock values and focus on fundamentals. As such, turning toward our favorite plays in 2020 and beyond, investors are encouraged to look at several sectors within the Internet, Digital Media and Technology space that have compelling fundamentals and/or turnaround prospects. In the Internet e-commerce space, we favor 1800Flowers.com (view previous report) as our favorite play. The company is at the forefront of technology enabled commerce, including conversational commerce through in-home devices. In the Ad Tech and Marketing Services space, we favor Harte Hanks (view previous report). We believe that the company is positioned for a turnaround in 2020 fundamentals. Finally, we recommend Akazoo (view previous report) as one of our favored ways to play the strong demand for streaming audio services.
Is The Golden Age Of TV Stocks Over?
As Figure # 3 illustrates, the TV sector slightly under performed in the fourth quarter 2019, up a 7% versus a 10% gain in the S&P 500. But, more importantly the TV stocks performed in line with a strong general market in 2019, up 28% versus the general market, which was up nearly 29% as measured by the S&P 500. This market-weighted index was led by the shares of Sinclair Broadcasting (up 62%), Tegna (up 43%), and Nexstar (up 30%). Others lagged the industry and the market, including Gray Television (view previous report)(up 11%) and E.W. Scripps (view previous report)(down 16%). The increase in broadcast TV stocks also outperformed the industry's average 22% increase in off election years, which goes back roughly 30 years. The question on everyone's mind, "Has the long period of out-performance ended?"
Broadcast television stocks were the darlings of Wall Street over the past decade, increasing 736% versus a gain of 189% in the S&P 500 in the comparable period from 2009 to 2019. Leading industry consolidators in the M&A fueled decade outperformed most in the group. The shares of Nexstar, which led the industry's performance, increased a stunning 2,782%, followed by Gray Television (view prevous report), which increased 1,338%, and Sinclair Broadcasting, up 723%. Several factors influenced the strong performance including the increasing importance of Retransmission revenue.
Fourth Quarter 2019 Traditional Media Performance
Total Retransmission revenue for the industry was a modest $760 million in 2009, or 4% of total broadcast revenue, and grew at a compound annual rate of 30% to an estimated $10.8 billion in 2019. In 2019, Retransmission revenue accounted for roughly 33% of total Broadcast TV revenue. This high margin and predictable revenue stream became a ballast to support a heightened M&A environment. Having scale was important to protect and to grow Retransmission revenue when negotiating the fees with cable and satellite operators. But, this revenue stream has become largely exploited by the end of the decade. Retransmission revenues grew an estimated 6% in 2019 and is projected to grow in the low single digits for the foreseeable future.
Furthermore, the M&A environment has cooled. A number of broadcasters have reached the ownership cap of 39% of US total TV households and it appears unlikely that the FCC will make a move to lift it. In addition, a number of TV broadcasters are shoring up balance sheets as a result of recent acquisitions, which has taken several broadcasters out of the M&A market for now. But, importantly, there is a smaller pool of attractive stations left to buy.
We believe that the strong Retransmission revenue and Political advertising growth has masked some of the underlying issues over broadcast TV advertising. The Internet has recently taken share from the Broadcasters, with the total share of advertising expected to dip to 28% in 2019, the first time the industry has been below 30% of total advertising. In addition, the growth of OTT platforms could pose an even bigger problem. While net Retransmission revenue may not be affected, given that Broadcasters make the same economics on the OTT platforms as it does on cable, there is a substantial risk that continued audience fragmentation as consumers shift to paid content service providers, like Netflix, could lead to lower ad rates, or CPMs. There may not be enough viewers that are attractive to advertisers.
Competitive pressures from the Internet were the concerns in 2009. At that time, analysts under estimated the growth of Retransmission revenue and had dire forecasts for the next decade for the Broadcasters. However, at this point, there does not appear to be a growth driver as important as Retransmission revenue. A new broadcast TV standard, ATCS 3.0, is still in its infancy and significant revenue opportunities have not yet been determined. We believe that there will be significant pressure for Broadcast TV executives to seek new revenue streams from the new broadcast standard in coming years.
Consequently, it is very likely that the next decade will be far different than the roll-up strategy of the past in terms of what will drive stock valuations. The wild card is a possible shift in the Political will to lift onerous ownership caps, which does not appear to be likely currently. The Broadcast TV stocks likely will find it difficult to climb the wall of worry over the secular challenges in advertising. It is not surprising that many group TV station owners are looking for growth outside of TV stations, such as Sinclair and CBS. We believe that there will be increasing attention on content creation to be competitive with the likes of Netflix and Amazon. Nonetheless, the fundamentals of the industry appear favorable in 2020, a function of favorable Retransmission revenue growth, the influx of Political advertising, and a favorable general economy.
How should investors play the industry? We favor companies that are below the ownership cap and have the ability to make acquisitions, like Gray Television (view previous report). In addition, we favor Broadcasters that have a developed business strategy into faster revenue growth areas, like E.W. Scripps (view previous report). Its growth businesses include Podcasting and OTT broadcast Networks. Finally, we like Entravision (view previous report) because of its relatively healthy balance sheet and likely beneficiary of Political advertising, as well.
Is Radio Attractive Again?
It has been nearly 2 years since John Malone, the CEO of Liberty Media, the owner of Sirius XM and Pandora, tried to increase its stake in iHeartMedia. Those efforts were repeatedly rebuffed by bondholders. But, recently, Liberty Media, which currently owns 4.8% of iHeart, asked the Justice Department for approval to increase its equity stake in an effort to determine any roadblocks. The Justice Department likely will have some concerns regarding the need for competition between Sirius XM and terrestrial radio. The conditions that the Justice Department may set could determine the economic value of pursuing a move to increase the stake. Why would John Malone seek to own a terrestrial radio company when he is already invested in two of the fastest growing segments of the audio industry, streaming and subscription audio? What are the implications should the Justice Department allow Liberty to increase its stake in iHeart?
First, one of the most attractive attributes of terrestrial radio is the reach. While time spent listening has declined (as it has for most mediums), radio still reaches roughly 92% of the US households, which has been relatively stable over the past 10 years. Furthermore, radio still has a significant amount of engagement with its audience. Consequently, radio is a megaphone that could potentially drive business. iHeart has effectively done this through the development of its podcasting business, for instance. It uses its own air time to promote it. Streaming audio companies, like Akazoo (view prevous report), uses free radio stations to drive its premium subscriptions, which is one of the reasons its customer acquisition costs are low. Similarly, iHeart would be able to use its megaphone to drive subscriptions to Pandora or Sirius XM. But, importantly, iHeart's platform is not just the terrestrial radio audience, but includes roughly 100 million users from its Digital businesses and an estimated 200 million from its social media presence,
Yet another reason for Malone's interest in iHeart is that advertisers seek a multi platform buy that delivers a significant audience. In our view, this has been one of the gating factors for the likes of Pandora and Sirius XM. There are very few people that listen to a particular station at any given time. Consequently, a combination of Pandora and Sirius XM, with a large terrestrial radio platform, a digital presence, concerts and social media presence, could offer compelling advertising platform opportunities. iHeart management has stated that advertisers may come in its door for one of its offerings and then expand into other platforms.
Finally, we believe that John Malone likes cash flow businesses. The radio industry, in general, and iHeart, in particular, is a cash generating machine. iHeart is expected to generate $375 million to $400 million in free cash flow in 2019. The company is expected to pare down debt in 2020, allowing it to reduce its debt leverage into the 4s by the end of the year.
What are the implications for the radio industry if the Justice Department grants Liberty approval to increase its stake? Such a move would be a "cattle call" for the industry to consolidate. Scale would be important to compete with the audience levels that iHeart delivers. There will be a need to compete against the potential increased competitive threats from the likes of Pandora or Sirius XM. But, radio companies need to consolidate smartly, without significantly levering up balance sheets, especially given the late stage of this economic cycle.
The Radio stocks had a nice bounce recently. The stocks outperformed the general market in the fourth quarter 2019, up 18% versus the market's 10% advance. The gains in the fourth quarter, however, were not enough to offset the year earlier declines. As a result, the Radio stocks under performed the general market for the full year 2019, down 6% versus a 29% gain for the broad market. This market cap weighted index masks some poor performances, like Entercom (down 41% for the year) and Beasley Broadcasting (down 17%). The strongest performer in the sector was Cumulus Media (view previous report), up 35%. The company had a series of favorable quarters following the emergence from bankruptcy. The radio stocks performed poorly over the past decade, as well. Over the past decade, the radio stocks on average was up an estimated 9% versus a general market gains of 189% in the comparable period. This is an estimate given bankruptcies in the industry.
So, what does the future hold for radio? We believe that the heightened interest in radio by a proven value creator, like John Malone, should provide a reason for radio investors to take notice. The fundamentals in 2020 appear favorable, which should allow radio broadcasters to aggressively pare down debt. Furthermore, many in the industry have restructured balance sheets, providing more financial flexibility should the economy turn sour. Companies like Townsquare Media (view previous report), which have a compelling, fast growing digital media business, stand apart from the pack in terms of growth and stock valuation. As such, it remains our favorite in the sector. In addition, we believe that there is still a favorable risk/reward relationship with Cumulus Media (view previous report), as that company continues to execute on an aggressive debt reduction strategy.
In A Precarious Spot
As Figure # 4 illustrates, Publishing stocks had a good 2019, but lagged the performance of the other traditional media companies in the fourth quarter. In the fourth quarter, the group was up a modest 5% versus a 10% increase for the general market. But, for 2019, the Noble Publishing Index increased a strong 24%, slightly under performing the 29% increase for the general market. The favorable performance for the year was bolstered by a good showing by the New York Times and the merger between Gannett (view previous report) and New Media.
2019 Traditional Media Performance
New York Times has successfully pursued a digital business model and its shares outperformed the sector. The company set a goal of delivering $800 million in digital revenue, roughly 50% of its total revenue by the end of 2020, and it appears to be well on its way toward that goal. The shares of New York Times increased 13% in the fourth quarter, outperforming the market's 10% advance. In addition, the shares increased 28% for the year roughly in line with the 29% growth for the general market. The New York Times shares increased a solid 160.4% for the past 10 years, but that increase was below the general market's increase of 188.5%.
The digital strategy of the New York Times and the revenue growth that the company exhibited over the past several years were inspiration to the rest of the publicly traded publishing companies to pursue a digital strategy. Certainly, the NYT shares reflected tangible benefits to its shareholders for executing on its digital strategy. The question is whether or not the New York Times model can be replicated by other publishers?
At this point, the rest of the industry is disheveled. Certain private equity firms are seeking an exit strategy from its investments in the industry, some of which appear to be milking cash flow and not investing into a digital future. Others are seeking scale to provide more opportunity for operating synergies and for an improved digital footprint. Finally, many in the industry are burdened with a significant amount of debt, which limits the ability to invest in a digital future. These are issues weighing on investors in the sector.
In our view, financial restructurings are likely and necessary. We agree that there are benefits from scale, but it is important that balance sheets are not burdened with a significant amount of debt. As such, we encourage investors to be selective and view investments in the industry as speculative. Our favorite in the industry is Tribune Publishing (view previous report), which currently has no debt and a sizable cash position. We would note that the company's current largest shareholder owns newspaper assets and its interests may not be aligned with all shareholders. Finally, we view the shares of McClatchy (view previous report) as a option on that company's financial restructuring.
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Director of Research. Senior Equity Analyst specializing in Media & Entertainment. 34 years of experience as an analyst. Member of the National Cable Television Society Foundation and the National Association of Broadcasters. BS in Management Science, Computer Science Certificate and MBA specializing in Finance from St. Louis University. Named WSJ 'Best on the Street' Analyst six times.
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Report ID: 11091