2009 Forecast For Large-Caps: Expect Rev Declines

The stark prospect of having to wait until 2010 for an ad recovery, and the implosion of some ad-based media and entertainment companies in the meantime, is the basis for sweeping sector alarms this week by two seasoned industry analysts.

BMO Capital Markets analyst Lee Westerfield slashed his forecasts for U.S. ad growth this year and next (to just under 2%). "Nearly all indicators we track show the media ad-spend climate deteriorating. given pricing decay in spot TV and radio and premium Internet display markets in recent weeks, and given that the key ad categories of auto, retail and financials are each down," said Westerfield, who previously forecast a recovery for later in 2009.

As this column has pointed out, the apparent stability of the recent broadcast network upfront is only as good as advertisers electing to exercise their cancellation options. Broadcast network ad revenues now are forecast to grow only 4% this year and to be flat, at best, in 2009; broadcast TV station ad revenues will grow 4% this year and decline 9% in 2009. Westerfield is one of many experts lowering ad growth expectations. Even ad guru Robert Coen of Universal McCann is expected to lower his 3.7% growth ad projections for 2008 today.



This ultimately bodes poorly for TV station and ad-supported media-company valuations, which are tied to trading multiples that tend to move in lockstep with two-year rolling average of future ad growth, Westerfield said. The 9-to-9.5-times trading multiples for television pure plays are at risk as Internet video markets develop as an alternative pathway for video content branded network program delivery.

Although he continues to see the media sector as generally under-performing the market, Westfield expects some broadcasters, such as CBS, to offset ad weakness with higher cable retransmission fees.

Lehman Brothers analyst Antony DiClemente virtually picks up where Westerfield leaves off in making his second major downgrade of the entire large-cap entertainment sector this year in response to plummeting ad prospects and "digital disruption." DiClemente has downgraded CBS, Disney, News Corp. and Time Warner (while maintaining Viacom). saying the national and local advertising downturn exacerbates the secular decline of the $24 billion annual domestic retail home video market and delivers a major blow to creators of film and TV content.

DiClemente's broader thesis -- consistently espoused by this column -- is that all "packaged media" is a declining business that will not be able to develop and quantify new digital revenue streams fast enough to offset deteriorating historical revenues -- even as companies scramble to acquire assets to grow profits.

Combined content and advertising revenues comprise about two-thirds of total revenues for large-cap entertainment companies, which are being challenged by both cyclical and secular issues. Digital disruption could cause deterioration in the marginal economics of creating and producing content at large-cap entertainment companies, which own four of the six largest film and TV studios, three of the top five broadcast networks, and two of the top five local television station groups. Even their cable networks could come under fire as viewing accelerates on multiple digital outlets.

The accelerated shift from physical to digital media also means a move from a simple, easier to predict contributions model to a more uncertain and complex contribution model with margin more dependent on the mix of digital products. That ultimately can erode the marginal economics of content ownership, DiClemente said. The notion that content creators and distributors could come up on the losing end of the digital revolution flies in the face of conventional wisdom, which holds that the more platforms you can play to, the more money you make. But that may not be true for the foreseeable future.

Legal digital media sales platforms, such as Apple's iTunes, tend to cannibalize profits from physical sales of packages movie media, similar to trends seen in recorded music labels and CDs. New digital options could discourage variable pricing of content, could erode profit per movie (as shifting from DVDs to legal to-own downloads), and generally provide more illegal, pirated film and TV versions. "The current lopsided ownership/rental split will shift more toward the lower-priced rental options when consumer behavior shifts to digital," DiClemente said.

The businesses whose revenues will be most at risk are feature film production, off-network television syndication, TV-on-DVD physical sales, the broadcast television networks and local broadcast television stations, he said. However, no media or entertainment company will go unscathed from the parallel forces of digital disruption and the adverse impact of a weak economy on advertising.

With advertising contributions varying widely -- as much as 73% of total revenues at CBS and as little as 19% of total revenues at Disney and Time Warner -- reliance on digital distribution can be uncertain at best. Time Warner leads the pack; it generates more than 14% of its revenues and 22% of its earnings from the Internet. But the company relies on its cable networks for 35% of its revenues and more than 50% of earnings. The other large-cap entertainment companies remain heavily dependent on core businesses (such as cable and broadcast networks, filmed entertainment and TV stations, publishing and theme parks, and outdoor) for the lion's share of revenue and earnings.

Even if you're one of the big guys, there is nowhere to run.

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