Even as online display and search will suffer some economic blows, the Internet continues to attract traditional media ad dollars, which are being diffused to offline channels, nontraditional marketing outlets, event sponsorship and direct marketing. The Internet not only gains share, but dampens the rate of expansion of the advertising pie.
"Ironically, this is increasing both the duration and projected recovery of the present advertising down cycle," according to Lee Westerfield, analyst at BMO Capital Markets. "We are now in the middle of an unprecedented advertising downturn in terms of severity and duration."
The downward adjustments for Internet advertising growth have been almost as stunning as the utter collapse of broadcasting and print this calendar year. BMO is the latest prediction in what has been a steady stream of dismal forecast revisions in recent months. BMO now calls for overall U.S. ad spend of negative 1.1% in 2008 and negative 1.9% in 2009--with no recovery likely sooner than 2010, when 5% growth could be supported by political ads and returning demand from automobiles and housing.
Online display advertising has deteriorated most drastically and must prove itself in terms of the CPM and CPA efficiency, Westerfield says in a new report.
Display advertising is now expected to dip into negative growth territory (down -2%) in 2009, before resuming double-digit growth to 11% in 2010. Search advertising will barely slip in 2009 to 21% growth before resuming this year's 22% growth again in 2010. Overall, Internet advertising will hang on to this year's 13% growth in 2009 before accelerating to 21% growth in 2010, according to BMO's revised forecasts. Overall and display advertising growth forecasts were much higher heading into 2008.
However, a bevy of secondary economic cyclical and systematic factors will reconfigure their earnings multiples, ROI and valuations over the next two years. That means the more severe the downturn, the more Google's search advertising will outperform the display advertising characterized by Yahoo, AOL and Microsoft. A new era of government regulations will invite such territorial sovereignty issues as trade regulation, tax jurisdictions, privacy protections and telecomm policy. As ad Internet valuations fall, so do the funding liquidity, confidence and exit hopes of the venture capital groups. For now, bye-bye money supply and capital risk premiums.
Internet media valuations have dropped from 20 times to 12 times earnings since December 2007. While they may recover half of that lost value by 2011 or 2012, Google and Yahoo--which Westerfield refers to as "the proxy for the Internet media sector"--will never return to their previous hyper-growth levels. The two companies captured an estimated 65% of U.S. and worldwide Internet ad spend and represent an estimated 70% of Internet media equity capital. Even with healthy, unlevered balance sheets, the Internet giants will be financially pinched.
Google could grow adjusted earnings 12.2% over 2008 to 2013 if it can sustain 11% to 13% global ad growth mainly from search. Yahoo could average 6.2% adjusted earnings growth over the same five-year period--if it can sustain 4% to 6% global ad growth.
Even these more sobering Internet advertising growth rates and valuations are a far cry from the severe deterioration that broadcast media will endure over the next 24 months. BMO predicts "even more advertising contraction" in the first half of 2009. Since national spot advertising is the most highly levered to a domestic recession, BMO now forecasts that overall national advertising will decline -14% both in 2008 and 2009. Although local can be more resilient, overall local advertising is expected to decline -8% this year and decline -6% in 2009.
More specifically, TV stations will suffer the most with a decline of 4.3% in advertising in this presidential election year and a decline of 15.6% in 2009, followed by a 12% increase in 2010. The broadcast TV networks will see ad spend up only 2.5% this year, but declining 8.7% in 2009, before rising only 4% in 2010. Still, there is no evidence--yet--of a rise in upfront cancellations in the current season for the fourth quarter or the first quarter of 2009, or a drastic pullback in scatter.
Westerfield bluntly observes: TV balance sheets are "being dismembered by a severe recession" accompanied by a precipitous loss of revenues and negative operating leverage. While radio is likely to remain ubiquitously distributed and profitable through this economic squeeze, TV stations will continue to experience "disintermediation" as network programming channels continue to shift to Web video markets. If television assets want to emerge from the recession with seven-times to nine-times earnings multiples intact, they will be forced to deleverage and consolidate. That process could be hastened over the next two years by the debt covenant requirements dogging many broadcasters, whose revenues are plummeting and whose debt-to-earnings ratios are double or triple what they should be.
For some companies, protracted advertising weakness is making an already bad situation worse. Unmanageable leverage risks can only be abated by improving earnings (almost impossible in this environment), selling assets (also difficult in light of tight credit and over-leverage) or amending current lending agreements. Westerfield identifies the broadcasters with "the highest risk of covenant breach": Beasley Broadcast Group, Cumulus Media, Emmis Communications, Entercom Communications, Regent Communications and Salem Communications.
The key takeaway from the BMO report: This is no routine recession, and it has no historical precedent. The permanent potency of online advertising, the diffusion of marketplace dollars and the paralyzing credit crunch alters the media landscape.