Brian Pitz, an equity research analyst with Bank of America's internet team, recently published a deep dive report on the impact of the housing woes and credit crunch upon financial service internet advertising. Key excerpts follow:
Our 12-month thesis on the sector
2006 was a year of investing in the business for many Internet names; 2007 should see continued implementation and growth as well as margin expansion. We suggest focusing on names that execute to the secular growth opportunities in both online advertising and e-commerce with innovation.
Our call today in a nutshell
An analysis of third-party data and channel checks reveals that online financial services advertising growth remains strong, despite recent subprime and housing concerns. We analyze display and search advertising separately. We believe competition among mortgage companies is increasing as more lenders focus on retail mortgage and agency eligible loans. This, coupled with higher measurability and targeting capabilities (relative to offline media), could increase demand for CPM and CPC based online advertising, we believe. We believe large-cap online advertising companies, Google (GOOG) and Yahoo (YHOO), are likely best positioned to gain from sustained demand for online advertising; including inventory from online financial services advertisers.
Risks to our call
1) While current online advertising trends appear healthy, we note that continued spillover from the mortgage crisis to other parts of the economy could have a longer-term negative impact on online advertising and e-commerce names.
2) Online media buys (both search and display) are more “fluid” than offline buys, meaning that advertisers can change/cancel their online buys more easily than offline media buys. A significant change in advertising budgets, particularly among financial services advertisers, could have a negative impact on online advertising names.
3) While not likely not having as much of an impact to Google and Yahoo, some anecdotal information suggests a weakening in prices for online mortgage-related leads, which could continue to pressure names such as ValueClick (VCLK).
We believe an online financial services meltdown may be overblown for 2007 Recent events in the US housing and subprime mortgage markets have raised concerns about their impact on online advertising companies’ Q3 and 2007 outlook. While we admit it is difficult to predict the broader impact of the mortgage crisis on the economy, our analysis and channel checks reveal little impact from financial services advertising on our large cap online advertising names, GOOG and YHOO, to date. While we are leaving our numbers intact, we continue to be on the lookout for signs of the mortgage crisis spilling over to the broader economy, which could have a negative impact on our e-commerce and online advertising names. We believe the higher measurability of online media likely makes it less vulnerable than TV, print, and radio to a sustained downturn in the housing and mortgage markets.
In addition, online companies’ relatively low penetration among local advertisers and SMBs (small businesses) has potentially limited their exposure to a downturn in the housing market.
Impact on the stocks
Our analysis of third-party advertising data and channel checks with media buyers indicate that demand for online financial services advertising continues to be strong. We believe this bodes well for our top online advertising names GOOG and YHOO as:
1) online advertising offers better targeting and measurability than offline media;
2) GOOG and YHOO are still relatively under-penetrated among local advertisers (brokers) and small and medium businesses; and
3) increased competition among lenders is driving mortgage-related CPCs higher.
We believe GOOG in particular could outperform in the quarter as robust search supply (query volume) and high demand for mortgage-related keywords continues to drive upside. In addition, GOOG’s recently implemented ad ranking system (based on maximum bids) should serve to drive competition and bidding activity, in turn increasing CPCs. Moreover, GOOG’s 64% US core search query growth and nearly 20% Y/Y growth in unique visitors in August (according to comScore) position it to become overtake YHOO as the #1 site in the US, ahead of YHOO within the next two quarters.
What is at stake?
While we admit that a sustained fallout from the mortgage crisis could have a negative impact on sectors of the economy outside of financial services, our analysis focuses around current trends in online financial services advertising. According to the IAB, financial services was the second largest online advertising category in the US and constituted $2.7B or 16% of 2006 online advertising revenue. While financial services were the fastest growing category in 2006 (+79% Y/Y), the category declined 8% Y/Y in 2005, compared to 30% growth in US online advertising during the same period. In addition, we note that the financial services category is fairly broad, including commercial banks, credit agencies, personal credit institutions, consumer finance companies, loan companies, business credit institutions, credit card agencies, and brokerage companies.
According to Nielsen NetRatings AdRelevance, roughly 42% and 19% of 2006 US online financial services advertising was derived from consumer credit and consumer loan related advertisers respectively, representing approximately 61% of online financial services advertising.
Little Impact from Mortgage Cycles Historically
We note that online financial services advertising has historically experienced less than expected impact from housing and mortgage cycles from a macro perspective. In fact, historical data shows that online financial services advertising and mortgage originations growth are negatively correlated (-0.77) with each other. We believe that higher interest rates (which generally negatively impact mortgage originations) could result in higher advertising for other products including deposits and CDs from banks and other financial institutions. While we would not rely on a similar trend to emerge during the current mortgage crisis, we believe it is important to note the offsetting positive factors impacting online financial services advertising.
Few Signs of Weakness in Q3 to Date
A) Online Display/Banner Advertising: Our analysis and channel checks indicate a minimal impact to US online financial services advertising from the subprime mortgage crisis. We looked at Nielsen NetRatings AdRelevance advertising spend data through August 2007 which shows US online financial services advertising spend growing 76% and 60% respectively (or 68% combined) during the first two months of Q307. Note that these numbers represent display advertising only (i.e. exclude paid search) and while we caution against using these numbers in absolute dollar terms, we believe they are directionally significant, giving us increased confidence that the subprime fallout has had little impact on overall online financial services advertising to date.
In addition, during its Q2 call, Bankrate (RATE, $40.34, N/R) noted that it continued to see strong demand for CPM and CPC advertising on its site, while increasing CPM rates for its advertisers. While not having as much of an impact to GOOG and YHOO, some anecdotal information from some industry sources suggests the potential weakening in prices for online mortgage-related leads, which could continue to pressure names like VCLK. Drilling down on the segments within the financial services category suggests consumer credit (Experian, Equifax) slowing from July to August, with consumer loans (LendingTree/IACI, Low Rate Source, Countrywide (CFC), Ameriquest) and bank accounts increasing during the same period.
An analysis of AdRelevance data for the top 5 online mortgage advertisers shows that companies including Low Rate Source and Countrywide continue to leverage (and actually increase) online banner advertising to drive sales. According to our Specialty and Mortgage Finance group, more mortgage companies are placing an increased focus on retail lending and agency eligible loans (with better credit metrics). We believe this could potentially increase their direct to consumer marketing efforts online.
B) Search: While our visibility into financial services advertising in paid search is more limited, we highlight that supply (query volume) of mortgage related keywords on Google remains robust and we believe YHOO and Microsoft (MSFT) are likely showing similar Y/Y trends. We looked at search volume for a basket of major keywords such as “mortgage”, “mortgage rates”, “refinance”, “home loan” and found the supply or volume of searches on these keywords in the US to be at or above year ago levels.
According to an article in Bloomberg (Aug 24th), Google’s chief economist, Hal Varian, noted that higher competition among brokers and lenders has lead to increased housing-related advertising on Google. In addition, Varian believes that offline media including television, print, and radio are more likely to be pressured as online media (and search in particular) is “measurable, it’s quantifiable and that's the very last piece of advertising a company wants to cut.”
Where could we be wrong?
1) While we believe online financial services advertising growth remains healthy despite weakness in the mortgage and housing markets, we note that online advertising names could be somewhat pressured if there is a slowdown in consumer spending.
2) While we are confident that paid search advertising generally has seen a minimal negative impact from the mortgage crisis, the lack of cost-per-click data around mortgage related keywords limits our visibility into paid search advertising trends.
3) Online media buys (both search and display) are more “fluid” than offline buys, meaning that advertisers can change/cancel their online buys more easily than offline media buys. A significant change in advertising budgets, particularly among financial services advertisers, could have a negative impact on online advertising names.
4) While we remain confident that online advertising in July and August have generally not been impacted by the mortgage crisis according to this data, we note that weaker demand for online advertising in September could have an impact on Q3. However, our channel checks continue to indicate robust demand in the financial services sector.
5) While likely not having as much of an impact to GOOG and YHOO, some anecdotal information suggests a weakening in prices for online mortgage-related leads, which could continue to pressure names such as VCLK.