Why I Bought News Corporation

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Back in July, I wrote a review of News Corporation for RealMoney.com outlining the bull case. The analysis remains relevant today so in light of the purchase of News Corporation shares for Northlake clients earlier this week, I am reproducing the article so you can learn more about this new holding….
I like News Corporation because it offers the fastest earnings growth among the mega cap media stocks but trades at the same P-E multiple as its peers on 2008 earnings. Furthermore, the company is active in M&A with a decent chance for a major transaction that would unlock value in MySpace. Since the Dow Jones (DJ) deal was announced, the shares have sat out the rally giving back gains made earlier this year. I think the weakness in the shares, down 10% since late May, has set up a great buying opportunity.
Some investors are concerned about the high price being paid for DJ and the strategic implications of the deal. However, I think they are overlooking NWS’s recent announcements of asset sales (TV stations and Eastern European billboards) that will sell at similar premiums to DJ and finance half of the DJ deal. Additionally, the DJ deal represents just 10% of NWS market cap so I don’t view it as unusually risky even if it fails to offer the synergies that Rupert Murdoch must be expecting….

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DVD Sales Moderately Weak But No Disaster

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I still got my eye on holiday DVD sales. Data is now available at the-numbers.com through December 16th. This includes the launch of the latest Harry Potter film and the second week of sales for Pirates of the Caribbean: At World’s End. Please note that this data is for the US only. This could be especially important for popular international titles like Harry Potter, Pirates, or especially Ratatouille which performed exceptionally well in the overseas box office.
My impression of these sales figures is that they are moderately light pretty much across the board relative to analyst estimates. Holiday DVD sales are very important to December quarter earnings for the major entertainment conglomerates which own movie studios including Disney, General Electric, Viacom, News Corporation, Time Warner, and Sony.
It is hard to call winners and losers among this group but I do have some observations….

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Selling Comcast. Buying News Corporation.

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Partially driven by tax considerations, I sold Northlake’s entire position in Comcast yesterday. I used the proceeds to purchase a full position in News Corporation. I completed this trade across Northlake’s entire base of separately managed client accounts and in my two main personal accounts.
The Comcast long proved to be disastrous. My analysis of the company’s fundamentals and the stock market’s likely reaction proved wrong. I bought the position last July at more that $27. It was a 3% for most accounts position so it cost clients about 1% relative to the S&P 500 benchmark. Ouch. I’ve chronicled repeatedly why I was long Comcast and why I think the stock is undervalued at these prices. I still believe the shares are undervalued but barring a dramatic action by management I don’t see the potential for a significant rebound (>20%) in the next six months. Current fundamentals aren’t nearly as bad as the stock price implies but they are weak relative to Wall Street expectations and risk remains that there is one more disappointment in operating metric or capital spending guidance.
On the other hand, fundamentals at News Corporation are very positive. 1Q08 results are already in the books and strongly suggested that estimates are too low. When Rupert Murdoch refused to raise guidance due to concerns about the economy, the shares sold off as the implication is that estimates for the remainder of the year are too high. I think this reasoning will be proved wrong and we will find out within the next six weeks when News Corporation presents at a major sell side conference and then reports its 2Q08 results.
Simply put, I think News Corporation is similarly undervalued to Comcast but it has positive operating momentum and a recognizable catalyst. Add in the tax loss benefit against gains I’ve realized this year in my market cap and style rotation strategies and on position trimming in Apple and Central European Media Enterprises and the swap from Comcast to News Corporation makes sense.
I’d like to reiterate that I think Comcast remains cheap and oversold at current prices. My investment strategy limits the number of long positions I can maintain at any point in time. Something had to be sacrificed. No doubt it will prove to be a sacrifice to the trading deities as well so you can hold the emails noting that I threw in the towel at the low that are sure to come my way when Comcast is trading in the low $20s.

TV Ad Market Strong. For Now.

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On Monday, the New York Post reported that scatter market TV advertising on the big four broadcast networks is running up 18%. Scatter market represents TV ad inventory available for sale on the spot market. This price increase is occurring despite another year of accelerated declines in ratings for prime time network TV shows. What is happening is that advertisers have not achieved the reach they desired with their upfront ad purchases so they are aggressively bidding for limited inventory and driving up pricing. This situation bodes well for 4Q EPS of the owners of the broadcast networks – Disney (ABC), News Corporation (FOX), CBS, and General Electric (NBC).
A gentler version of this rising ad prices/falling ratings dynamic has been going on for more than a decade enabling the broadcast network TV market to grow modestly despite the steady market share gains for cable TV and other forms of media. The concept sold by the broadcast networks has been that “we are the only place where you can still reach a mass audience even if it is ways less massive than it used to be.” The winners at any point in time are the networks that are on top of the ratings or sustaining ratings momentum (currently ABC and FOX)….

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Box Office Recovery Continues

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The box office continued its late year recovery with the three day weekend for the top 12 films rising 40% from a year ago. This strong performance builds the prior weekend’s gain of 37%. As recently as December 13th, the quarterly box office was running down 9.5% but two weekends of strong gains have reduced the deficit to 4.6%. With three films paying very well (National Treasure 2, I Am Legend, and Alvin and the Chipmunks) and another popular franchise to be released n Christmas Day (Alien vs. Predator), the box office should continue to expand vs. a year ago through the end of the year. By year end the quarterly decline may be around 2% and the year to date gain should be greater than 5%. The quarterly results will be at least as good as recently lowered estimates for the theatre stocks imply suggesting that the group could receive a January effect bounce starting any time. I remain long Regal Entertainment.
In other media news, News Corporation announced that it is selling 8 TV stations in mid-size markets for $1.1 billion. These stations have been for sale since mid year so no surprise here. However, I think the sale will remind investors that News Corporation is shifting its asset base toward a higher long-term growth profile. I remain long a small amount of News Corporation, looking to get much longer in the next few weeks as I free up cash from year end and early 2007 trades.

Impact of Presidential Election

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There is a lot more on investor’s minds these days than the 2008 Presidential election. However, the Iowa caucuses are just 16 days away and recent polls indicate the races in both parties are extremely unpredictable. Who knows if past market patterns in Presidential election years will hold given the overwhelming focus on the health of the economy and the credit markets. But as a reminder, I want to pass along some info from a Ned Davis Research commentary that went out on Monday.
First, the market tends to trend down in the first half of a Presidential election year regardless of which party ultimately wins the election. The depth of the decline has been more severe in years where the incumbent party loses the White House. Second, the market has rallied from a June low through September regardless of the election outcome. This would seem to coordinate with the determination of the nominees and the optimism that is generally sought at the late summer political conventions. Third, the end of the year has been sensitive to whether the incumbent party wins. When the incumbent party has won, the market has continued to rally right through to year end. When the incumbent party has lost, the market has peaked in September and trended lower until mid-December. Finally, Like many years, Presidential election years have shown a tendency to rally in late December and this has occurred whether the incumbent party wins or loses…..

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DVD Sales Mixed So Far

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Just before Thanksgiving I highlighted my concerns that holiday spending on DVDs could be weaker than expected. At the time, I identified two potential problems. First, the studios have to deal with a generally weak holiday spending environment. Second, the amazing success of the box office this summer put a glut of high profile DVDs on retailer shelves. So assuming consumers were inclined to spend on DVDs, any single title could get squeezed or all the titles might lag sales goals. Now, another problem has emerged which is great success for video game titles. Halo, Guitar Hero 3, and others appear to be selling very well this holiday season.
Early returns on DVD sales were mixed. Transformers was first out of the box and did very well selling 8 million units at its launch. Spiderman 3 was next and underwhelmed with 3 million units. Ratatouille got off to a good start with 3.8 million units but Shrek The Third, which had domestic box office more than 50% above Ratatouille, sold just 3.3 million units in its first week. Things looked a little better when Live Free or Die Hard sold a better than expected 2.1 million units.
While the jury remains out, the latest sales data is much more promising. Last week saw the release of Pirates of the Caribbean: At World’s End and The Bourne Ultimatum and both performed very strongly. Pirates sold 8 million units and Bourne sold 3 million.
I suspect the final outcome will be a moderately weaker than expected DVD sales season with more titles than usual underperforming…..

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A Legendary Weekend At The Box Office

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Proving once again that people will buy tickets when there is appealing in the theatres, the weekend box office rose 38% for the top twelve films according to BoxOfficeMojo.com. It’s easy to point to home theatres or digital distribution but this past weekend and last summer showed that demand for the movie theatre experience remains robust if the studios release good product.
That was certainly the case this weekend when the top two films massively exceeded expectations. I Am Legend set December box office records with $76.5 million vs. estimates of $40 million. This marks the seventh straight #1 opening for Will Smith who by any measure is now the most bankable star in Hollywood. The #2 film was Alvin and the Chipmunks. The film grossed $45 million, fully three times most estimates.
Entering the weekend the quarterly box office was running down 9.5% but assuming the gain holds through the weekday play dates, the gap should fall to 6% or less. The gap should close further through year end as the almost certain blockbuster National Treasure 2 opens on Friday. That would mean that there are three films pulling in ticket buyers where just one film was popular a year ago.
Year to date the box office is up over 5% despite the poor fall and early winter. This follows a gain of over 4% in 2006, helping to isolate 2005’s 6.1% fall in receipts as the exception. Prior to 2005, the box office was up every year since 1992. The same can’t be said for ticket sales (those are flat over the past two years) but studio and theatre costs are measured in absolute revenue not number of tickets sold. I stand by my belief that the 2005 drop was a fluke and continues to color the movie business much more negatively than it deserves.
If the rest of the year performs as strongly as I expect, on Wall Street the theatre companies should be the prime beneficiaries. Regal Entertainment, Cinemark, and Carmike are all trading at or very close to 52 week lows. Regal and Cinemark have excellent current yields that provide support. I think the stocks can rally a buck or two from here before year end.

The Writer’s Strike Is About To Bite

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I am surprised that the talks broke off between writers and producers. When the strike was launched there was a lot of discussion on both sides about how close they were to a deal. I figured that when they decided to start up negotiations again under a strict blackout a deal was at hand. My view was reinforced by two factors. First, the writers union is led by a folks who were willing to wage a strike so they had already proven to the producers that they were serious. Second, the fact that the writers seemed be winning the public relations war in a landslide. It seemed like a perfect setup for a deal.
Now things are looking ugly and the strike is dragging on long enough that it could impact media stocks. As a reminder, it is TV that could get hurt. That means that network owners and TV producers have the most to lose. Disney (ABC), NBC Universal (GE), News Corp (Fox), and CBS are the network owners. NBCU, Fox, Viacom, and Time Warner are the big TV producers.
The problem is most acute at the networks. Network TV is in a long-term state of decline as viewers diversify their media consumption. Cable networks have steadily gained share and now new digital distribution is starting to build viewership. With most popular original series about to run out of episodes, ratings will take a nosedive starting in January and February. The timing couldn’t be worse as this is the first year advertisers are using the new currency of live commercial ratings plus three days of DVR playback. Ratings were unusually poor last TV season and although there is no an apples to apples comparison, they appear to be down sharply. Finally, the lousy ratings have actually tightened the ad market because the networks have had to offer “make goods” of ad time to compensate for low audience delivery. That means that if ratings nose dive under a prolonged strike scenario there is no obvious way for the networks to make good other than cut prices dramatically.
The financial impact of a prolonged strike on the networks is unlikely to hurt earnings at the networks owners because the cost of the replacement programming is going to be very cheap. However, the big picture risks of an accelerated decline in audience ratings and the shifting ad currency have serious long-term implications that could impact valuation of network assets. That said, CNBC is way overdoing the coverage of the strike relative to the stock price risks for the companies.
CBS is by far most exposed as the network is the primary driver of its profits. Disney and News Corporation have less to worry about given their broad base of entertainment assets. I remain bearish on CBS which also has serious ratings issues that put hundreds of million of operating income at stake. I still like News Corp and Disney which have plenty of growth levers away from network TV to drive operating income.

UBS Media Conference Recap

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I’m back in Chicago and have had some time to digest the UBS Media and Communications Conference. Below are brief comments from every presentation I attended. As you read, keep in mind that I found the general background of the conference to be cautious. This impression is based mostly on the uncertain advertising environment and the decelerating growth in the cable sector. Don’t confuse my comments with a bearish view, however. Media companies are in pretty good shape to weather the storm due to strength in margins and cash flow, and new growth initiatives. The group as a whole may not work well for a few more quarters but there is enough good for individual ideas to be money makers.
The following comments are meant to provide my immediate impression of the presentations with an emphasis on stock price performance in 2008 weighted to the first half of the year. I am trying to find the best media stocks to own not necessarily big absolute price gainers. The comments are listed in the order of the presentations I attended….

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