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Quarter-End Insights

Our Outlook for the Media Sector

Yahoo and Microsoft are standing by as Google strengthens its wide moat.

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The  Microsoft (MSFT) and  Yahoo (YHOO) saga continued to be a dominant story in the media industry in the second quarter. We think this issue is relevant as it demonstrates the growing importance of online advertising at the expense of traditional media. As we pen this article in mid-June, talks between Microsoft and Yahoo appear to be over. We could rattle on and on about the poor corporate governance and lack of regard for shareholders, but in short, we think Yahoo's management did its shareholders a great disservice by not getting at least $31 per share from Microsoft when it had the chance.

Instead of these two companies coming together to form a viable second player to challenge  Google's (GOOG) dominance, Google's wide economic moat continues to expand, in our opinion. In lieu of a deal with Microsoft, Yahoo has agreed to a partnership with Google in which Yahoo will outsource a portion of its search advertising business to Google. We think Yahoo's near-term cash flows stand to benefit, but Google will be the long-term beneficiary of this partnership if it goes through. (We think the Department of Justice will give this partnership a long look given Google's already-dominant share of search ad dollars.) This partnership could ultimately lead to advertisers leaving Yahoo's search platform altogether, which would begin a cycle of Yahoo outsourcing an even larger part of its search business to Google.

Outside of online advertising, most other areas of media are suffering through a slower advertising environment, which is not a huge surprise given the weakness in the U.S. economy. The "old media" companies without economic moats, such as newspaper publishers and radio broadcasters, are now facing cyclical issues in addition to secular challenges. For example, according to the Newspaper Association of America, overall newspaper ad dollars declined 13% in the first three months of 2008.

Cable television advertising is one area of traditional media that has held up. According to TNS Media Intelligence, cable TV ad revenues increased 4% in the first quarter of 2008. Some of our favorite investment ideas are companies that possess dominant cable networks.

Valuations by Industry
Our average star rating for the media industry is 3.32, which indicates that the overall industry is slightly undervalued, in our opinion. We think there are some attractively priced stocks in the cable TV and media conglomerates segments. Two of our favorite cable stocks are  Comcast (CMCSA) and  Time Warner Cable (TWC).

 Media Industry Valuations
Segment

Current Median Price/Fair Value

Three Months
Prior
Change
(%)
Broadcast TV 1.03 0.97 6%
Cable TV 0.84 0.83 1%
Media Conglomerates 0.90 0.81 11%
Publishing 1.03 0.96 7%
Radio 1.07 0.97 10%
Data as of 06-13-08.

Media Stocks for Your Radar
We see compelling investment opportunities in three wide-moat companies that are currently undervalued by the stock market. We also think a company with a unique cable asset and an online recruiting firm are being overlooked by the market at this time.

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

Price/
Fair Value

Monster Worldwide $41 Narrow Medium

0.52

Time Warner $25 Wide Low 0.58
News Corp. $25 Wide Low 0.67
Discovery Holding Co. $35 Narrow Medium

0.70

Walt Disney $40 Wide Low 0.80
Data as of 06-20-08.

 Monster Worldwide (MNST)
We believe that Monster is positioned well to take advantage of the long-term trends of the online-recruiting industry. In our opinion, Monster's shares are attractively priced, even after we forecast a near-term slowdown in sales growth for its North American careers unit. We think most of its growth opportunity lies in its international careers business, which increased 44% year-over-year and accounted for about 41% of Monster's total revenue during the most recent quarter. We expect its international business will continue to generate lofty revenue growth and increased profitability.

 Time Warner (TWX)
We believe Time Warner controls some of the most prominent assets in media, including Time Warner Cable, Warner Bros., HBO, and other valuable cable networks. Most of these businesses are leaders in their respective industries and possess formidable competitive advantages. We're optimistic that the intrinsic value of these assets will eventually be realized under the leadership of CEO Jeff Bewkes, who took over in January. The company recently announced it would spin off the assets of Time Warner Cable.

 News Corporation, Ltd. (NWS)
With its suite of diversified media properties around the world, News Corp. appears to be well-positioned for the foreseeable future. Its largest business segment, Fox Entertainment Group, owns a vast library of motion pictures and television shows including "The Sound of Music," "Star Wars," and "The Simpsons." Besides the proven ability to create great content, News Corp. can also distribute its content around the world through its theatrical film-distribution capabilities, television networks, and satellite television providers. The company also owns one of the premier online distribution channels via its purchase of MySpace.

 Discovery Holding Company (DISCA)
The bulk of the value of this firm comes from its 67% stake in Discovery, which boasts attractive cable networks Discovery Channel and TLC, among others. One of Discovery's key competitive advantages comes from its massive library of nonfiction content. We think Discovery's content, presented largely in documentary form, has strong universal appeal, transcending cultures and languages. As a result, Discovery is able to effectively repurpose its content to about 1.5 billion cumulative subscribers in more than 170 countries, which should help drive international growth. Also, much of Discovery's content is timeless, allowing the company to reuse it in various forms for years.

 Walt Disney Co. (DIS)
The strength of the Disney brand has allowed the company to exploit its characters and franchises through box office and home video sales, theme park and resort attendance, and merchandising. The company has also aggressively built out its online presence, allowing its customers to consume additional content, play games, and buy more merchandise. However, the company's largest profit generator is its media networks, including ESPN, ABC, and the Disney Channel. While we anticipate solid performance in filmed entertainment, theme parks, and merchandising, we expect the media networks to account for the majority of the company's profit growth for years to come.

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