Radio Earnings: Bleak Forecasts and Contrarian Plays

As the radio industry heads into the thick of its earnings releases over the next week or so, the market seems to already be predicting 2008 will be a pretty awful year for the sector. To date, fourth quarter 2007 results have been released by industry heavy weights Clear Channel (CCU), Emmis (EMMS), Entercom (ETM) and Radio One (ROIAK), and CBS Corporation (CBS) is scheduled to release on February 26th. While the story on CBS will largely be the impact of the writer’s strike on its television network, it has a sizable large market radio group that is in the midst of an operational turnaround important to not only the company but also the health of the industry overall.

So far, all seem to have consistent stories with the focus shifting to 2008’s dismal forecast. This goes against general conventional thinking as this year holds two significant advertising events- the U.S. Presidential election spending and Olympic advertising, which in prior cycles generally fueled significant annual growth rates for traditional media. More importantly though, what isn’t being discussed much is that these forecasts start to raise serious alarms for 2009 when those quadrennial events won’t be around to lend support to the sector.

For the past 3 months, core radio advertising spending has shown significant erosion with continued year over year drops. According to the Radio Advertising Bureau, the industry saw gross annual declines of 6% in November, 6% in December, and 7% in January compared to the same period the prior year. There had been some disparity in those industry results throughout 2007 as smaller market broadcasters tended to fare much better than their major market counterparts, but that spread seemed to be tightening as the year drew closed.

In a note to clients last month Bear Stearns analyst Victor Miller pointed out that political spending may only be masking these larger declines by stating, “Given December’s lack of political comps and presence of some political spending in 4Q 2007, the monthly decline was disappointing.” He points out that Q4 2008 should be exceptionally strong given political spending, but then maintains only a flat overall outlook for radio spending in 2008. While this exceptional political spending is welcome help to the industry this year, focus again starts to shift to 2009 for radio stocks, particularly in Q4 2009 when political driven comps will be extremely high.

Another media analyst, John Blackledge of J.P. Morgan, is calling for an even larger drop of 3% in radio ad spending in 2008, and suggests it would be far worse if not for political advertisements. In a note out to clients on February 25, 2008, he points out that there are both “secular and cyclical challenges facing the medium”. Highlights of his note include:

• We estimate that radio industry advertising revenue should decline 3% in 2008, driven by continued secular pressure (with continued audience losses leading to loss of ad share) as well as cyclical pressure as the soft macro trends should lower demand for advertising on the medium.
• We believe the radio industry is already amidst an advertising recession, given declines in 2H07. The radio industry has underperformed nominal GDP by 5% on average annually since ’04, but in 2H07, the industry underperformed nominal GDP by about 9%. We believe the below average underperformance will likely persist for most of 2008, offset to some degree by political spending in 2H08.
• The radio industry underperformed real GDP by about 8% during the ’01 recession. JP Morgan economists expect about 2% real GDP growth in 2008. Applying the '01 recession underperformance (of 8%) would imply radio industry revenue decline of 6% in 2008.
• However, the radio industry should benefit to a degree from political spending in 2H08, which should reduce some of the cyclical pressure on the medium. The radio industry should garner some direct political advertising as well as some “displacement” revenue, as advertising dollars intended for TV will likely flow to other media, like radio, in 2H08.

The concerned views of these analysts about core business in the sector has made its way to investors as the market has reacted harshly to radio stocks over the past 6 months. Amongst the hardest hit has been Citadel Broadcasting Corporation whose stock has been severely punished by investors, and indications are that it has yet to reach bottom. According to data released by the New York Stock Exchange and reported by Reuters last Friday, the company has been the target of short sellers who increased their positions from late January to mid-February by more than 65%, making it one of the top 5 increases in short positions for the period in the entire NYSE. There are now about 27.4 million of the company's shares held short- more than 10 percent of its total shares outstanding.

Ironically, the radio stocks aren’t the only targets of the market’s angst towards radio right now. It seems the messenger is also getting shot as a number of large investment banks have recently laid off their media analysts who cover the sector. The most notable in recent rounds of cutbacks by the banks was the departure of Jonathan Jacoby at Bank of America, a most unfortunate occurrence as he had an understanding of the business like few others. This leaves only a handful of analysts who still cover the intricacies of broadcast media, and even fewer who cover radio specifically indicating that the financial institutions don’t have a lot of long term confidence in the sector. This makes it even harder for radio to get the message out to investors of what is working in their businesses. To the complaint of many radio executives, much of the “good news” never seems to get past the industry trade publications into the general financial media, and with fewer analysts raising awareness to investors, this may get even harder.

Most of these executives would tell you that radio is in the midst of a complete overhaul as it prepares to wage battle in the digital age. Many of these initiatives are coming very late in the game, but could succeed as the industry has a long history of adapting to competitive forces so long as it has the financial resources to invest in itself. Further declines in 2008 or a cataclysmic 2009, however, could jeopardize what little financial resources these companies have to make those investments in that future. With investors heading for the doors and bankers reportedly selling existing bank debt of broadcasters at 70-80% on the dollar, it doesn’t look like there are a lot of traditional financial partners out there willing to take further gambles on the industry.

The one significant bright spot in this otherwise bleak scenario, though, is the opportunity for the contrarian play. When everyone else is running out, that is usually when the smart players show up and make windfall profits. Most recently, billionaire Sam Zell reentered the broadcasting space with his takeover of the Tribune Company, and a number of private equity players who traditionally shunned the sector are reportedly starting to find current valuations very attractive. Just today, February 25th, private equity firm The Gores Group announced they are buying a $100 million stake in Westwood One (WON).

Zell’s investment is most notable as he has done this before in the early 1990’s with the takeover of radio broadcaster Jacor Communications. Under his control, Jacor became a major consolidator of radio properties and was ultimately sold to Clear Channel. We may soon see others follow Sam Zell’s lead and it could lead to a rash of takeovers and further consolidation in the space.

Time will tell, but for the short term radio broadcasting stocks are no place for the quick return. To play in this space, it will require a deep understanding of the players involved and extreme patience as the industry sorts out its financial issues to reinvent itself once again.

Count it down, but don’t count it out.

Disclosure: None

Disclaimer: This article reflects the individual views of Mr. Hannan and may not be attributed to any person, company or other entity with whom Mr. Hannan is affiliated.

Comments

[J.P. Hannan]

Thanks for the emails I got on this one. Always welcome feedback on my articles.

[User 121623]

It is not hard to be a contrarian here at these price levels. By way of example, CDL reported a blah quarter but they still had significant and higher free cash flow. At these levels, the stock trades at 2x free cash flow. At these prices, it is a stub, an option, with no expiration date.