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With Ad Market Back to Normal, the Spotlight Is on Big Media

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The ad market is back to its usual pattern, following the performance of the economy, the health of corporate profits, and the intensity of competition among major advertisers.

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The meat of earnings season for media companies began last week and continues this week. Disney (DIS), Time Warner (TWX), News Corporation (NWS), and Scripps Interactive (SNI) mostly reported good news and guidance last week. This week Omnicom (OMC), CBS (CBS), Comcast (CMCSA), Discovery Communications (DISCA), and DirecTV (DTV) will continue the parade. I expect more good news and continued leadership for media stocks.

The bottom line from last week's reports is that any weakness in national TV advertising that occurred in the December 2011 quarter has reversed. Business may not be booming but scatter pricing has firmed up, scatter volume is positive for networks with time to sell, and upfront cancelations are normal.

My thesis for some time has been that we have entered a traditional ad market, having put the cyclical bounce off the bottom in the rearview mirror. In hindsight, it is apparent that late in the December quarter advertising trends softened. I view this period as the end of boom that followed the historic low of late 2008, early 2009. The pickup thus far in 2012 signals that the ad market is back to its usual pattern, following the performance of the economy, the health of corporate profits, and the intensity of competition among major advertisers.

For now, the ad market is healthy, but we are no longer in a rising-tide-lifts-all boats-equally environment. Companies with strong ratings across their portfolio of networks and ad inventory to sell will be winners. Companies with depressed margins, cash flow, and weaker ratings -- those companies forced to invest more heavily in new programming -- will be losers.

Let's take a look at last week's reports.

Disney had mostly good news on the advertising front in a generally positive earnings report across the board. There had been worry about ESPN ad growth given weaker NFL ratings, loss of NBA games due to the lockout, and timing differences for college bowl games. These issues were magnified by worry about long-term affiliate fee growth given the focus on sports programming as a driver of ever higher cable bills. ESPN reported low single-digit ad growth, better than some feared. Management said growth was double-digit adjusting for one-time issues. The outlook was positive with more double-digit growth in the pipeline for the March quarter. Also important to Disney is theme parks, where results were excellent. Finally, management spent some time on the call discussing the recent carriage agreement with Comcast. Locking down ESPN affiliate fees for almost a decade goes a long way to putting to rest fears about ESPN being sent to its own tier or slowing its affiliate fee growth.

Time Warner reported low single-digit ad growth, also better than some had feared. The company's lead networks, TNT and TBS, have had weak ratings in 2011 and TNT had the added burden of the NBA lockout. Looking ahead, the company pointed to the resumption of NBA season, better profitability on the second year of the NCAA basketball deal, and improved ratings on acquired programming to help drive ad growth back to the mid to upper single digits. I think the poor ratings at the entertainment networks will require additional programming investment, which will be a drag on profitability over the next year.

News Corporation reported just mid-single-digit advertising growth but noted that regional sports network weakness depressed an otherwise low teens gain. Management reaffirmed guidance for mid-teens operating growth for the entire company. I am a little wary of the FOX network given much weaker American Idol ratings so far this season. Easy gains in the fall due to the modest success of X Factor has the network well ahead season-to-date but sustaining those gains if Idol has finally hit the downside of its lifecycle will present challenges in the years ahead. Also back on the radar at News Corporation is the UK hacking scandal following weekend arrests at The Sun, a much larger newspaper than the closed News of the World. Investors would just assume News Corporation exited newspapers but not by force of scandal.

Scripps Interactive had industry-leading ad growth in the low double digits and forecast more of the same looking ahead. The big news from Scripps was higher expense growth that will depress margins. Program investment will increase 13-15% this year with other expenses up 8-10%. Weak ratings at Travel Channel are the primary culprit but HGTV and Food have required investment in fresh programming as well coming off a year of inconsistent ratings. Investors were expecting higher expenses in 2012, but both increases are above expectations and will pressure margins and EBITDA growth. Scripps has a meaningful but lesser commitment to share repurchase and dividends than its peers. Now faced with slower operating cash flow growth, I see the stock as a laggard in the group.

Looking ahead to this week's reports, I have long favored CBS shares and expect a very strong report given a strong ratings year at the CBS Network amid moderate programming expense growth. Discovery Communications is expected to produce the highest ad growth in the industry due to good ratings at most of its big networks. The stock has done quite well, and while I am long, I worry the expectations bar is too high.

Disclosure: CBS, Comcast, DirecTV, and Discovery Communications are net long positions in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, and related technologies. Steve Birenberg is co-portfolio manager of Entermedia, owns a stake in the Funds' investment management company, and has personal monies invested in the Funds. CBS and Discovery Communications are widely held by Northlake Capital Management, LLC, including in Steve Birenberg's personal accounts. Steve is sole proprietor of Northlake, a long only registered investment advisor.

This column was previously published by SNL Kagan on www.snl.com.
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No positions in stocks mentioned.
Entermedia is a long/short equity hedge fund focused on media, communic= ations, and related technologies. Steve Birenberg is co-portfolio manager o= f Entermedia, owns a stake in the Funds' investment management compan= y, and has personal monies invested in the Funds. CBS and Discovery Communi= cations are widely held by Northlake Capital Management, LLC, including in = Steve Birenberg's personal accounts. Steve is sole proprietor of Nort= hlake, a long only registered investment advisor.

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