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2009 FORECASTS
After the latest round of cuts in early/mid January, our entertainment company forecasts
show C4Q08E revenue down 2% PF and EBITDA down 18%, bringing CY08E to 4% revenue
growth and a 4% EBITDA decline. Despite national TV and film media not stumbling until the
fall, 4Q08 was awful enough that every media ended up showing an EBITDA decline in CY08
except Cable Networks (+5%). The full breakdown is included in the tables.
We estimate CY09E will be significantly worse for our entertainment coverage than CY08,
with revenue -2% and EBITDA -8% (ex-Time Warner Cable given spin). The damage is
predominately at pure ad-supported media (local media and broadcast TV). Our 2009 EPS
estimates are about 8% below consensus, on average, and thus we expect continued cuts
by the Street through 1Q09 reporting. At this point, we expect 2009 EBITDA growth only
from Discovery (pure-play cable nets, gaining share, cutting costs) and Time Warner (easy
restructuring comps, Turner/HBO doing well).
We are including our updated U.S. advertising forecast, which is being revised significantly
downward from our last revision early last fall. We now estimate that 2008 advertising
revenue dropped 5% from 2007 (prior -2%) and 2009 will see a record 10% advertising
decline (prior -3%). Both our company and sector forecasts anticipate that Y/Y declines will
improve each quarter during the year, though we do not expect an outright return to ad
growth in any quarter until 2010.
OUTLOOK
Without question the dominant issue for the entertainment sector in 2009 is the economy.
Typical discussions around the evolution of digital distribution and competition, share shifts,
deals and regulations pale in comparison to the impact this recession is having on our
forecasts. We have included in this report a number of tables that attempted to demonstrate
how media stocks behaved during prior recessions in the hopes this would help investors
time an appropriate re-entry in media stocks in 2009. For example, despite the perception by
many that media stocks lag market recoveries, our work shows that media stocks tend to
recover coincident with the S&P500, which tends to be about the mid-point of recessions,
and this recovery is usually before the economy or media businesses improve. This would
argue that at some point we have to ignore the poor economic and media trend data and
focus on buying these stocks on valuation or asset value.
However, the current level of advertising deterioration is unprecedented (both with regards to
2009, and also three consecutive years of declines from 2007-2009), visibility is remarkably
poor, and with advertising declines having broken through all prior historical recession
correlations it is difficult to have any confidence in our latest forecasts. While we integrated
the poor 1Q09 trends into our entertainment models during our last revision round in early-tomid
January, our bias remains towards further estimate cuts across our entire coverage
universe. For example, how much will film profitability deteriorate if foreign media
companies cut back on, or can not afford to pay for the films and TV shows they already
licensed from Hollywood, hurting film profits? Then, with marketing being the only major
cost line at studios that can be quickly adjusted, will film companies dramatically cut back on
advertising in 2009 to make up some of the shortfall, hurting network profits? And so on.
Thus, despite what appear to be attractive valuations at this time (15+ year lows, discounts
to S&P multiple, well below our DCFs, high FCF yields), lack of confidence in the earnings
estimates underlying these valuations holds back any change in our sector view.
Also worth noting, the recovery path in 2010 is difficult to gauge (obviously) at this point, and
it seems likely to us that at best media businesses can hope for mild growth off what will
seem like a highly depressed 2009 base. This is in contrast to prior recoveries which were
typically more robust. We are concerned about: (1) given media is discretionary, will
consumer spending on media ever recover to 2007’s cheap credit-fueled level, especially if
consumers retrench to reduce debt loads the next few years; and (2) will bankruptcies,
consolidation and rationalization among key consumer businesses drive ad spending as a %
of revenue (or GDP) well below recent levels. With this in mind, consensus expectations for
16% EPS growth for entertainment companies in 2010 seems optimistic. One school of
thought is that entertainment stocks will not recover until 2010 expectations are reasonable.
WHAT’S NEXT
4Q08 earnings season begins next week, and as noted above we expect (1) poor outlooks
given lack of visibility and awful 1Q09 ad pacings; and (2) some companies pulling their
practice of giving guidance. The dominant discussion will be costs and margins – the one
thing that has visibility and is well under management control. While headcount reduction
announcements have been multiplying, given the dramatic deterioration in most media we
wonder if 3-10% reductions will ultimately be well short of the change necessary. Balance
sheets and capital deployment will be the other obvious discussion point. We continue to
see little if any balance sheet issues among the large-cap entertainment companies, but any
change in share repurchase and dividend policies could spark volatility.
Disney is unlikely to resume share repurchases, but given it has the best balance sheet by far
any shift could be a leading indicator for the sector. Time Warner will likely maintain
maximum flexibility in determining what to do with its cash horde ($10b) post-TWC split, and
so we expect little news. CBS is likely to cut its dividend at least in half, if only because it is
pointless and perhaps even inappropriate (in this uncertain environment) to pay out an 18%
dividend yield. This might actually be received positively by investors as it moderates
balance sheet risk. To the extent the dividend is not cut, it will lead to concern that Mr.
Redstone, Chairman, is maintaining the dividend to support his highly leveraged holding
company (National Amusements); this is not an environment where investors will suffer poor
corporate governance. Some have noted to us that there might be further major write-downs
of goodwill at media companies, but we tend to find these adjustments have no impact on
our forecasts and are backward looking reflections of stock performance.
Companies should provide some semblance of an update on 1Q09 ad pacings, the important
2Q09 network options take-rate, and trends for DVDs/film. Pacings are always as much art
as science, with managements having to balance Y/Y pricing and sellout changes to gauge
where revenue might end up for the full quarter. With inventory wide open on most media,
advertisers are waiting to the very last minute before booking their ad buys, and this distorts
Y/Y comparisons. Nevertheless, ad pacings are so bad, 1Q09 without question will be the
worst quarter we have ever seen. TV stations are pacing down 20-50%, radio stations down
25%, outdoor down 20+%, and print down 15+%. 1Q09 seasonality is not helping; January
and February are the smallest local ad months of the year and downturns can be magnified
during this stretch when few products are being launched. Still, we are not yet seeing any
pick-up in the week-to-week pacing trends, and March seems to be trending as bad as
January/February, giving little support for an optimistic view that seasonality is contributing to
the awful local ad pacings. Overhanging TV stations as well is the difficult 2H09 political ad
comps, which contributed an estimate 15-20% in 2H08 TV station revenue.
1Q09 national network ad revenue is holding up well at 4Q levels (-5%), a surprise given the
deterioration in local advertising and continued poor economic data. We believe this is partly
due to the upfront network commitments made by Detroit (autos), partly timing issues with
how inventory was sold last season (4Q make-goods delivered in 1Q08 last season vs.
delivered in 4Q08 this season), and partly a reflection that advertisers are relying on TV as the
core, most effective way to deliver their marketing messages. Nevertheless, national should
resume deterioration in 2Q as more advertisers recalibrate their 2009 ad budgets given a
disappointing start to the year for many companies. Thus, we would expect a rise in 2Q09
upfront options vs. the only slightly above normal level for 1Q09. Options are due February
1st, but some networks are giving advertisers until February 15th (everything is negotiable in
a recession).
CONCLUSION
While we believe entertainment stocks are generally inexpensive, we are equally concerned
about lack of earnings visibility, still deteriorating ad pacings and the likely numerous
aftershocks to our forecasts even when the economy eventually begins to recover. For longterm
investors, we suggest focusing on high barriers to entry, strong brands, international
growth prospects, strong consumer brands, healthy corporate governance, sterling balance
sheets, and favorable management execution track record, including the ability to manage
costs during this downturn. Catalysts and lower cyclical sensitivity does not hurt either. In
particular, cable networks has been holding up best in this downturn, and while that in and of
itself implies stock risk as results likely drop off a bit through the year, we prefer higher
exposure to this media over any other. All of this has led us to having just three Buy ratings
in the group, Discovery (pure-play cable nets, gaining share, and excellent cost management),
Disney (very high barriers to entry, best balance sheet, excellent mgmt track record, highest
degree of confidence in asset value) and Time Warner (cash horde, 50% cable nets post-spin,
restructuring comparisons help 2009 growth).
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