• by Diane Mermigas , August 6, 2010

Valuing disrupted media is a sobering and challenging task that will continue complicating mergers and acquisitions for years, even in a recovering economy.

The incessant flow of new interactive devices and applications disrupting every facet of media remains at odds with the lingering albatross of costly legacy. That juxtaposition throws values and potential deal math into uncertainty, tipping the scales between obstacle and opportunity.

The latest stunning example is the sale of Newsweek to Dr. Sidney Harman for $1 and some liabilities in exchange for his pledge to The Washington Post sellers that he will not dismantle the magazine. How the new owner juggles continuing losses at Newsweek may give rise to a new definition of what constitutes "dismantling."

Like the sale of TV Guide to private equity for $1 in 2008, the transaction heightens concerns about the future implications of not being able to accurately value and trade media whose legacy operations and assets are severely challenged. Their intellectual capital has enduring merit; their debts are a concrete reminder of how much it costs to secure.

What will television stations be worth when video finds its way to every screen by way of the Internet or cloud computing? Even cable, satellite and telecom operators will be challenged --their bundled services and programming gradually stunted by anywhere, anytime on demand standard. What will newspapers and magazines be worth if their subscription and advertising revenues are too deeply undercut by the prevalence of free virtual content and marketing?

How do you assess the value of even the most sophisticated video games and films that become fodder for social network mash ups and manipulation?

No one knows. So much value creation amid steady value destruction makes for a more promising outlook than current earnings multiples and weak growth forecasts suggest. Qualifying it is the problem.

Valuations based on this year's earnings generally reflect "catch up" improvements from last year's recessionary abyss. Next year's projected earnings will look tepid by comparison. The digital reshaping of user payments and advertising into an interactive marketing will create more valuable revenue streams. But the transformation will take time. Until then, how will media values be determined and justified?

Return on invested capital is one way to measure disrupted media value in the near term. It provides a finite snapshot of the way companies build value during this tumultuous transition, regardless of where values have been or where they might be years from now.

For instance, Lewis Dvorkin's revamping Forbes in the mode of online entrepreneurial journalism is one approach to jump-starting the digital value of existing print resources.

Comcast-owned Daily Candy's launch of a location-triggered shopping alert app for mobile devices for stores where its registered users roam is another way to remake advertising into an interactive, personalized marketing tool.

Needham analyst Laura Martin endorses ROIC as the best way to measure the value that disrupted media could accrue by innovating with cash and existing resources. Historically, there has been an 85% to 90% statistical correlation between ROIC and valuation in the media space, she said. "As applications evolve that use (the Internet's) unique strengths, a broad swath of traditional businesses will become extinct," Martin observes in a new report.

The key to building value is using interactivity to create complementary or additive -- not substitute -- offerings that extend or reinvent traditional advertising, content and communications.  ROIC is a way to track a company's response to the challenges created by the Internet as it evolves into what Martin calls "a general purpose technology" or commodity like electricity.

Even the tactical choices media companies make today, based on the mistakes of newspapers and music, could prove insufficient as the disruption continues down different paths and in different places. 

New companies and services spawned by the Internet are not disadvantaged by established media's outmoded, expensive legacy structure and operations. They don't have displacement cost and income. For instance, Hulu generally offers users free programming that otherwise costs an average $70 per month to bundle on cable and costs the TV networks millions to produce.  Content produced specifically for Web consumption, in five-minute episodes for 12 consecutive weeks, may cost only about $100,000 and require much less viewers or paid advertising to monetize, Martin points out. Such developing emergent economics are at the heart of shifting media values.

The values assigned to new media companies are beset by their own issues. At the recent Techonomy Conference, Google CEO Eric Schmidt conceded the Internet search giant is gobbling up startups more for the intellectual talent than assets. Google announced it will pay $182 million for the social gamer Slide.

With so much cash on corporate balance sheets (Google has more than $30 billion in cash), there is no cost of capital to put money to work. The only risk: understanding how to create value from interactivity, which changes everything. To that end, Martin estimates that of the major media companies she tracks, Viacom will make the biggest strides in ROIC, which will increase 3% to 15.2% in 2011 over this year. At the opposite end of the scale, Time Warner will improve ROIC less than 1% to 7.6% in 2011 over 2010.

The bottom line is whether companies everywhere on media's sprawling spectrum can create lasting value faster than it is lost in the changing digital tides.