Look Behind the Numbers

Earnings season offers investors a few surprises
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As the third-quarter earnings season comes to an end, I've uncovered four truths about the industry moving into the new year.

The national ad market shows new signs of life. A couple of months ago, network ad salesmen were expecting a gloomy Christmas. The upfront market was surprisingly weak, and a late-summer surge in orders didn't materialize. Suddenly, however, some networks are seeing new demand and reporting stronger demand than expected.

Viacom Co-President/CBS Chairman Les Moonves says his broadcast networks are “doing great” in the scatter market: “I think we are taking the lion's share. We're seeing some numbers that are slightly above what the upfront was. There is plenty of activity.”

On the cable side of Viacom, Tom Freston's MTV Networks are seeing even stronger demand. “We have seen a really terrific scatter market in the third quarter, up double digits,” he says.

For the fourth quarter, he adds, “We're looking at unit rates pretty much across our portfolio. They are about 20% higher than the upfront rates.” Half of that is because of stronger Nielsen ratings, the rest from higher cost per thousand viewers (CPM).

E.W. Scripps' cable networks President John Lansing offers less detail but sees the same thing: “some good pressure supporting our pricing going into the rest of the year.”

The local ad market remains weak. There's not much real relief in sight for TV stations. The Winter Olympics should perk up business for groups with NBC stations, and the midterm elections should help broadcasters with strong local newscasts next year. But the core business is weak.

The big problem is automotive, which accounts for 30% of the revenue of many stations. Financial difficulties at the car manufacturers translates into a crunch at TV stations. Hearst-Argyle CEO David Barrett sees spending cuts from GM, Dodge, Chrysler, Jeep, Ford, Toyota, Lexus, Honda, Acura, Lincoln, Mercury and Saturn. The only increases came from relatively smaller spenders: Hyundai, Kia, Subaru, Mercedes, Volkswagen and Suzuki.

But cars aren't the only problem. Stations are seeing weakness in other important categories—fast food, movies, telecom—without strength in other ad categories (although retail and housewares seem to be picking up). “Right now,” says Tribune CEO Dennis FitzSimons, “it is a buyer's market,”

Deutsche Bank broadcasting analyst James Dix estimates that local advertising will be off 2% for the year, excluding the effects of this being a non-election year.

There are two cable industries. One is vibrant, made up of strong companies aggressively deploying new phone and video products; the other is composed of companies that are loaded with debt, losing subscribers and struggling to launch new products. Comcast, the largest operator in the U.S., is generating notable growth in operating cash flow, while Time Warner and Cablevision are securing new phone customers at rates no one would have predicted three years ago.

Meanwhile, Charter Communications, Adelphia Communications and Mediacom are struggling. But the market barely makes the distinction. Stocks in strong cable companies have been pounded down to valuations that investors haven't seen since the mid 1990s, seven to eight times annual cash flow. That means Comcast—which should wind up 2005 posting 16% growth in cash flow—is valued at about the same level as Gannett, which is expected to post no growth at all.

What does the market fear? Competition. As cable operators steal phone customers away from the Baby Bells, telcos are retaliating by jumping into the video business. Since the telcos have all been down this road and failed before, it remains to be seen how successful they'll be. But certainly, the phone companies see two cable industries, too. It's no accident that, when Verizon lit up its first video system last month, it avoided markets where strong companies like Cox or Time Warner operate. It chose Keller, Texas, where the incumbent operator is Charter.

Stock buybacks still don't seem to be working. Media companies continue to spend billions of dollars buying back their own shares—to no apparent affect. Wall Street investors have been clamoring for buybacks or some sort of “return of capital to investors” for months, and companies have complied.

It's easy to understand Time Warner CEO Dick Parsons' decision to dramatically increase his company's stock-buyback plan from $5 billion to $12.5 billion. The company is under attack by activist investor Carl Icahn, who'd like to jack up its stock price by borrowing $20 billion to buy back stock, load the debt onto Time Warner Cable and spin it off.

That way, Icahn and hedge-fund players can cash in their options on Time Warner stock and never have to worry about the long-term prospects of the company they leave behind. It would leave Parsons stuck with the task of running a company stripped of its steadiest source of growth: cable systems. Icahn will have moved on to some other stock.

I understand the arithmetic behind stock buybacks. Shrinking the number of shares outstanding amplifies a company's cash flow per share and should send its price soaring.

But look at Viacom: Even though splitting in two, the company disclosed that it spent $1.2 billion on share buybacks during the third quarter and kept spending through October. The company has bought $6 billion of its own shares in the past year.

The result: Viacom's stock price has dropped from $37 per share to $32.

The same with Tribune. According to its third-quarter report, the broadcasting and newspaper company increased its buyback and has spent $1.7 billion repurchasing shares. So what happened to its price? It dropped from $42 in 2004 to $35 in September 2005.

So all of you media titans considering big stock buybacks, proceed with caution.

E-mail comments to jhiggins@reedbusiness.com

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