Free cash flow, M&A hot topics in media earnings

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About The Dow of Steve Steven Birenberg, president of Northlake Capital Management, comments on the market impact of topical events in the media & communications sectors.

Most of the major media companies report quarterly earnings this week. I have 16 earnings calls on my calendar. I recognize that investors will read through from one company to the next thus pressuring managements to lump together their calls, but this is ridiculous!

Media stocks have been moving lockstep with investor sentiment toward the economic recovery. Lately that means that a lot of the big gains in the stocks off the March and July market lows have been given back. Ahead of earnings week that might be a good thing as far as the stocks are concerned. Short-term reactions in stocks are all about how incremental data points are received relative to expectations.

Make no mistake, the expectations bar for media stocks this quarter is still pretty high. Advertising trends must improve significantly on a sequential basis. Guidance commentary must support further meaningful sequential improvement extending into 2010. Recent action has lowered the bar slightly, however, and lower expectations are generally a good thing on Wall Street because they are easier to beat!

As noted, advertising trends are going to be the key driver of media stock prices this week. According to Mike Morris of UBS, his universe of media stocks is expected to report a 9% drop in advertising. This represents sequential improvement from negative 12% reported in the second quarter. Morris anticipates further improvement in the fourth quarter with negative 7% growth. Like most analysts, myself included, 2010 is projected to show a return to growth.

All the major ad mediums are expected to show improvement in the third quarter. Print, outdoor and local broadcast TV are expected to bring up the rear with declines of 15% to 25%. Cable and broadcast networks, driven by national advertising, are expected to fare best with declines of just 2% to 4%.

Advertising is clearly picking up, and major advertisers such as Procter & Gamble are reporting improved financial performance. This is loosening ad budgets especially where reach is broadest, such as national TV. Companies want to ensure a strong share of the advertising voice as the economy recovers and during an ideally improved holiday selling season.

I fully expect advertising trends in the third quarter improved at least as much as the consensus expectation, but it will be commentary about current trends and early 2010 that will really matter to investors. This is especially the case given more mixed economic data recently that has soured investor sentiment toward the economic recovery. I think management teams will support sequential improvement in the fourth quarter, but they will do so cautiously.

Movie trends will also be closely scrutinized, as third-quarter box office was off less than 1%. According to Jeffrey Logsdon of BMO Capital Markets, the rental business was robust, up 10%, even as DVD sales fell again. This is a poor trade-off for studios from a profit perspective, but the rebounding rental business is often overlooked in the many articles about the declining DVD sales business and the problems it is causing for the major studios.

Over in Cable System Land, the Street will hear from Comcast Corp., Cablevision Systems Corp., Time Warner Cable Inc. and DIRECTV Group Inc. AT&T Inc. and Verizon Communications Inc. have already reported, and their subscriber growth in TV and broadband fell slightly short of estimates.

This could be good news for cable due to rebounding market share, or it could be a sign that the whole multichannel business remains under pressure by weak economic conditions.

M&A will be a focus of cable calls with the NBC Universal Inc./Comcast deal front and center. Cablevision will also be updating on progress on the Madison Square Garden spinoff, while DIRECTV is very close to closing the Liberty Entertainment Group merger. In general, investors are going to wonder about strategies for free cash flow. The stocks are no longer valued as growth businesses right at the time that free cash flow is accelerating. Comcast seems to be looking to vertical integration. Some investors speculate on horizontal mergers for all the other multichannel distributors. Other investors just want free cash flow returned to shareholders via dividends, share buybacks or debt repayment.

I remain long CBS Corp., Discovery Communications Inc., Liberty Entertainment and AT&T. Obviously, I expect decent reports from the media companies. I also expect trends favoring national TV advertising, and cable networks in particular, to remain the most favorable.

CBS, Discovery Communications, Liberty Entertainment and AT&T are widely held by clients of Northlake Capital Management LLC including in Steve Birenberg's personal accounts. Opinions expressed in this piece are solely those of the author and do not represent the views of SNL Kagan.