Media Stocks: Beaten Down, Almost Buyable

Media stocks have been crushed this year, and Wall Street has been piling on. On Monday, Lehman Brothers analyst Anthony DiClemente issued a  research note downgrading the entire industry (see here), pointing to the potential long-term adverse effects of digital distribution. Is it all over for traditional media?

DiClemente's main thesis is that the decline in "packaged media" -- such as DVD sales -- will outpace the growth in digital media sales. "The question is the rate of decline; we believe the decline in packaged media revenues will dramatically outpace growth in digital media revenues in the next two years," writes DiClemente in his report. Set aside for the moment that DiClemente's own investment bank is under siege -- and that all of Wall Street is melting down. Let's focus on whether media Armageddon is occurring.

I believe the fear of "Media Armageddon" is largely overdone for many of these companies and that some of these media stocks are setting up for great buying opportunities in the next several months. Even though they will be pressured by the move to digital, some of them, including Disney (DIS) and News Corp. (NWS), are positioned quite well for the move. At any rate, earnings disasters are being priced in pretty well by the general market decline, so it may soon be feasible to profit from the despair.

DiClemente has one idea that seems about right: Maybe there's reason to doubt the conventional wisdom that somehow, the film and TV business will manage to avoid the fate of the music industry, which was pummeled by iPods and P2P pirates. Factual evidence would indicate that film and TV is doing OK and not getting hit by piracy as hard as music.  DiClemente seems to be saying that such optimism is unwarranted.

Indeed, the market might be discounting these stocks in anticipation of some sort of catastrophic event. Many media stocks have experienced astonishing declines. And even in cases in which some of the “legacy companies” have made some wise decisions – such as News Corp. buying  MySpace before the social networking space became the next bubble, event the good deals haven’t really helped share prices.

You just need to see the numbers. Here is what has happened to a group of the most notable entertainment media stocks over the past 52 weeks:

• CBS Corp. (CBS) : down 48 percent.
• News Corp. (NWS): down 36 percent.
• Viacom (VIA): down 32 percent.
• Time Warner (TWX): down 31 percent.
• Walt Disney Co. (DIS): down 13 percent.
• Yahoo Inc. (YHOO): down 12 percent.

The CBS decline looks especially egregious in light of the fact that CEO Les Moonves was recently declared the  second-highest-paid CEO in 2007  by the Associated Press. (see here).  Shocking, eh?

Is there a bottom to any of these stocks soon? Should you consider buying them? Well, you might give it a go if your idea of weekend fun is juggling chainsaws. In other words: Wait a while, and see how the markets shape up. But there will be deals.

I ran a couple of screens to see whether you could view any of these stocks as values and I found that some of these stocks are starting to get very cheap in terms of the free cash flow, and you could start to consider looking at them, if the market begins to stabilize. Two stocks that I would consider would be CBS and Disney, though the Moonves factor is certainly disconcerting.

Here are the price/free cash flow ratio for the stocks in this group:

• CBS Corp. : 6
• News Corp.: 24
• Viacom: N/A
• Time Warner: 9.5
• Disney: 13
• Yahoo: 22

Source: Smartmoney.com, Morningstar

The big problem, of course, is that a prolonged recession could bring down the earnings of these companies in the future. Remember that part of Lehman's thesis is that they will suffer in "packaged media," as the Internet siphons off more entertainment revenue. But so far, earnings in the entertainment media sector have held up surprisingly well.

Can earnings come down? Of course. But that's why the stocks have already been crushed, on a fear of a prolonged consumer recession. The bad news is already being cooked in. Would I buy any of them now? Gun to my head, I would take Disney, which appears to be the in the best shape of them all.