For most nonstrategic investors, the media industry has always been too expensive. Companies trade hands at very high multiples due to a variety of factors, including the simple fact that the media business is perceived as glamorous and alluring.
Overvaluations may still be an issue with the larger-market companies but, perhaps, not in the middle market, which is showing progress. The big players, including such names as CBS Corp., Walt Disney Co. and Time Warner Inc., have well-performing stocks. However, with price-earnings multiples greater than 10 times (16.2, 15.6 and 14.3, respectively), these large companies are expensive and likely to have slower growth, compared to companies in the middle market trading at lower multiples.
As such, it's a good time to look for opportunities here as confidence slowly grows across the economy. Talk of a double-dip recession has largely passed. The S&P 500 index is up more than 3.5% since the end of 2011. These signs spur a shift away from weather-the-storm attitudes of isolation toward more social attitudes involving interaction and entertainment. This is where the media industry can best capitalize during this shift.
It is important to note the types of deals done over the past year. For 2011, the largest deal was the acquisition of Seven Media Group for $4.15 billion by West Australian Newspapers Holdings Ltd. The majority of deals, however, were between $1.6 million and $244.7 million. To me, this reflects banks and investors not being willing to take write-downs on marginal companies or being satisfied with slight positive returns where alternative options are few. A good example is the stockholders of Lions Gate Entertainment Corp., who rebuffed an offer from Carl Icahn, feeling that the 10% premium did not rise to the real value of the asset. As such, the remaining deals reflect smaller values, which is why I believe this trend will continuue.
There are five key factors to keep in mind when considering deal opportunities in the middle market of the media industry:
A PE multiple of less than 10 times. This is important, because it will likely provide a larger upside to those at a premium of more than 10 times, as mentioned earlier. Perhaps middle-market media companies are now trading where they should have been historically. Assuming even low- to middle-level growth percentages, and a potentially new environment in which banks will deal in order to create growth, this sector has the potential to drive significantly larger margins.
Tangible assets like libraries and licenses. Tangibles represent cornerstones on which to build growth and value. Remember the lesson from the dot-com bubble of overvaluing the creation of virtual forums.
Partners and management with a similar vision. Having a similar vision will avoid the problem of conflicting viewpoints limiting the ability to create synergy and to then carry it forward as momentum through the marketplace.
A digital component offering flexibility across multiple platforms. Considered opportunities in the media industry must reflect digital as a component for their operations, as the percentages in increased spending for wired and mobile advertising have been ahead of television. The traditional media companies have been fairly successful in migrating their subscribers toward their digital assets. Also, 2012 is an election year, meaning there is a bump in spending by politicians and political groups across media forums and in companies that find new ways to communicate with voters. An interesting milestone that was reached not too long ago is that there are now more digital subscriptions than people in the United States.
Changing impact of the stick value. The term "stick value" has traditionally meant the value of the license plus any hard assets the station might have. It is a convenient methodology for buying assets that have no predictable cash flow. As the trend moves to digital, it is easier to data-mine for values of subscribers and other factors that can make a more predictable calculation. Look for media opportunities that are able to effectively data-mine to determine their performance and have the ability to track trends for future performance.
The time for investing in middle-market media companies may just be right. If you listen carefully, you just might hear opportunity knocking.
Gary Adelson is a managing director of NHB Advisors Inc.