Magic Formula Business Sector #7: Media
|Morningstar Industry||Stock Days||Unique Stocks|
|Film & TV Production||28||1|
As you can see from this table, the Media sector comprises several very different business models, so let's dig into each one individually. Once we're done, it will be pretty clear why this table stacks up the way it does!
The Publishing industry consists of companies that produce media such as magazines, books, flyers, and other generally printed media. Magic Formula stocks from this sector include Financial and Educational powerhouse McGraw-Hill (MHP), the parent of Standard & Poor's, as well as investment research firm Value Line (VALU) and Verizon's local phone book publisher, Idearc (IAR).
Publishing in general is a great business. Many of these companies use the subscription revenue model, which is very attractive as customers pay for product before receiving it, allowing the firm to invest the proceeds, earning a return even before delivering the product. Also, the cost structure of the publishing business is mostly fixed. The printing machinery and distribution network of a typical publisher can deliver 750,000 copies for only slightly more than the cost of delivering 500,000 copies, meaning higher volume falls directly to profits (also known as leveraging costs). This allows excellent return on capital for the larger publishers. Lastly, these firms have valuable intangible assets in the form of brands that protect their products from competition. Value Line, despite a complete lack of product innovation and no embrace of the internet, can still afford to charge a premium for their product because of it's long standing reputation with investors.
In general, publishers make pretty attractive investment opportunities. However, beware the internet. More than any other business sector, the internet has affected the business model of media companies drastically. Once upon a time, newspapers were an outstanding business. Many had a monopoly within their city, as few cities were large enough to support more than one. However, the internet allows anyone to read news from around the world, advertising has moved online (leading to falling print ad rates), and classified ads took a hit from eBay (EBAY) and Craigslist. Keep in mind how the internet can hurt (or help) your publisher of choice.
There is an almost insatiable desire for media companies to expand their brands into every conceivable form of delivery, in the search for revenue growth. This is not necessarily a poor strategy, if done correctly. For example, take long time Magic Formula entrant Viacom (VIA.B). One of Viacom's most valuable properties is MTV, which of course started as a cable television station airing music videos. Today, MTV produces numerous television programs which are monetized through advertising, DVD sales, digital delivery, etc. The MTV brand is also used to sell compact discs, video games, and a popular website. AND Viacom has expanded MTV into movie production, with films such as Napoleon Dynamite and Jackass. Clearly, the company has milked the MTV brand for all it's worth, and this is the path to earning high returns on capital.
What you don't want in a Media Conglomerate is a company that is acquisition happy, buying company after company to build a media empire. The sordid tale of the Time Warner-AOL merger (TWX) comes to mind. Here were two media companies with no common business coming together simply to create a bigger firm. Unfortunately for Time Warner shareholders, they were "rewarded" with AOL stock at it's most expensive point... and it was all downhill from there.
With Media Conglomerates, look for those firms that use their established brands wisely, expanding them into new forms of media. Avoid those "media empires" that acquire new business simply to get bigger. This is almost always a losing strategy.
Film & TV Production
The only Magic Formula stock in this industry was New Frontier Media (NOOF), a publisher of adult entertainment media. This industry consists mainly of the pure play movie and television studios. There are not many of these left, as most studios are now part of a Media Conglomerate. Some examples would be Dreamworks Animation (DWA), with it's Shrek and Madagascar franchises, and possibly CBS (CBS).
It's pretty clear why this is not a good industry for the Magic Formula. This is a "lumpy" business with a hit driven model. Dreamworks can earn huge profits for a few months on the back of a blockbuster movie like Shrek, but then struggle for years to regain that profitability. Even in television, a few hit shows can lead to big profit gains, and when those shows run their course, the profits disappear. Remember when NBC was the #1 network with Seinfeld and Friends? Yeah, me neither.
Film & TV Production companies are difficult to invest in, even for non Magic Formula investors. I recommend avoiding them, unless you like risk and have a strong hunch about an upcoming film or TV show.
Ahh, radio, the granddaddy of all broadcast media. It's also a business model that has taken serious hits over the past ten years, as satellite radio, digital music, and recorded audio programs ("podcasts") have increasingly become the preferred forms of audio entertainment. The one Magic Formula radio stock was Westwood One (WON), which has a stock price of $1.71 as of this writing. Compare this to a price near $40 in late 2003 and it's clear this is not an industry we want to be investing in. In fact, stocks in a clearly dying industry are one of the main things to look for in a bad Magic Formula stock. So let's move along...
This is another case where Morningstar's industry assignment doesn't make a whole lot of sense, as the only Magic Formula stock is Corus Entertainment (CJR), who is actually a radio and television producer in Canada. Most of the companies in this category are cable TV providers, such as Comcast (CMSCA).
Cable TV providers run a pretty difficult business. It requires a lot of capital expenditures to expand and maintain cable networks, and a lot of capital expenditures generally means low returns on capital, which in turn tends to keep a stock off the Magic Formula screen. What's more, with satellite television and the internet, cable no longer has the competitive moat it once had, leading to price competition and loss of profits. While some cable companies have been able to use their networks to provide additional services such as high speed internet and VOIP, the industry itself will never rank high in the Magic Formula. Without Corus, it wouldn't even appear at all.
Media - Summary
In the Media sector, focus on Magic Formula stocks in the Publishing or Media Conglomerate industries, with a special focus on publishers. Always keep in mind that the internet is a significant force in media moving forward. For conglomerates, look for those firms that expand established brands into new forms of media, earning more money without having to spend on brand building. Avoid those conglomerates that are only interested in building empires. Film and TV studios are boom and bust companies that are difficult to value, and the Magic Formula turns these companies up after the hit movie has already made it's money. It's rare that Radio or Cable TV companies will appear on the Magic Formula. Radio is best avoided, as broadcast radio is a dying business model.
Magic Formula Business Sector Countdown
#7 - Media
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