• by Erik Sass , February 15, 2006

A glum fourth-quarter analysis from Merrill Lynch on the newspaper industry titled "2005: A Year to Forget" reported a 2 percent rise in ad revenue among the eleven major newspaper holding companies, but tempered this good news with the observation that the number missed Lynch's own projection of 4 percent.

The picture looks even worse from the investors' perspective. Merrill Lynch estimates that average earnings per share (EPS) fell 5-6 percent in 2005, with the trend apparently accelerating as the year ended, with a 7-8 percent drop in the fourth quarter. Merrill Lynch had predicted a 4 percent increase in EPS over 2005.

Moving forward, in the same report Merrill Lynch analysts issued a less optimistic EPS growth projection of 2 percent for 2006, which the report predicted is "likely to remain a challenge." What's more, the year will be characterized by continuing--and possibly worsening--volatility. The report forecasts that rearguard strategies such as cost containment are likely to play a central role in driving whatever EPS growth does occur.

Gloomy observations abound. For one thing, Merrill Lynch notes that an apparent bright spot in retail ad sales may be an artifact of post-Christmas sales advertising carrying over into the first quarter of 2006. Although not mentioned in the report, unseasonably warm weather, and resulting robust January and February retail sales, may also be giving newspaper retail ad revenue a bump. Zooming out to long-term trends, Merrill Lynch predicts that retail advertising is likely to continue shifting from newspapers to direct mail and TV.

Like radio, newspaper ad revenues are likely to continue suffering from the desertion of auto ad revenue to new platforms, including the Internet. Merrill Lynch admits that it underestimated the decline in auto ad revenues, which ended up falling by a remarkable 10 percent in 2005. And while newspapers continue to invest significantly in their online portals, thereby salvaging some of the lost revenue from auto ads and other categories, the disparity in cost to consumers between free online content and paid paper editions will likely mean further deterioration in the advertising salability of the paper editions.

It may come as a surprise that Merrill Lynch predicted--and the newspaper industry delivered--any rise in ad revenue at all, at a time when the business is threatened by the emergence of new ad platforms, including the Internet.

There were indeed a few bright spots for holding companies in 2005, including a healthy performance by E.W. Scripps and continuing strong ad demand from the real estate sector. But in the first case, Merrill Lynch attributes Scripps' performance more to good returns from that firm's non-newspaper holdings--including HGTV and the Food Network--and in the second case notes it's unwise to assume continued strong real estate ad sales amid growing speculation that the real estate market is experiencing a bubble.