Not All Media Stocks Are The Same

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By Greg Peel

We know that all media stocks are not the same, because for years now they have been separated by the market into the “old media” world of newspapers, radio and free-to-air television and the “new media” world of the internet, cable television and digital media in general. Indeed, UBS notes that while the media sector on the Australian market is trading at an FY11 forward earnings price/earnings of 15.1x, that figure is split into 11.7x for “old” and 20.1x for “new”.

If you consider that the historical full-market average PE is 14x, you might say that old media looks undervalued and new media overvalued but that would be to ignore the underlying and now gradually maturing secular shift which pervades the sector, GFC or no GFC. In simple terms, metro newspapers are being replaced by digital versions as is analogue FTA-TV while classifieds are now the preserve of internet-based specialists and viewers are moving towards a view-on-demand basis instead of a TV guide basis.

And today's youth are never likely to read a newspaper at all in hardcopy and few even drag themselves away from the computer to watch tele, with rare exceptions such as Masterchef or sport. Gen Y is probably blissfully unaware mum and dad found their house and cars in newspapers classifieds once upon a time.

The secular shift is nevertheless not over, nor is it an overnight phenomenon. There are still enough tired old fools like me who prefer to spend half an hour each morning wrestling the seemingly seamless plastic wrap off my home-delivered Herald and to settle in of an evening to Spicks & Specks on ABC FTA-TV (albeit delivered via satellite re-send). That is why the old media companies and the new media companies have a PE split. The story ain't over yet.

But the story is now far enough down the track that it is fully understood by the market. There remains a PE gap because new media still have greater future earnings potential than old media, but among the old media stocks which have collective PE of 11.7x, and the new media stocks which have a collective PE of 20.1x, there are those which are over- or undervalued in their own right, at least according to analysts.

The recent earnings reporting season gave stock analysts a chance to assess how things are going.

UBS notes that on average, the sector delivered FY10 earnings 1% above consensus. But company managements were collectively cautious in their FY11 guidance, so forward earnings were downgraded by an average of 2%. Those stocks which surprised to the downside included APN News & Media ((APN)), Ten Network ((TEN)) and West Australian Newspapers ((WAN)) while surprising to the upside were Carsales.com.au ((CRZ)), Seek ((SEK)) and Fairfax ((FXJ)).

There is almost, but not quite, a consistent split here. As a purveyor of newspapers, magazines and directories, APN is a wrinkly. So is West Oz, but then its fortunes rise and fall with commodity prices (strong prices = mining boom = strong WA economy = lots of job and house ads). Ten is still a wrinkly despite making a late charge into digital channels, which are still FTA. Ten simply lives and dies on the strength of whatever franchise is working at the time, from Big Brother to Idol to Masterchef.

Carsales and Seek are clearly teenagers, albeit Seek is now so well established it's almost Gen X. And Seek's outperformance is currently due to its successful foray into education which has really little to do with media. Its online classifieds business is mature.

The odd one out is Fairfax, which is still very much an old media company. But the story of Fairfax is one of strong foresight but poor execution. The company moved into the digital space early by trying to sell the Fin Review online, but charged so much for access that the world stayed away in droves. Now, with thanks to rival Rupert Murdoch, the quiet shift is on towards charging out digital newspapers at a reasonable price. And Fairfax has remained in touch with its classifieds competition through its internet websites such as Drive and Domain.

Fairfax was almost written off in the GFC by the market, but has proven its critics wrong and bounced back with a vengeance. What is notable, nevertheless, is that old media undertook an extensive capital raising program in response to the GFC, and now balance sheets are looking rather healthy.

Which brings us to the core of media revenues – advertising. Here the lines are now blurred given the rise of practices such as viral internet advertising and television product placement to replace the newspaper ad or lengthy TV ad break. But anyone who has to constantly unwrap his Herald from not just stubborn cling wrap but also some wrap-around full-page spread, or has been forced to sit through the relentless and repetitive ad breaks in Masterchef, knows that old-style advertising is still alive and well and threatening to hang around for many a moon yet. Have razor blades ready when the Commonwealth Games begin.

Advertising spending is now back in earnest having vanished completely in the GFC. The strong numbers achieved in the second half of FY10 are already showing up as continuing in the first half of FY11. And as UBS notes, longer booking cycles are providing confidence that strength will indeed prevail. Such revenue, along with recapitalised balance sheets, has allowed media companies to reinstate their dividend payouts.

Yet managements remain cautious. They are cautious because there remains a global economic uncertainty which threatens to shut down ad spend once more if things go back to panic, and they are cautious because it was easy to show good earnings growth in FY10 over FY09 – given no one spent any money on ads in FY09 – but it will obviously not be possible to repeat those comparable numbers in FY11 over FY10.

Comparables always seem ludicrous to me, and a fall-back point for the unintelligent analyst or investor, but that's the world we live in.

Deutsche Bank expects all media companies to make incremental investment in their digital platforms in FY11 having shut down capex during the GFC. Just as to how this is accepted by the market is a case in point. Seek, for example, is expected by Deutsche to make the heaviest relative investment. But given this will be in its burgeoning education division, earnings growth potential renders such investment worthwhile. Ten, on the other hand, is throwing a lot of money into its new FTA digital channel Eleven, and into expanding its news service.

Analysts are concerned this might be good money going after bad. So far the big news around Eleven is that Neighbours – a show watched only by envious foreigners and lonely local diehards, and now a hundred years old or something – will move to a new time slot on the new channel. If that's the best we have to look forward to, goodnight. And the other risk is that Eleven simply fragments the Gen Y target audience of Ten, and offers yet more Simpson re-runs to fill in the blanks.

(I recently read that between FTA and cable, The Simpsons appears on Australian TV 53 times a week.)

Moreover, Ten's decision to pump more money into that which it has always shunned for the most part – news and current affairs – seems like an unnecessary addition to a crowded market (note ABC 24) and, again, anathema to the Gen Y audience Ten has so cleverly consolidated over the years.

If something new doesn't eventually come along to replace an over-flogged Masterchef when we're all over the cooking show concept, Ten is in big trouble.

But while this looks like new media winning and old media losing again, consider that UBS has today initiated coverage on the REA Group ((REA)) – once known as Realestate.com.au – with only a Neutral rating. While the business is sound on a medium-term view, say UBS, at 23x forward earnings the stock is simply fairly valued.

Indeed UBS suggests that on a PE basis, REA and Carsales appear the most expensive while Fairfax and APN appear the cheapest. But if you go another step down the ratio line, to PE over earnings growth (PEG), Newscorp ((NWS)), Austar ((AUN)), Seek and Fairfax are the more attractive and APN and West Oz Newspapers the least.

If I had a dollar for every time an analysts said News Corp was “compelling value” only to see Rupert buy into some other new fad (or old fad) at great expense, I'd be a very wealthy man. How's MySpace going these days?

As for Austar, the company has been able to shoot goals through what's know as ARPU but not through growing its subscription base (as is also the case with Foxtel). ARPU is average revenue spend per unit and basically reflects the fact existing customers are paying up for new channel packages and fancy hard-drive boxes which allow you to pause for a leak or fast-forward through ads (assuming you record first).

One wonders how Austar's satellite TV service will be faring by the time fibre cable reaches the bush.

Yet UBS has a preference for Austar, along with Seek, Austereo ((AEO)) and Southern Cross Media ((SXL)).

In the case of Austereo, it is considered that while radio is old media it will never die. We still listen to radio at the breakfast table or in the car, or in the shed when the finals are on, no matter how whizz-bang other digital offerings become.

As for Southern Cross Media, regional old media is also considered a stalwart. This also works for Fairfax after its 2006 acquisition of Rural Press.

Across all media companies, there exists the ongoing possibility of more industry consolidation and takeovers.

So the rule of thumb with media sector investment is don't just separate into old and new. One must consider whether the market is over- or undervaluing the pros and cons. And one must also take note of diversity or lack thereof, and that which is specifically driving earnings growth potential.

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