Innovation in information technology has been a catalyst for creative destruction in media and advertising. Expect this trend to continue as new communications media displace old ones and new entrants shake up established markets. This is an environment which is good for entrepreneurs and bad for current market leaders and their investors. Investors should look to companies that are growing in this challenging environment for potential bargains.
Weak Ad Sales
There are many signs of weak ad revenue inside of multiline companies. Microsoft (MSFT) suffered a major write-down of $6.2 billion dollars after their online ad service company, aQuantative, hasn't performed to the level creators anticipated. Television and cable companies like Discovery Communications (DISCA), Time Warner (TWX), and Walt Disney (DIS) all reported slight increases in advertising revenue after the companies raised the cost of advertising on their channels. This was not due to higher sales volumes, but the price increases. Since CBS did not raise prices it actually suffered a drop in revenue. It should also be noted that Time Warner reported declining revenue from outside the United States.
The secular decline in print media is nothing new. The advertising revenue for the New York Times (NYT) dropped 7%, which is not surprising since newspaper advertising in general has been on the decline for some time. The New York Times did, however, manage to compensate for the loss with other sources of revenue and showed an overall increase of 3%. The advertising and marketing holding company, Interpublic Group (IPG), saw a 3% drop after losing big business U.S. accounts like SC Johnson & Son.
Though there seems to be an overall slowdown in advertising, there were several gainers. AOL, after many years of struggling to turn the business around, reported a 6% increase in advertising revenue. This is the fifth quarter in a row that its advertising revenue has risen. The web media company IAC/InterActive's (IACI) is another gainer. Its search segment made an astonishing leap of 46% since this time last year. There are even winners among print media. The producer of Better Homes and Gardens and Fitness magazines, Meredith Corporation (MDP), reported an 11% gain in advertising.
Value Bottom Fishing
A bad industry outlook does not mean that there are not some bright spots. Investors should search for bargains among the firms that have done well despite the turmoil.
At a price near $35 per share, AOL is the best investment among the companies enjoying sales growth. This mid-cap stock is still cheap even after a 133.3% jump in price over the past year. AOL shares are trading at a bargain 3.33 price-to-earnings ratio, less than half the 14.1 average price-to-earnings ratio of the S&P 500 index. The price-to-book multiple of this stock is 1.05, cheaper than the 2.05 S&P 500 average. Investors should consider this number somewhat inflated because the price-to-book ratio fails to account for internally-developed intellectual property including patents, brands, and trademarks. If the economic value of these assets were even partially recorded on the balance sheet the firm's price-to-book ratio would be lower. The firm's 1.53 price-to-sales ratio is in line with today's prevailing market multiples and does not distract from its other, attractive valuations. Analysts expect that the firm's earnings growth will accelerate with annualized earnings growth estimates at 19.8% over the next five-years.
In contrast, shares of IAC/InterActiveCorp are not trading low enough at $52 to compensate investors for the risks. IACI shares are trading at a pricey 25.2 price-to-earnings ratio, a value that is significantly greater than the 14.1 average of the S&P 500. This is not a compelling value.
Similarly, Meredith Corporation is not a compelling buy. Its stock is trading around $35.00 per share, which translates into valuations that resemble those of the broader market. The firm has a 1.13 price-to-sales ratio, a 15.15 price-to-earnings ratio, and a 1.95 price-to-book ratio. Investors should pass on this media company at these mediocre valuations. Essentially, these price multiples offer no reason to invest in a tough industry.
AOL offers investors compelling valuations and is one of few media companies seeing revenue growth. Investors should consider AOL as a small investment in a diversified portfolio mostly based on its cheap valuation. Unfortunately, IACI and MDP shares are not priced to reflect declining revenues in the industry.
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