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Our Outlook for the Media Sector

Newspapers struggle, but online ad revenue is a bright spot.

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The stock for the average media company currently looks slightly overvalued. The only industry that is trading below our estimate of its fair value as of March 15 is the media-conglomerates industry. Here,  Disney (DIS) and  Time Warner (TWX), whose economic moat ratings we've recently upgraded, look particularly cheap. But some of the more interesting developments in the media sector, both good and bad, are from the newspaper-publishing industry.  

Times have been tough lately for newspaper publishers, to say the least. In fact, according to figures published by the Newspaper Association of America (NAA) in mid-March, total industry advertising revenue slipped 0.3% in 2006. To put this in perspective, the downturn in 2006 marks the first year-over-year decline in industry ad revenue since 2002, which was the end of the last economic recession in the United States. We don't see much improvement this year; rather, we see another annual decline of 0.3% in 2007, largely from lower print classified ads.

One bright spot among the group has been the strong growth of newspaper publishers' online-ad revenue. According to NAA, online revenue from newspapers' core sites grew 31.5% in 2006 for the second year in a row, and we expect continued robust online growth of about 25% in 2007. Currently, online advertising is still dwarfed by print advertising, making up only 5.4% of the industry's total. But this is up from about 4.1% in 2005, and as newspapers' online efforts continue to flourish, online revenue should account for a double-digit percentage of industry revenue by 2009.

Valuations
We don't see a whole lot of compelling value in the market for newspaper stocks right now, despite some recent stock-price declines. (Newspaper stocks fall into the Media Conglomerates and Publishing industries in the table below.)

 Media Industry Valuations
Segment

Average
Star Rating

Average
Price/Fair Value
Stocks Covered
Broadcast TV 2.20 1.08 5
Cable TV 2.56 1.11 9
Film and TV Production 2.00 1.20 2
Media Conglomerates 3.32 0.98 22
Publishing 2.73 1.08 15
Radio 2.57 1.16 14
Data as of 03-15-07.

In our opinion, print ads, which make up the lion's share of newspapers' ad revenue, will continue to be at risk, particularly in the first half of 2007. We anticipate ad revenue from print ads will be down another few percentage points for the year. In particular, print national and classified ads should continue to face challenges, as ad spending in these categories is particularly susceptible to the threat of the Internet.

Meanwhile, we think margins will continue to be pressured at newspaper publishers. Newspaper companies should see some benefit in 2007 from lower newsprint prices and usage. But newsprint and supplements make up only about 15% of publishers' total operating costs. Because the bulk of newspaper publishers' costs are fixed, anticipated top-line challenges should cause negative operating leverage to continue. We wouldn't be surprised to see yet another round of layoffs in the near future as publishers attempt to combat this.

Internet Leaders among Newspaper Companies
Despite facing some tough newspaper-industry headwinds, you may want to keep an eye on the companies listed below. Each one has newspaper-related Web sites that are generating impressive online-ad revenue growth. Each one also has a unique play on the Internet that could provide an interesting investment opportunity if the market becomes overly pessimistic about their core newspaper operations.

 Stocks to Watch--Media
Company Star Rating Fair Value Estimate Economic
Moat
Risk

Price/FV

Gannett  $65 Narrow Average 0.86
Tribune $35 Narrow Average 0.84
Dow Jones $38 Wide Average 0.90
The New York Times $22 Narrow Average 1.06
E.W. Scripps $52 Narrow Average 0.86
Data as of 03-22-07.

 Gannett (GCI),  Tribune (TRB), and  McClatchy (MNI) collectively own online-recruiter CareerBuilder. CareerBuilder recently overtook rival  Monster (MNST) in revenue, unique traffic, and job postings in North America. CareerBuilder is still in investment mode, so it hasn't achieved the profitability that Monster enjoys. But online recruiting is a very scalable business; we expect CareerBuilder's profitability to grow rapidly, adding to the bottom lines of Gannett, Tribune, and McClatchy. We also see great opportunity for CareerBuilder as it begins expansion into markets overseas.

Wide-moat  Dow Jones (DJ) remains one of our favorite media companies. Because of Dow Jones' focus on unique, valuable business content, it is one of the few newspaper companies that can charge readers for access to its content online. As the demand for real-time business information continues to grow, we expect that Dow Jones will continue to build upon its online Wall Street Journal "circulation" of about 800,000. We remain impressed with Dow Jones' efforts to reduce its reliance on its printed products. With the help of its Factiva acquisition, about 40% of revenue will come from non-newspaper sources, by our estimates.

 The New York Times  (NYT) is another newspaper company that can charge consumers for its content online. TimesSelect and new offering Times Reader won't likely add a whole lot to the company's revenue, but incremental costs should be minimal, allowing a healthy portion of the associated revenue to flow to the bottom line. The New York Times should also be virtually done building its new headquarters this year, freeing up a significant amount of cash that had been used for construction. We wouldn't be surprised if the company used some of its freed-up cash to make Internet-related acquisitions unrelated to newspapers, similar to its purchases of About.com and Calorie-count.com. Assuming management doesn't pay too much, any such acquisition could provide a nice boost for the company and increase the amount of its online revenue from 8% of total revenue in 2006.

Like The New York Times,  E.W. Scripps (SSP) has invested in non-newspaper Internet properties. We expect that Scripps' interactive-media segment, consisting of Shopzilla and uSwitch, will see about 30% revenue growth in 2007 as online-comparison shopping continues to gather steam. As a result, we expect the company's interactive-media segment (which excludes the results of the online operations of its newspapers, TV stations, and cable networks) to account for about 13% of the Scripps' total revenue this year, up from 11% last year.

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James Walden does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.