Automotive Angst: Detroit’s Woes Impact TV Stocks

For investors in pure play television stocks, the comments coming out of Detroit in the wake of disappointing sales of new vehicles in May were not what you wanted to hear. While most industry observers expected sales to be down, the extent of the decline in large models caught many by surprise.

Pointing to the 10.7% slide in total U.S. sales for the month, auto execs used words like “watershed year” and “profound shift” in buying patterns as consumers turned their backs on gas-guzzling trucks and SUVs in favor of smaller, more fuel-efficient cars. Declines of 30-40% in trucks and SUVs were the norm (see Automotive News; requires free registration).

It’s well-known Detroit relies heavily on high-margin, large-model car and truck sales for the bulk of its profit. But as sales of those vehicles plummeted while gas prices rose, so did the marketing dollars to support the brands (see here; requires free registration). Unfortunately, advertising spent to promote small and mid-sized cars hasn’t made up the difference. Compounding the problem is that more ad dollars were shifted to the Internet.

With automotive advertising comprising 20-25% of total sales for many local stations, TV operators felt the impact. Broadcast revenue at the nation’s largest publicly traded television chains eased 0.5% to $1.4 billion during the first quarter of 2008 (see “Television Industry – First Quarter Revenue Survey”).

Significant percentage increases in political advertising and higher income from retransmission agreements with cable and satellite providers, as well as continued growth in online advertising, helped offset declines in local and national ad spending, particularly among automotive marketers. Local advertising at the 16-group sample slipped 3%, while national advertising fell 6%, for a combined decline of 4%.

Like my previous article on the newspaper business, I have to add this quick caveat about the data: These aren’t “same-store sales” figures. They’re my estimates based on an analysis of the quarterly numbers reported by the 16 pure play TV operators and the TV divisions of larger media companies. That said, because of the mixture of network affiliation, diversity of markets served, and minimal M&A activity, I believe it paints a pretty accurate picture.

Certainly, the writer’s strike made a dent in Q1 ad revenue. But reading Seeking Alpha’s first quarter conference call transcripts, several broadcast execs specifically cited double-digit declines in automotive advertising as the key reason for the softness in revenue.

April results at Gannett (GCI) (-5.3% total; local -3.2% and national -13.%) and Media General (MEG) (-3.8% total; local -1.2% and national -15.9%) also showed automotive weakness. In MEG’s case, local automotive was actually up, but drops in auto and telecom billings contributed to the decline in national advertising for the month.

Fortunately, EBITDA margins held up pretty well during Q1, dropping only 100 basis points on average for the pure play TV operators, thanks in many respects to ancillary revenue streams like retransmission fees, which drop straight to the bottom line. In comparison, a brutal ad climate (especially in classifieds) resulted in an average 300 basis point decline in EBITDA margins for newspaper publishers.

Despite the difficulties in Detroit (pardon the alliteration), it’s not all gloomy on the ad front. Broadcasters definitely will benefit from the Summer Olympics. Also, TV execs expect more political advertising revenue to flow into the market. They believe a lot of money has been sitting on the sidelines during the marathon contest for the Democratic presidential nomination. With that decided, broadcasters anticipate both parties, as well as 527 organizations and PACs, will ramp up spending in the run-up to the November elections.

Nevertheless, the very real possibility of a prolonged automotive slump and its impact on broadcast cash flow and earnings can’t be ignored. Increased advertiser use of cable TV and the Internet is also a concern. Lastly, today’s tight credit markets could put a damper on M&A activity, which traditionally has helped put a floor on TV broadcast stocks (see here and here for an overview of valuation multiples:).

As a value-oriented investor, I wouldn’t add to or establish positions until Detroit gets back on the ad track, especially with TV pure plays trading at enterprise value/TTM EBITDA multiples of 9-11x. Even then, I’d wait patiently until multiples drifted lower.