Commentary

Media and Advertisers In Damage Control

How companies respond to unrelievedly bad economics over the next year will separate the winners from the losers. The first indications will come in troubled third-quarter earnings calls amid lower forecasts on a dramatic pullback by advertisers and consumers, and sobering admissions that it's all going to get worse before it gets better.

Clearly, the purge extends to the Internet and Silicon Valley, where companies from Google and Apple to the smallest start-up are getting their first bitter taste of mainstream angst. Some of last year's double-digit online advertising growth that was halved in the second quarter is beginning to flat-line. Not even big media can find shelter in the folds of escapist entertainment for the dreary masses, with one-third of their revenues tied to softening advertising dollars. Deutsche Bank analyst Doug Mitchelson Thursday lowered operating cash-flow estimates for the entertainment sector, which will barely budge from $34.8 billion in 2008 to $35.3 billion in 2009.

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Merrill Lynch analyst Jessica Reif Cohen downgraded Walt Disney--the most robust of the entertainment conglomerates--anticipating that its operating income will flatten in fiscal 2009 in the midst of rising unemployment and consumer spending retreat. About 60% of Disney's revenues are vulnerable in the economic downturn, as they are tied to advertising and consumer products.

In a similarly dire note on News Corp., whose fiscal 2009 operating profit growth estimates have been slashed from 6% to 2%, Cohen underscored a critical issue for all media companies. The credit crunch makes it "increasingly difficult to value stocks in the sector and it is unclear what the catalysts will close the gap between market value and our estimated fair value."

The implications of such a schism are enormous, considering that all companies borrow, buy and sell based on their value--all definitions that have never been more uncertain. It's the difference between doing deals, funding innovation, taking risks and making growth investments--or not--for at least the next 18 months. Standard & Poors' downgrades to negative credit watch on General Motors and Alcoa late Thursday, prompted by weaker earnings and liquidity, are a harbinger of what is to come for other companies that fuel the flow of revenues both as advertisers and as the source of consumer goods and services. The further collapse of automotive and financials--two of the largest advertising categories--has a particularly adverse impact on all local media.

Earlier this week, Goldman Sachs analyst Mark Wienkes cut 2009 and 2010 earnings-per-share estimates to 10% below consensus across all entertainment players on the theory that no sector is too big to go unscathed, as local and national advertising plunge into a worst-case "2001-like downturn" that was the steepest on record. Using that as a guide, Wienkes estimates 2009 advertising revenue declines of -17% for television stations, -10% for broadcast networks and for magazines, -8% for newspapers and for radio, and -5% for outdoor. Surprisingly, cable network ad revenues collectively will decline 1% in 2009, online advertising growth will be whittled down to single digits in 2009, or a gain of 9%. In addition, Wienkes warns that there is "a one-quarter lag between slowdowns in earnings growth and a corresponding slowdown in advertising growth."

So, even media and Internet-related companies with healthy cash flow and cash reserves face the necessity of rewriting their forecasts and game plans with revenues decelerating on the one hand and stock values crashing on the other. Both the Dow Jones and NASDAQ markets are down about 40% from their year-ago highs; the Dow has lost 21% of its value in just the last 10 trading days of the credit crisis.

The other shoe to drop for these companies is a massive spending retreat by advertisers and consumers that will not become fully evident until the fourth quarter and early 2009.

Economists and analysts are hinting about how bad it can be, and the extent to which corporate revenues and earnings will deteriorate. After all, this is a recession compounded by a global crisis of credit, currency and confidence for which there is no precedent.

Goldman Sachs says large-cap entertainment will ride out the storm anchored in national broadcast and cable TV--their single largest revenue source, which is primarily sourced from 10 broad categories, in which the top 10 advertisers represent nearly three-quarters of the total ad dollars spent. Even in the worst of times, most of that spending will stick.

Even the massive consolidation of financial services has a silver lining, Wienkes contends. Based on what occurred with the regional rollup of Telco providers and big-name Telco mergers, overall spending on national advertising should increase among financial services companies. The beneficiaries will be the Internet as well as broadcast and cable companies, while the losers could be local TV, radio and newspapers already hurting financially with nowhere to run for cover.

Media conglomerates are expected to err on the side of caution by accumulating cash to protect their significant free cash flow and low leverage rather than continuing with their aggressive share buybacks or asset acquisitions, Wienkes said. The big players can easily service debt during the squeeze; even CBS has more than $1 billion in cash, a low 2-times net leverage and significant free cash flow.

Bernstein Research analyst Michael Nathanson Thursday reduced earnings-per-share estimates for media conglomerates except for Disney based on the deterioration of the economy and ad markets through 2009. However, there remains a balance between continuing steep declines in television advertising, the deceleration of online ads, the general flattening of studio entertainment, the tanking of publishing, and the vacillation of other businesses that provides enough moving parts to keep them afloat. The bigger issue in the long run is how ad-deficient, debt-burdened, locally anchored middle- to-small-sized media companies will fare and respond to a virtually no-win situation.

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