Tuna Amobi, senior analyst at Standard & Poor’s Equity Research, doesn’t like to mince words about the direction of the U.S. economy in the coming year. “We’re telling investors to be very, very cautious because the data seems like it’s going to get even choppier as we look ahead,†he says. Economists from Standard & Poor’s believe the economy will grow at a sluggish 2.5% in 2011. They also predict a 25% chance of a double-dip recession.
In spite of that gloomy outlook, Amobi is surprisingly upbeat about some of the companies he reviews as director of S&P’s media and entertainment equity research group. “You’re going to see a media sector that rallies ahead of that recovery and some stocks that outperform,†he notes. black enterprise talked to Amobi about the entertainment companies he’s recommending to his clients now.
Give us an idea of some media stocks that can outpace the market over the next year or so.
I want to talk about three companies: Discovery Communications Inc. (DISCA) and DreamWorks Animation SKG Inc. (DWA), which I recommend as “strong buys†and Time Warner (TWX), which I rate as a “buy.†The common thread across all three companies is that they are all pure content players, which is important as you look at the proliferation of media distribution outlets and shifts in consumer patterns. The second common thread: These companies are well positioned to capitalize on advancements in digital technologies like
Let’s start with Discovery.
Discovery (DISCA) is a company that we like primarily as a pure content provider with a unique level of business and geographic diversification. By business diversification we mean the diversification of revenue into not just advertising but also what we call affiliate revenues, which are the revenues the company receives from cable providers or satellite TV providers. The importance of affiliate revenues was highlighted during the recession, when you saw a lot of advertising-dependent players get hammered. Well, Discovery came through the recession in a significantly better position, thanks in large part to the affiliate revenues, which account for more than half of the company’s income. Affiliate revenues are usually long-term contracts that a company negotiates with cable and satellite. That’s why the company came through very strongly. They were also the only [publicly traded] media company to grow advertising revenue in 2009. That also speaks to what we think is a very strong content pipeline. Their core channels are Discovery Channel, TLC, and Animal Planet. Beyond that, they have a lot of other channels that are at various stages of development or rebranding. In terms
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They have a very strong management team. I want to emphasize that Discovery has, by far, the industry-leading margins among all the cable networks out there. We expect that this margin will continue to expand. I think this is not to be overlooked: In January, they’re going to launch the Oprah Winfrey Channel, which is a 50/50 joint venture. The brand name which Oprah brings to the equation is incredible. Her network has already signed a couple of multimillion-dollar, multiyear deals with major advertisers. We expect for Discovery long-term earnings and free cash flow growth of approximately 20%, more than double the 8% to 9% growth that we expect for some of their competitors. So, on any number of metrics it seems like a compelling play, which is why we’re looking for a 12-month target price of $55.
So, DreamWorks is in a similar category in terms of its appeal?
Yes, DreamWorks (DWA) is a specialized film studio that represents a compelling pure play on the growing popularity of 3-D movies. Since Avatar was released by News Corp. last
The company’s balance sheet is strong. It has no debt. It’s returning cash to the shareholders through a stock buyback program. We think that the company’s profile could make it a potential takeover candidate. There are a number of larger studios out there that could use their expertise. So, our target price of $40 for the next 12 months does not necessarily include a takeover premium. We will not rule out the possibility that a takeover could occur. This is still one of those rare-breed independent studios.
Now on to Time Warner. Has this company turned things around lately? For most of the last decade, the stock was stuck in the doldrums.
I know. But it’s a new operation now. It’s a leaner and meaner Time Warner (TWX). AOL, for example, was spun off [in an initial public offering] last December. Time Warner Cable was spun off as well. What you have left in Time Warner is a pure content player positioned to capitalize on new consumption patterns and the proliferation of distribution outlets, whether cable, satellite, online, or mobile. And talk about a strong balance sheet. They have north of $4 billion in cash. A chunk of that came from the special dividends that they received from the Time Warner Cable spin off. It is one of the few companies in media paying decent dividends–about 2.6% yield, which is saying a lot compared to its peers that are paying very modest dividends if any. Time Warner has some of the leading premiere assets in the entire media and entertainment space–whether it’s HBO or the Turner Networks (TNT and TBS). Their film studio, Warner Brothers, is arguably the most profitable studio with the most consistent track record over the last decade. Time Inc., the magazine publishing arm, is coming off of a major restructuring to take advantage of digital technologies like iPad apps. For Time Warner, our 12-month target is $38.