Watching the ebb-tide

Media companies’ prospects for 2007 largely depend on the extent to which the drop in ad revenues is cyclical rather than structural. By David Forster.

In 2006, fully listed UK media companies rose 1.3% on average, with the best performing sub-sector being professional information, followed by marketing services. This was spookily similar to the outcome for 2005, when fully listed media companies rose 1.5% on average, with professional information and marketing services again the best-performing sub-sectors.

Of course, some would claim that this was entirely predictable and no doubt regular readers will recall the conclusion of this column of a year ago/ “Provided the economic outlook remains stable, the sector should be capable of further modest progress this year. Acquisition activity will remain high. Professional publishers will continue to prosper.”

Although many professional publishers did perform well in their own right – Datamonitor rose 92% in 2006 after 120% in 2005 – the sub-sector’s relative strength reflected the continued dire performance of many consumer media companies, with radio and outdoor companies down 26% on average, after falling 19% in 2005.

At Home in the New Age
A key determinant of the performance of the consumer-facing areas of media in 2007 will be the extent to which those companies with business models under structural pressure can prove, or convince investors, that they have successfully adapted to the new digital paradigm. Of course, investors will also focus on the broader economic outlook, given the cyclical nature of many consumer media companies’ revenues.

In recent weeks there has been evidence of an intriguing debate – namely, the extent to which the sustained downturn in some areas of television, press and radio advertising is cyclical rather than structural. What is most intriguing about it is that it appears to presuppose there is a downward cycle taking place, whereas as we know that the UK is undergoing a period of economic growth that is so prolonged the Chancellor has earned the prefix “lucky”. Although there have been times when a downturn in advertising has prefaced an economic downturn, this has typically been by a quarter or two, not the two years that some areas of media are experiencing.

Of course if you do “buy” the cyclical downturn thesis, it enables you to look for signs of a cyclical upturn – the green shoots of recovery.

In order to clarify my thoughts on the matter I visited an old friend of mine who made his fortune in the canal industry. Having walked me round his lock full of gleaming barges and field of eager-looking shire horses (my friend assured me that an upturn in canal traffic was just around the corner) I asked him about the trackrecord of canal owners transitioning to other forms of distribution.

He confessed that in the UK success had been limited. We studied the history of the Grand Union Canal and noted that in 1859 John Fowler and William Radford had prepared a plan for a railway to run beside the canal from Kings Cross to the Regent’s Canal Dock. However, the proposal did not get past the draft bill stage. Somewhat worryingly, the next notable event in the canal’s history was almost a century later, with the publication in 1955 of Canal Cats by Cicely Fraser-Simpson – “a small book, set on the Regents Canal, that will appeal to children and cat lovers”.

We speculated that the existence of France’s Canal Plus meant that at least some had managed to migrate their business model to the new digital age, but were disappointed to discover that the name was simply a translation of “more channels”.

One of the problems of structural change is that there is no precedent and therefore calling the bottom of a revenue decline can be akin to catching a falling knife, as investors in EMI have already discovered this year. Whereas in music, large elements of industry revenue have simply disappeared, in some other areas of media, such as classified advertising, there is a continuing migration from offline to online taking place.

Shifting Sands
In these instances we can be more methodical in terms of analysis as it is possible to monitor the extent to which falls in one area are being offset by increases in the other, and to predict at what point there will be an inflexion with net revenue growth returning. However, this does not necessarily mean that the historic dominant players’ fortunes will be restored, given that there are numerous examples (Monster.com and Rightmove for example) where huge market share shifts occur during the process of migration.

In conclusion, those companies relying on a cyclical upturn to bail them out are likely to prove disappointed. There is little reason to argue that the structural pressures on TV, newspapers and music will abate, although ITV’s woes are undoubtedly being exacerbated by CRR (contract rights renewal), which is becoming an increasingly blatant anachronism. Although there have been signs of private equity circling assets in each of these spaces, it is notable that the Daily Mail & General Trust’s proposed sale of Northcliffe was pulled due to the reserve price not being met, and that Apax failed with its offer for ITV as did Permira with its potential offer for EMI.

This suggests that, even if private equity interest persists, there is little evidence of an appetite to pay significant premiums to current valuations. This caution with regard to consumer media suggests that professional media will continue to fare relatively well. Marketing services companies should also make further progress, with investors in the global ad agencies looking forward to the US quadrennial in 2008 of a US presidential election and Olympic Games.

• David Forster, director of IBIS Capital. david.forster@ibiscapital.co.uk

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.

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