Diversity demands focus

Many media stocks followed the market and performed poorly, but the underlying sector issue remains structural change, argues David Forster

There are those who believe that the performance of the stock market is driven by the hard-nosed rational decisions of financial experts. Others think that markets are driven by little more that a mixture of primordial fear and greed, and even superstition.

The latter group argue that stocks go up at the start of the year – which typically they do – because the mentality of investors at the beginning of a new year is to focus on what new stocks to buy and hold in the months ahead. However, as summer approaches and thoughts turn to holidays – and this year the football World Cup – the temptation will be to lock away profits, which typically leads to a bout of selling during May.

So ingrained has this pattern become that it has led to the clichéd adage “Sell in May and go away”.

Of course, all this fear, greed and superstition stuff is utter hokum â¦. except that, yet again, May has turned out to be a dire month for stock market performance. FTSE media companies fell by 4.4% on average in May, taking the Index into the red for the year to date. AIM-listed media companies, which are typically smaller, slid a precipitous 9.1% on average.

Range of concerns

May’s weakness in the media sectors was shared by the wider market, which fell over 9% from April’s five-year high.

The rational explanation is a combination of concerns/ notably the outlook for economic growth in the US and other economies including the UK, a rampant oil price, political uncertainty including Iraq’s ongoing instability, and growing awareness of the potential economic costs of global warming.

It is not surprising that free-to-air television was May’s worst performing sub-sector, given the association between advertising and economic growth. However this poor performance was entirely down to ITV, which fell 7.8%, while SMG proved to be the month’s best performing fully listed media company, up 8.2%.

The principal factor behind the discrepancy in performance was ITV’s continued heavy reliance on TV advertising while SMG was able to produce a reasonably upbeat AGM statement focusing on its revenue diversity and good progress in areas such as outdoor, radio and cinema advertising.

Pay-TV was May’s best performing sub-sector, driven by a robust performance by BSkyB, up 1.1%. Although BSkyB has some exposure to advertising (below 10%), its focus on subscription revenue means that it is seen as relatively immune to the vagaries of the economic cycle when compared to those companies that are heavily advertising reliant.

GCap’s announcement of its final results confirmed a widely flagged slump in profits. However, the fact that its 4.6% share price fall over the month was broadly in line with the sector average suggests that the market may be starting to fully discount any remaining strategic and operational issues and a still uncertain advertising outlook.

GCap’s shares are now down over 70% from their five-year high – taking into account the effect of the GWR/Capital merger – and while phrases such as “never catch a falling knife” spring to mind, genuine fundamental and strategic value is starting to emerge – unless one is a structural radio industry bear.

The quoted UK media sector has been a tough place to make money as an investor in recent years, except for hedge funds that can benefit from both rising and falling prices. But it continues to be an investment banker’s dream, with no sign of a let-up in the pace of corporate activity.

High corporate activity

May’s highlights included EMI’s approach to Warner Music, further stake building by Vincent Bolloré in Aegis Group, anticipation of a positive outcome to EMAP’s sale of its French operations and three acquisitions by Pearson, as well as a raft of smaller deals across the sector.

While the detailed rationale underpinning each deal may be unique, the overriding theme in media remains structural change. In the words of GCap Media’s chief executive, Ralph Bernard/ “Media markets are changing fast”.

Daily Mail & General Trust’s recent commentary on the performance of its Teletext subsidiary is symptomatic: “Advertising revenue from Teletext’s analogue services fell by 23% year on year, but revenues from its digital services rose by 50%.” The problem is that the 23% decline is from an (unspecified) big number and the 50% growth from a small number.

Share price nirvana is crossover time: when the decline in industry analogue revenue is outweighed by growth in digital revenue. In fact, because the stock market always looks to discount (anticipate) newsflow, the key to a sustained recovery in the sector’s fortunes is likely to coincide with the time when investors can see the light at the end of the tunnel and an end to the process of digital migration.

Where we are in that process varies enormously on a sub-sector by sub-sector basis. Television is moving toward a pre-determined analogue switch-off date.

With regard to radio GCap noted that: “There have now been 3 million DAB digital radio sets sold in the UK. It took five years to sell the first million sets, 11 months to sell the next million and just five months to sell the third million. By 2009, more than 40% of homes in the UK are expected to own a digital radio.”

In the world of global professional information approximately 40% of Reed Elsevier’s &£5bn revenue is already derived from online services which have superior growth and cost characteristics than its remaining print-based and offline products.

At the very least, this diversity highlights the dynamic nature of the media industry and the requirement for focus and specialisation; a point which applies not just to industry operators but those seeking to invest in the sector.

The IBIS Capital Media Indices

IBIS Capital is a corporate finance advisory and investment business focused on the media sector.

The IBIS Capital Media Indices are a set of proprietary analytical tools developed to monitor the UK media industry from the perspective of the share price performance of publicly listed companies.

The indices group companies with similar business models into sub-indices.

The indices also include a split between media companies fully listed on the London Stock Exchange and those listed on the Alternative Investment Market (AIM).

Methodology

The indices monitor all UK media companies listed on the London Stock Exchange and on the AIM with a market capitalisation over &£10m. Some companies included are listed overseas or have split listings.

Indices are based on the market capitalisation of each constituent company but, in common with other recognised stock market indices, they make a number of adjustments.