Tuesday, January 12, 2020

Digital, Media & Entertainment Industry Report
Are We There Yet?

Michael Kupinski, DOR, Senior Research Analyst, Noble Capital Markets, Inc.

Refer to end of report for Analyst Certification & Disclosures

Overview. Optimism grows as core advertising, which excludes Political advertising, seems stronger than what many analysts anticipated for the fourth quarter. We believe that analysts are getting ahead of their skis. 2021 will be a long and somewhat bumpy ride. In our view, there is a lot of noise around core advertising given the unprecedented amount of Political advertising. As such, we are not as sanguine as many about the advertising recovery. In our view, core advertising is not expected to recover to 2019 levels until 2022.

Television: Did the M&A market open earlier than expected? We believe that the TV stocks will be buoyed by the M&A market. But, we anticipate that 2021 will be bumpy. As the year 2021 closes, investors likely will focus on 2022 and the prospect of another banner Political year. Our favorite picks for 2021 focuses on two companies that have the financial flexibility to pursue acquisition fueled growth.

Radio: Why this is among our favorite sectors for 2021? Based on our estimates, the industry appears poised to outperform revenue growth across most media sectors in 2021. Furthermore, the average Radio stock is trading at roughly 9 times enterprise value to depressed 2021 cash flow estimates. While the multiple may appear high based on most recent trading multiples over the past five years (excluding 2020), the valuations appear to be compelling considering the strong double digit cash flow growth that is expected in an advertising recovery.

Publishing: Will there be fewer public publishers? Publishing stocks increased a strong 42.3% in the fourth quarter, outperforming the general market The takeover offer for Tribune came in on New Year’s Eve and, as such, the recent rise in the stock price was not reflective in the Q4 performance for the group.

Digital: The Pandemic had a varying impact. Surprising was the rapidity with which Digital advertising declined in 2Q and how quickly it recovered in 3Q (and into 4Q). In addition, there was a notable acceleration in the move toward ecommerce. We highlight one of our favorites, 1800FLOWERS.com. In addition, the esports industry went mainstream as broadcast networks sought content. We highlight one of recent recommendations, eSports Entertainment.

Overview

Are We There Yet?

Most investors are happy to see 2020 in the rearview mirror. The pandemic hit the industry hard, both in terms of fundamentals and stock prices. In terms of fundamentals, the media industry performed slightly better in the second half than the dire predictions made in the midst of the pandemic. Revenues rebounded from the disastrous second quarter, fueled by record breaking Political advertising. Many companies raised revenue and cash flow guidance in the third and fourth quarters due to the heavy Political advertising spend. But, even factoring out the huge influx of Political, advertising trends seemed to have improved. We caution investors, however, not to get over their skis on optimism. Political advertising, especially the level at which Political came in, created a substantial amount of noise around core advertising. The perceived momentum currently may not be as robust into 2021. The general economy is still reeling from store and restaurant closures and other restrictions. While a vaccine offers hope that there will be a return to “normalcy”, we remain cautious about the issues that will need to be addressed post pandemic. As such, investors who are optimistic that 2021 advertising returns to 2019 levels, may be like children on a long road trip asking “are we there yet?”

For instance, there appears to be a large number of potential bank foreclosures and forced evictions as Covid restrictions on evictions are relaxed. In addition, there appears to be little Congressional interest in additional financial support to families. This could disrupt consumer behavior in coming months. Furthermore, while everyone is hopeful of returning to 2019 revenue levels, we believe that a large number of businesses are not likely to return quickly and many may be permanently closed. Finally, there is a looming issue of what the government will do to help pay for the increased Pandemic-related expenses, implying tax hikes may be coming. There is a 96% correlation to advertising and discretionary spending. As such, tax hikes could potentially cut into consumer’s appetite to spend and, subsequently, advertising. While we anticipate continued improved revenue trends, we are not as sanguine about the advertising recovery in 2021, which we discuss later in this report.

On the stock front, for investors that were fortunate enough to buy media stocks during the midst of the pandemic, the returns were very strong. In the fourth quarter, particularly, media stocks increased on average 40%. Even with the strong performance in the second half of the year, most media stocks did not overcome the shortfall earlier in the year as Figure #1 illustrates. For the most part, media stocks are down modestly in the single digit percentages for the year, except for the Radio industry. There, despite the 33.5% increase in stock prices for the fourth quarter, the Radio stocks are still down a whopping 37%. Within the traditional media sectors, the publishing stocks performed the best, up nearly 34% for the year. This group benefited from the larger cap stocks in the industry, New York Times and News Corp. Both benefited from strong digital audience growth and digital revenue growth. 

As we look forward toward 2021, Radio stocks appear to offer the best value and the most upside appreciation potential, assuming a continued advertising recovery. But, this industry is not without risks. Many of the Radio companies have heavy debt burdens, which may be tricky if the advertising recovery does not continue. For investors looking for a balance of leveraged returns in a return toward “normalcy”, our favorites are Gray Television, Entravision, and Travelzoo. For more risk tolerant investors, we encourage investors to take a look at eSports Entertainment, one of the few compelling growth segments of the media industry, focused on the gaming space.

Figure #1

 

Television Broadcast

Will M&A Buoy The Group In 2021? 

The fundamentals of the television industry substantially improved in the fourth quarter, fueled by an extraordinary and unprecedented influx of Political advertising. Many companies raised Q4 guidance to reflect the strong Political advertising. To put the Political advertising numbers into perspective, for most broadcasters, Political advertising accounted for nearly 30% of total Q4 broadcast revenues. Comparatively, in 2016, Political advertising accounted for roughly 11% of total Q4 broadcast revenue. What makes the numbers so extraordinary is that Retransmission revenues in Q4 2016 were roughly 25% of total broadcast revenues and in Q4 2020 represented about 32%. In total, Political and Retransmission revenue accounted for roughly 62% of total television broadcast revenue. Cash flow margins, as measured by adjusted EBITDA, is expected to average in the high 30s percent range. The robust margins are expected to reflect the high margin Political advertising and the significant cost reduction efforts by companies striving to maintain cash flow during the Pandemic.  

Some investors and analysts appear to be sanguine about the outlook for the TV fundamentals heading into 2021. We are not as optimistic. Some analysts point to the relatively healthy advertising environment, excluding Political. Given the large influx of Political, we believe that there is a lot of noise in the those core advertising numbers. We believe that key advertising categories, such as Auto, appear to be recovering nicely, with some broadcasters indicating that it was down a modest 3% to 8% in the fourth quarter. To put this into perspective, Auto was down as much as 75% in the second quarter. But, some large local advertising categories, such as restaurants, travel, and retail will take longer to return to 2019 levels, in our view. In addition, as we look forward toward the first quarter 2021, there will be some tough year earlier comps from the large influx of Political advertising from the Democratic primaries. Recall the unprecedented amount the Michael Bloomberg spent on the primaries? In January 2020, it was reported that he spent $300 million and $500 million in February. 

Q1 and full year 2021 outlook

Consensus revenue estimates for the first quarter anticipate TV industry revenues falling 3.6% on average, which we believe to be optimistic. In our view, the estimates do not appear to fully reflect the absence of Political advertising, nor the lingering local economic impact from the pandemic. Our revenue estimate anticipates that the average TV company will report revenue declines in the range of 9.2%. The second quarter should reflect much stronger revenue trends given the easy comparable a year earlier, the midst of the economic shutdowns from the Covid pandemic. While we anticipate strong second quarter revenue, we do not believe that the recovering core advertising trends will be enough to offset the absence of Political advertising. As such, we anticipate that full year television advertising revenue on average will decline 7.3%. Our estimate is below that of consensus estimates that anticipate modest full year 2021 revenue decline on average 1%.

The deal market opens. 

While television fundamentals appear to be still affected by the economic fallout from the Covid pandemic, the deal activity in the industry has picked up. This follows the surprising offer from E.W. Scripps to buy Ion Media on September 24. Ion Media was on the market prior to the development of the Covid pandemic early in 2020, but was pulled when economies were closed and Covid mitigation efforts unfolded. Scripps made a gutsy move to buy Ion in the midst of the pandemic and in spite of the lack of visibility on the economic and advertising recovery. More recently, the M&A environment seems to remain healthy given that Quincy Broadcasting and Meredith announced plans to sell TV stations. Investors turn their attention to the likely buyers, Gray Television and private equity firm, Apollo Capital. In our view, the sale of television stations will support public market valuations in the TV group.

Where do TV stocks go from here?

The Television stocks outperformed the general market in the fourth quarter with the Noble TV index up 39%, significantly outpacing that of the general market, as measured by the S&P 500 Index, up 10.8%. Unfortunately, the strong year end performance did not offset the weak performance earlier in the year. For the year, TV stocks are down 8.7% versus a 15.4% gain for the general market. The only stock that outperformed the group in both the fourth quarter and full year performance was Entravision. The EVC shares were up a significant 82.9% in the fourth quarter and 6.1% for the full year. 

Despite challenges with the anticipated pace of the advertising recovery and the tough year earlier comparisons, we remain constructive on the television stocks. We believe that the TV stocks will be buoyed by the M&A market. But, we anticipate that 2021 will be bumpy. As the year 2021 closes, we believe that investors will once again focus on 2022 and the prospect of another banner Political year. The TV stocks typically do better the year prior to an election year, up an average 22%. Although, this was not the case in the last two elections. While many TV companies will focus on debt reduction given recent acquisitions, we believe that those with flexible balance sheets will turn toward M&A to enhance longer term growth potential. As Figure #2 illustrates, there are several companies with relatively low leverage, including Gray Television and Entravision that appear poised for accelerated growth through acquisitions. As such, our current favorites are Entravision and Gray Television.  

 

Figure #2 
 

Radio Broadcast 

Why this is one of our favorite sectors for 2021? 

Based on consensus estimates, fourth quarter revenues are expected to show substantial sequential quarterly improvement from the third quarter, down roughly 12% versus an average 22% decline in the third quarter. The improvement is expected to reflect a sizable boost from Political advertising, although Television gets the lion share of Political dollars. Broadcasters that have digital, podcasting, and diversified operations, likely will perform better than those industry averages. Digital, which for many radio broadcasters includes podcasting, appears to be growing revenues in the double digits. Overall, the industry revenue decline for 2020 is likely to be among the weakest in the media space. The stock prices likely reflect this reality (which is discussed later in this report). 

Looking forward toward 2021, Radio may have one of the best revenue recoveries in the media space. This is largely due to the fact that the industry does not have as difficult Political comps as others. Even though Political was at record levels for Radio in 2020, it still accounted for only 4% of total 2020 Radio revenues. While this is up from roughly 3% in the past, it is not a large nut to overcome given the prospects of a rebound in advertising. To put this into perspective, Political advertising for Television accounted for as much as 30% of total revenues. We do believe that consensus revenue estimates for 2021 may be a little high. The average consensus revenue growth is expected to be 13.5%, a revenue growth estimate that does not anticipate that the industry revenue in 2021 achieves that of 2019. Our 2021 Radio revenue estimate is 7.3%. Nonetheless, we believe that the revenue trends appear favorable.  But, revenue will be lumpy. The strongest revenue growth quarter will be the second quarter, which will be up against the easy comps from the year earlier depth of the pandemic. Q2 2020 revenues were down in the range of 55% to 65%. 

The improving revenue and, subsequently, cash flow trends will be a welcome relief to many Radio companies with stretched balance sheets. 2021 cash flow is expected to have strong double digit growth, in excess of 20%. As Figure #3 illustrates, the average debt to trailing cash flow for the industry is an historically high 11.1 times. Many companies managed through the pandemic either with government loans or concessions on debt covenants. Yet, there were some Radio companies that were able to manage through without tripping covenants. We believe that most companies will be able to quickly pare down debt and debt to cash flow levels will drop to be an average 6 times by the end of 2022. The industry has managed with the relatively high 6 times handle before. 

Will Radio stocks recover? 

As Figure #5 illustrates, the Radio stocks had a strong rebound in the fourth quarter, up 33.5%, as measured by the Noble Radio Index. But this strong performance was below that of many media sectors including TV, up 39%, and Publishing, up 42.3%. Nonetheless, some of the strongest performers in the industry in the fourth quarter were the larger radio groups including Cumulus Media, up 62.9%; iHeart Media, up 57.5%; and, Entercom, up 52.2%. Townsquare Media increased a strong 43.1%. These companies outperformed the Radio Index and many companies across the media spectrum. The remaining publicly traded stocks traded below the Noble Radio Index. 

As illustrated in our Radio comp table, the average Radio stock is trading at roughly 9 times enterprise value to depressed 2021 cash flow estimates. While the multiple may appear high based on most recent trading multiples over the past five years (excluding 2020), the valuations appear to be compelling considering the strong double digit cash flow growth that is expected in an advertising recovery. As such, the Radio stocks represent among our favorite sector for 2021. 

Figure #3

  

Publishing

Will there be fewer public Publishers?

The fundamentals of the Publishing industry varies by company and depends upon which side of the Digital divide the company is on. Some companies, like The New York Times, have transitioned well toward a Digital driven model. Nonetheless, the Publishing industry’s transition toward Digital accelerated during the Pandemic. Unique visitors and Digital subscriptions accelerated as travel-restricted consumers sought news and information about Covid and the Presidential elections. Despite the double digit revenue growth for Digital advertising and subscriptions for some Publishers, total revenues are expected to decline in the range of 20%. National publishers, however, may see modest single digit declines in revenues. 

Importantly, many in the industry are reengineering cost structures. While the Pandemic caught many media companies flatfooted without cost mitigation strategies to maintain cash flow, many Publishing companies simply accelerated cost reduction plans already in place. The Pandemic allowed many companies to reduce the office footprint or renegotiate office leases at much lower rates. As a result, many Publishers have actually exceeded cash flow expectations. Tribune Publishing is a good example of this. The company recently raised fourth quarter and full year 2021 cash flow guidance. As we look toward 2021, we anticipate that revenue trends will significantly moderate, especially since Digital revenues represent almost 50% of revenues for many Publishers. Cash flow for the industry should improve as cost mitigation efforts flow through to a full year of operations. 

Investors are focused on the recent offer by the Alden Group for the remaining 68% of the shares of Tribune Publishing that it does not own. The $14.25 per share offer follows the company’s closing on the sale of BestReviews, which bolstered the company’s already strong cash position. Based on our estimates, Tribune is expected to end 2020 with as much as $220 million in cash and virtually no debt. We wonder how serious the Alden Group is about acquiring Tribune. We believe that it is likely that independent board members will reject the low ball offer. The question will be whether the Alden Group will increase its offer to levels that reflect the intrinsic value of the company. Given that the company raised cash flow expectations, we have raised our price target to $20.75. In our view, a value representing a 10% to 15% discount to our price target would be a reasonable take-out valuation. 

The takeover offer for Tribune came in on New Year’s Eve and, as such, the recent rise in the stock price was not reflective in the Q4 performance for the group. Nonetheless, Publishing stocks increased a strong 42.3% in the fourth quarter, boosted by a 145.4% increase in the stock price of Gannett in the quarter. The GCI shares began the upward trend following the company’s 10Q filing on November 2, as investors concerns over the company’s high debt leverage were assuaged. In addition, the company significantly reduced headcount through a large employee buyout in November.  

As we look forward toward 2021, we view the shares of Tribune as among our favorite plays. In our view, the company has a large cash position to fund accretive acquisitions. We place the probability of the Alden Group raising its offer to a range we believe would be reasonable as low. The TPCO shares currently trade at less than 3 times Enterprise Value to cash flow, as measured by adjusted EBITDA. This valuation varies from the multiple listed in Figure #4, a valuation that reflects only EBITDA. We believe that the TPCO shares stand on its own with significant cash flow and a large cash position. 

 Figure #4

Figure #5 

Digital Media & Technology

Digital Advertising Recovers Quickly; Gaming and Podcast M&A Ramp Up

A year ago we wrote that over the previous decade online advertising as a share of all advertising had more than tripled to 50%, up from just 15% of advertising at the start of the decade.  Our expectation was that this trend would continue.  What we could not foresee then was that a global pandemic that would redefine how we went about our everyday life.  Businesses were required to close offices and shut down brick and mortar outlets and find ways to conduct business virtually.  The pandemic forced people to work from home and businesses to accelerate their digital transformation.  Ecommerce provided a much needed source of revenues to offset the loss of in-store sales, and, after a 2Q pause in online advertising, businesses increased their use of digital media to promote and drive traffic to their own ecommerce operations.   

If 2020 surprised us in two ways, it was 1) the rapidity with which advertising declined in 2Q, and 2) how quickly it recovered in 3Q (and into 4Q).  While traditional advertising mediums such as TV (-35%), radio (-48%), outdoor (-37%) and newspaper (-44%) advertising really struggled in 2Q 2020 (just after the pandemic started), online advertising (-3%) held up remarkably well.  Within online advertising, it was a bifurcated market:  Advertising revenues at Google (-8%) and Facebook’s (+11%) decreased by 2% on a combined basis while revenues from all other publicly traded online advertising companies decreased by a combined 16%.  Advertising results in 3Q were encouraging, particularly as those trends continued into 4Q.  At traditional media companies, revenues moderated substantially, while at online advertising companies, revenues returned to mid-teens growth (+13%).  Again, the online advertising marketplace was bifurcated, with online advertising at Google (+10%) and Facebook (+22%) growing a combined +14%, while online advertising from all others increased by 7%.  If there is a silver lining to the advertising struggles of 2020, it is that we foresee the “mother of all easy comparisons” in 2Q 2021 combined with the benefits of vaccine distribution which should enable the beginnings of an economic recovery. 

Two Trends to Watch in 2021:   Connected TV Advertising and Retail Media

The pandemic accelerated a number of technology trends, from the use of online groceries to the consumption of multiplatform gaming services to increased viewing on streaming services.  Viewing habits have been evolving for years, but online video platforms greatly benefited from work at home requirements. Over the last 4 years, nearly 19 million fewer homes now receive pay television services, according to Leichtmann Research Group, which tracks quarterly changes to subscriber counts.  The biggest declines have come from satellite TV providers (11.9 million fewer homes).  These declines have been offset somewhat by virtual MVPDs (multi-channel video providers) such as Hulu, Sling TV, and FuboTV. 

Connected TV (CTV): Forced to stay at home, consumers have migrated to subscription video on demand (SVOD) platforms such as Netflix and Disney+.  Fortunately for advertisers, advertising on demand (AVOD) services have also benefited from a migration of consumers to their platforms.  AVOD combines the premium viewing environment of television with data-driven targeting of online advertising.  AVOD service providers include TubiTV, PlutoTV, Vudu, Crackle, Peacock, as well as connected TV device makers such as Roku and Samsung.  AVOD doesn’t begin to replace linear TV viewing and advertising, but it acts as a strong complement by providing incremental reach as linear TV’s reach continues to erode. 

Connected TV (or CTV) advertising is relatively small, but its future is bright.  During its third quarter conference call, The Trade Desk (TTD) noted that “our CTV spend grew more than 100% year-over-year in the third quarter as advertisers follow consumers to streaming platforms.  eMarketer forecasts that connected TV advertising grew by 27% to $8.1 billion in 2020 and will grow by another 40% to $11.4 billion in 2021.  

Retail Media:  The pandemic related surge in ecommerce sales has also led to accelerated growth in retail media (also known as ecommerce channel advertising).  Retail media is display or search ads that appear on retailer platforms and direct users to products available for purchase there.  Amazon is the best situated company in this sector and is the main supplier of retailer media outside of China (where retailer media is already well established). 

Following in the footsteps of Amazon’s fast growing advertising business are retailers like Walmart, Target, eBay and Kroger, all of whom are looking outside their core business for growth and have found it in digital advertising.  Each of these companies has the requisite scale to compete for advertising dollars, as well as first-party customer data.  Most are now building the technology in-house to further expand profit margins in this sector.  Sponsored product advertising is the most prevalent form of retail media advertising, and it is estimated that Amazon has a 75% share of this market. 

eMarketer projects that marketers will spend $17.4 billion on advertising on ecommerce sites in 2020, a 38% increase over 2019.  While this type of advertising benefited from the pandemic, it is also being driven by the “cookie-less” online advertising future in which it becomes harder to track users.  Ecommerce sites have the advantage of first party shopping and intent data plus attribution capabilities for measurement and optimization.  Expect to hear more from this sector in the future.

Another Year of Strong Stock Price Returns in the Internet and Digital Media Sectors

Earlier we noted the upcoming easy comparisons in 2Q 2021, which could help explain why advertising related stocks continued to bounce back in the fourth quarter.  All three segments of Noble’s Internet and Digital Media sectors, where advertising is the primary revenue stream, performed well in 4Q 2020.  Noble’s Ad Tech (+63%) and Digital Media (+18%) significantly outperformed the S&P 500 (+12%), while Social Media (+9%) performed slightly below. Only the non-advertising related stocks, those in the MarTech space, underperformed (+0%). 

One of the companies that we follow,1800FLOWERS.com, significantly benefited from the surge in ecommerce and gifting in the midst of the pandemic. In its fiscal first quarter end September, revenues surged 51.6%. In our view, the spike in activity will be long lasting as it has significantly enhanced the company’s customer acquisition. The FLWS shares increased 5.6% in the fourth quarter, contributing to 12 month performance of an astonishing 84.5% gain. While revenue and earnings comparisons will be difficult against the Pandemic spurred growth, we believe that contributions from its recent acquisition of Personalizationmall.com will enhance the company’s long term growth. In addition, the strong fundamentals over the past several quarters have significantly improved its financial position, which should allow the company to make future revenue growth investments. We continue to view the FLWS shares among our favorites in the ecommerce space. 

On the opposite end of the spectrum, Travelzoo was negatively affected by the Pandemic and the subsequent travel restrictions. TZOO is a online media company that offers entertainment and travel deals. The company’s swift decision to focus on travel vouchers allowed it to significantly improve its financial position and avert a devastating travel marketplace. The vouchers allow the consumer to cancel or change travel plans without fees and were a big hit. As a result, the company’s cash position has surged and could be as much as $70 million, or nearly $5 per share, at year end December 2020. We believe that there is pent up demand for consumers to travel post Pandemic and Travelzoo appears well positioned to capitalize on that prospect. The TZOO shares are down modestly for the year. But, for investors fortunate enough to buy the shares during the depths of the travel restrictions in March 2020, the shares have nearly tripled from a low of $3.65. We view the TZOO shares as a compelling play on a return toward “normalcy” as the Covid vaccines open economies and travel restrictions are lessened. In addition, as Figure #6 illustrates, the company compares favorably on Enterprise Value to Revenue relative to its peers.

Yet another beneficiary of travel restrictions and stay at home mandates was the esports industry. The industry gained mainstream attention as traditional sports content was constrained during the economic shutdown. As such, broadcast networks turned toward esports to fill the programming void. Viewers of esports platforms tend to stay on the platform for longer periods than traditional sports or other computer applications making the sites ripe for advertising revenues. Furthermore, we believe that the esports will follow the trajectory of traditional sports into sports betting. The GMBL shares increased a strong 55% since our initiation on October 28th. The company recently made a series of acquisitions and announcements that strengthen its ability to be one of the leading companies in this space. As such, we view GMBL as among our favorites in 2021. 

Finally, one of our favorites for 2021 is a marketing services company, Harte Hanks (HRTH). The company is in a turnaround mode and should swing toward significant cash flow generation in 2021. As Figure #7 illustrates, the company compares favorably to its Marketing Services peer group on the basis of Enterprise Value to Revenues and EV to EBITDA. 

Figure #6

 

Figure #7

Companies mentioned in this report:

Harte Hanks (view report)

1800FLOWERS.COM (view report)

eSports Entertainment (view report)

Entravision Communications (view report)

The E.W. Scripps Company (view report)

Gray Television (view report)

Salem Media Group (view report)

Travelzoo (view report)

Tribune Publishing (view report) 

Cumulus Media (view report)

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Senior Equity Analyst focusing on Basic Materials & Mining. 20 years of experience in equity research. BA in Business Administration from Westminster College. MBA with a Finance concentration from the University of Missouri. MA in International Affairs from Washington University in St. Louis.
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Underperform: potential return is >15% below the current price	0%	0%

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Report ID: 11744