It is no secret that media has long been a very popular sector among private equity investors. Its popularity was shared among lenders, who were willing to lend to media companies at much higher multiples than they would to other industries because of the underlying franchise or license value. The bad news for media investors and lenders is that the 2007 to 2009 period is no normal cyclical downturn, and the oligopolistic franchise value no longer exists.
The advertising revenue base and valuation multiples for radio and magazine companies have experienced a permanent structural decline. The bulk of the decline has been driven by the loss of pricing power for radio and print advertising due to the emergence of the internet. There is also potential for further decline as consumer spending, and thus advertising, becomes a smaller share of the US economy. The good news is that there is light at the end of the tunnel for radio and magazines.
Surviving the current downturn will be a victory for any media investor, yet there are opportunities for new investors to enter the industry.
End of the Advertising Boom
Total advertising expenditure as a percent of GDP experienced a major structural increase from 1975-2000, corresponding with a long term increase in consumer spending to GDP. A funny thing happened after the 2002 recession, however. Even though consumer spending remained elevated, advertising as a percent of GDP fell. The reason for the decline appears to be a large decline in inflation-adjusted pricing of radio and print advertising, while Internet and television retained their pricing power. Trough-to-trough, inflation-adjusted radio advertising prices have declined around 30% from 2002-2009 and magazine pricing has declined 23%. Consumption of radio and print magazines is down only marginally. The price decline is the result of a massive increase in advertising inventory that has accompanied the rise of the Internet. In addition, the Internet provides superior ROI measurability to advertisers. In other words, the oligopoly pricing model (and profit margin) of traditional media has been destroyed.
The bottom in media and the “new normal”
The good news for magazine and radio is that the price erosion caused by the Internet has already occurred and that the sectors have likely bottomed. The bad news is that the decline is permanent and 2009 revenue should be viewed as the “new normal”. Radio and magazine advertising revenue should enjoy a mild cyclical recovery in 2010-2011, and grow at around 2% per year thereafter. This growth projection is based on flattish consumption and price growth in line with inflation.
Radio and magazine companies should now be valued as low growth, cyclical companies. Using this valuation methodology means 5.5x-6.75x EBITDA for large diversified companies and 4.5x-6.0x for the less-diversified companies that tend to be owned by private equity firms. Given that the median debt to EBITDA ratio for these companies is currently around 6x, there is very little equity value left in the sector. The lenders are or will be the de facto owners of virtually every private equity backed media company.
At these valuations, the proper debt level is probably 2x-3x EBITDA. New investors have an opportunity to strike interesting deals with the lender-owners to obtain ownership and extend the loan terms in exchange for delevering the balance sheet and bringing in management expertise. Given the number of distressed properties there is the potential to profitably use M&A to build scale. The industry is a restructuring story, not a growth story, however. Each content vertical needs to be consolidated down to one or two viable properties, so investors will need to be discriminating about what to buy and hard-nosed about what to shut down or sell off. Costs will need to be reduced significantly at most companies. Magazine owners will need to bring in the expertise to develop profitable online operations and radio owners will need the programming skills to compete in the marketplace. There is money to be made in the media sector, but now you really need to earn it.
Tyler Newton is Partner & Research Director at Catalyst Investors, a growth private equity firm based in New York. He blogs about investing and economics at www.tylernewton.com.
The above is a summary of a recently-released Catalyst research report titled “Traditional Media: Down but Not Out”, which can be found at www.catalystinvestors.com.