By Robert Goldsborough
For the past few years, taking an investment in the beleaguered traditional media space has been the very definition of a contrarian view.
"Old media" companies have ridden a roller coaster in recent years as investors first questioned their competitive positions, their high levels of debt in some cases, and ultimately some firms' very survival. Investors then saw many of these names come roaring back in 2009 and, in some cases, 2010 as well.
Whether debt-laden newspaper publishers who have seen their ad revenues siphoned away by the Internet, radio station operators who find their businesses under siege both by the Internet and by satellite radio, or even TV station owners who have lost viewers to fragmentation, cable, and the Internet, traditional media companies clearly have required a view vastly different from the masses. Investors also have needed nerves of steel. A perfect example is the newspaper publisher McClatchy (MNI), which has ridden a roller coaster in recent years, with its stock price plunging 98.8% from the end of 2004 through the end of 2008, and then--after advertising trends stabilized some, and investors realized that the company wasn't yet headed to oblivion--surging 354% in 2009 and rising another 31.9% in 2010.
For investors interested in investing in media but understandably wary of single-stock risk, the ETF structure would seem to be an ideal option. However, in the ETF universe, there are surprisingly few options for investors interested in owning a diverse set of media companies--particularly involving old media. Here, we will spell out the current dynamic for traditional media companies and then discuss what ETF options investors have to invest in the space.
Despite recent rebounds, old media companies aren't out of the woods by a long shot, with secular trends continuing to favor migration to digitally oriented media--particularly from newspapers--and clear questions remaining over what the level of digital advertising will look like for such firms and whether any lost revenue can be supplemented by pay walls. My colleague Joscelyn MacKay recently noted that despite an improving economy, newspapers' year-over-year revenue growth remains negative, even as TV and online ads have sharply recovered. She called attention to the vicious cycle that publishers are facing: U.S. newspaper circulation has fallen during each of the past 15 years, and newspapers' share of ad spending decreased to 23% in 2009 from 31% in 2002.
Can digital advertising growth save traditional newspapers? Morningstar's equity analysts do not believe so. Joscelyn predicted that publishers will be unable to cut costs as rapidly as long-term revenue declines take place and expressed skepticism about publishers' abilities to monetize digital content, noting that the USA Today and New York Times websites and iPhone apps all receive high traffic but remain free. She also questioned whether any meaningful revenue ultimately will be generated from subscriptions to websites and apps. For all those reasons, Joscelyn argued that the shares of publishers Gannett (GCI) and New York Times Co. (NYT) are currently overvalued.
Meanwhile, on the broadcasting side, TV stations and networks continue to wrestle with how to deliver content in an environment where cable networks have been producing more and more compelling content, and increasingly savvy viewers prefer watching shows when they want, through the use of digital video recorders and on-demand services. That said, several TV broadcasters have posted especially impressive numbers in recent quarters, the result of strong political advertising in 2010 and a local and national spot advertising recovery. CBS, which Morningstar's equity analysts believe is overvalued, has done a great job generating strong audience ratings relative to its peers and owns valuable content that is tough to build from scratch, while Sinclair Broadcast Group (SBGI), which owns, operates, or provides sales services for 58 TV stations, recently reported very strong results, owing to significant political revenues but also strong ad spending from a wide variety of other sectors. The recent results of other broadcasters like Belo Corp. (BLC), which owns 20 TV stations, and Meredith Corporation (MDP), whose 12 TV stations account for about 20% of revenues, have been more mixed, but nonetheless have been buoyed by strong political spending and an ad rebound. (Publicly traded, pure-play radio station owners are rare--solely micro- and small-cap companies like Entercom (ETM), Emmis Communications (EMMS), Spanish Broadcasting System (SBSA), and Cumulus Media (CMLS), which are held in very few ETFs.)
Media conglomerates-- Walt Disney (DIS), Time Warner (TWX) and News Corporation (NWSA)--have been doing well. Disney, which owns ABC, has seen great growth in its cable networks (far outpacing its broadcasting growth), owing to strong affiliate fee growth and ad revenue growth at ESPN, demonstrating the power of live sports programming when time-shifted viewing continues to proliferate. Time Warner's cable networks, which generate more than 70% of operating profit, have grown rapidly from similar growth in affiliate fees and strong demand in the up-front ad market, and its filmed entertainment revenue group has enjoyed nice growth as it has continued supplying important TV content to both broadcast and cable networks. And News Corporation, which owns FOX and cable networks like Fox Sports, Fox News, Fuel TV, and FX Network, is being fueled by similar trends as its peers--strong cable networks growth (60% of operating profit) and less-compelling results in its other segments, including filmed entertainment (tough comparisons with Avatar).
Another current dynamic in media is a potential pickup in transactions after a period of virtually no major deals in the space since Tribune Co. went private in late 2007. Recently, for example, cable and home Internet service provider Comcast (CMCSA) won government approval to acquire TV network NBC from General Electric (GE). And just this month, published rumors have suggested that Gannett might be looking for a buyer for USA Today.
The bull case for old media is that major advertising categories finally are starting to stabilize, particularly with an improving economy, and that all the "bad news," so to speak, about the industry's transition from traditional distribution channels to digital distribution is priced in to the share prices of traditional media companies. However, the obvious bear case long has been that old media companies have not moved quickly enough to transition their businesses to digital media (and as such have lost their first-mover advantage and onetime market dominance when it has come to providing news and information). Bears also would say that traditional media companies have not cut enough, that they have lost massive advertising revenue vehicles (like classified ads) to the Internet, and that with more and more free online information, old media companies are disadvantaged by the fact that they are largely unable to monetize any digital media efforts that they undertake.
In 2010, investors clearly were of two minds with old media companies. Some firms significantly outperformed the market, while others lagged considerably. Of the publishers that did well, McClatchy, E.W. Scripps (SSP), and Journal Communications (JRN) (all of which were up 29% or more), two key characteristics emerged: a lack or near-lack of debt (in the case of Scripps; JRN has a modest amount of debt) and a realization that bankruptcy no longer was imminent (in the case of McClatchy). Meanwhile, among the publishers that did the worst in 2010--Lee Enterprises (LEE) (down 29%), Media General (MEG) (down 26%), and New York Times (down 21%)--debt fears are front and center. The two biggest pure-play TV station owners, Sinclair and CBS, both did great in 2010 (Sinclair was up 103%, while CBS rose more than 35%), and took advantage of the improved operating environment and concomitant increased cash flows to pay down debt and, in the case of Sinclair, reinstate a dividend. Longer-term, significant debt levels are leaving traditional media companies with few options to transform their businesses. At this point, investors clearly are betting that the old media companies with cash on their books will survive, at the very least. Whether traditional publishers and broadcasters can thrive in this new era, however, remains to be seen.
The only true pure-play media ETF is PowerShares Dynamic Media Portfolio (PBS), a quantitative-active fund that tracks a dynamic Intellidex benchmark that selects and ranks stocks based on capital appreciation using a 25-factor proprietary model. The fund draws 30 media companies from among the 2,000 largest U.S. stocks, in terms of market cap, trading on the NYSE and the Nasdaq. The Intellidex strategy divides media companies into categories by size and weights them within each size category. The methodology evaluates companies quarterly, based on a variety of criteria, including fundamental growth, stock valuation, investment timeliness, and risk. PBS, which charges an expense ratio of 0.63%, holds a wide variety of holdings that are both old and new media, including newspaper publishers like Gannett, companies holding both publishing and broadcasting assets like E.W. Scripps, pure-play traditional broadcasters like CBS, Belo and Sinclair, ad agencies like Interpublic (IPG) and Omnicom (OMC), cable and satellite providers like Comcast and DirecTV (DTV), media conglomerates with big cable network holdings like Time Warner, Viacom, and Disney, and Internet companies like Google (GOOG) and Ancestry.com (ACOM).
During 2010, PBS rose 19.6%, easily outpacing the S&P 500's 12.8% rise. Since its inception in June 2005, the fund is up 1.5%, however, well behind the S&P 500's 11% gain during that same interval. Unquestionably underlying that performance lag is the massive drops in many old media names since that time.
Other than PBS, media companies--both old and new--mostly tend to be found in tiny weightings at most in broad consumer discretionary ETFs like iShares Dow Jones US Consumer Services ETF (IYC), PowerShares Dynamic Consumer Discretionary (PEZ), PowerShares Dynamic Leisure & Entertainment (PEJ), First Trust Consumer Discretionary AlphaDEX (FXD), and Rydex S&P Equal Weight Consumer Discretionary (RCD).
Traditional media companies also are held in micro-cap ETFs like PowerShares Zacks Micro Cap Portfolio (PZI), Wilshire Micro-Cap ETF (WMCR), iShares Russell Microcap Index (IWC), and First Trust Dow Jones Select Microcap Index (FDM), but they make up minuscule weightings in those funds. In addition, as my colleague Samuel Lee recently noted, investors interested in owning a basket of micro-cap companies are far better off owning a mutual fund than a micro-cap ETF, given the micro-cap market's general illiquidity and inherent front-running that goes on.
So what is the best way for an ETF investor to gain exposure to old media? We recommend that investors consider PBS for exposure. Although its Intellidex methodology means that the individual stocks that it holds change each quarter, PBS typically contains a good mix of different kinds of media companies, many of which are exposed to traditional media. For example, it currently invests more than 20% of its assets in cable and satellite companies, many of which pipe traditional TV stations to viewers' homes. Another 10%-plus of assets are invested in pure-play TV station operators, and another 8% of assets are invested in publishers. Going a step further, we see that non-digital marketers like Harte-Hanks (HHS) make up another 7% of assets, and then media conglomerates--many of which rely on old-media properties as well as newer-media ones--comprise another 15.5% of the fund. (Internet companies make up much of the remainder of PBS.) Clearly, PBS offers investors the best basket of traditional-media companies, with the stock-picking benefits that the Intellidex provides.
One thing for investors to note: While PBS is more liquid than many dynamic PowerShares funds, it still isn't incredibly liquid. As such, investors should pay close attention to bid-ask spreads when investing.
Disclosure: Morningstar licenses its indexes to certain ETF and ETN providers, including Barclays Global Investors (BGI), First Trust, and ELEMENTS, for use in exchange-traded funds and notes. These ETFs and ETNs are not sponsored, issued, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in ETFs or ETNs that are based on Morningstar indexes.