FULL REPORT INCLUDING DISCLOSURES AND CHARTS CAN BE FOUND HERE: Madison & Wall 8-9-13.pdf
As we continue to think through the impact on the media industry from the announced merger of Omnicom and Publicis it is appropriate to attempt to quantify the degree to which media owners may be hurt, and to how they can mitigate the issue. Media owners are in a much weaker position as a consequence of the deal because the manner in which they negotiate with buyers will shift, with buyers improving their advantage in the coming years.
The merger will cause media inflation to fall for many large nationally oriented media owners, and indirectly will lead to revenue growth curtailment in our view. Media inflation will most likely still occur, but it will probably be at a slower pace than it has been in the past, and this will in turn lead to long-term revenue growth reductions.
Applying some simplified assumptions, we preliminarily estimate that ad spending by large advertisers on national media owners' properties will fall by perhaps 1-3% vs. what would otherwise have occurred. By our estimates, such a change would translate into an average loss of 3% in equity value for 9 major national media owners, or $15 billion of equity value in total. If it occurs, this value does not disappear: instead, it will reflect value reclaimed by agencies and the marketers they work for, who will be in a better position to receive the same quantity of media (i.e. numbers of impressions) for less money in the future. However, the actual degree of decline will not become evident for several years to come, and media owners will have time to establish new negotiating levers of their own which could yet prevent such a value transfer from occurring.
In this report, we articulate our views on how the merger will impact media negotiations and then revenue growth. Approaching the topic in a more visual manner, subsequent pages (in the linked PDF) show the factors impacting agency holding companies and media owners going forward.
Is Media Price Inflation Over?
For as long as we have been opining on such matters, we have stated that TV advertising was relatively immune to decline. DVRs were never going to hurt the industry, and neither was the internet in general ; nor online video in particular. The reason for our historical optimism was that a) we always saw TV as the "least bad" form of advertising in terms of the medium's unique ability to satisfy large marketer goals, and b) media negotiations were impacted by an industry structure which perennially favored the media owners over advertisers and marketers, and enabled pricing power to translate into better-than-otherwise-would-have-occurred revenue growth for the medium.
Media owners will retain their advantage for the next couple of years at least (and thus we don't expect anything to interrupt historical trends over that time), but the reshaping of the industry that we think will flow from the merger of Omnicom and Publicis will at least partially reverse the media owners' advantage. From the perspective of equity investors who establish fair prices for securities based largely on the value of cashflows generated far out into the future, assessing the consequences of the merger will matter.
Network TV CPMs Have Grown By Average of 7% Each Year On Average Since 1980, Driving Industry Revenue Growth at the Same Time. Advertisers Would Prefer This Trend Comes To An End. We have previously demonstrated that broadcast networks translate negotiating advantage into price increases that have far exceeded revenue growth. The notional value of the content they produce is important, of course, but value is far from the sole driver of price for a good or service as any supplier of child care or consumer of water can attest. Arguably, advertisers buy network TV for its reach advantage more than the content quality, and on this basis we could easily argue that the quality of the advertising product has diminished at the same time as pricing rose substantially.
By our estimates, the pricing of broadcast network prime time inventory exhibited a CAGR of 7% between 1980 and 2012, a period during which consumer price inflation rose by a CAGR of only 3%. Revenue for network TV grew by a CAGR of 4% during the same period, leading to a tripling of revenue. Much of the revenue growth occurred because of the introduction of new categories of marketers (wireless, pharmaceuticals, film studios, consumer electronics, big box retailers, etc.), partially offsetting the shifts of budget shares from network and into cable that occurred because like-for-like inflation levels were so high.
Pricing power is important because it is a key factor supporting long-term revenue growth even if it does not impact marketers' absolute budgets in any one given year. Further, the pricing power networks have realized are important to the broader industry because their price increases have served as "anchors" (in negotiation parlance) for the negotiations that cable networks undertake with agencies. Thus, sustained levels of media inflation have gone a long way towards driving the growth of national TV advertising in the US. Between 1980 and 2012, national TV (including broadcast network, national cable and syndication advertising) grew by a CAGR of 7% vs. the broader advertising industry which grew by a CAGR of 4%, according to Magna Global data. New categories of advertisers certainly contributed a significant share of this growth as well, of course.
Incentives to Drive Pricing (and Spending) Down Via Centralized Negotiations at the New Publicis-Omnicom Group Will Be Strong, While Risks to Centralizing Will Be Limited. Our view is that within two years following the merger's completion (i.e. in time for the 2016 Upfronts), Publicis Omnicom Group will have established common oversight over their media agencies, and we expect that this will lead to alteration of the manner in which they negotiate. If they choose to more closely mirror GroupM's one-voice-to-the-market approach, media owners will face two dominant players who will account for the majority of revenues of many of the country's media owners. With the kind of centralization we expect, agencies will be better positioned to minimize the use of media buying tactics which contribute to media inflation. A larger and centralized group can get a better read on the market, identifying which media owners will be weakest or strongest and which can be played off against each other. This can then flow through to the media property selection process. Our guess is that whatever the degree that these sorts of tactics are common today, they will become much more common in the future.
The day-to-day clients of many media agencies tend to prefer tactics that are more customized to individual client needs, and media agencies who are smaller will continue to position themselves as better able to meet these needs. However, the role of procurement in marketing is becoming increasingly powerful, and our guess is that the preferences of day-to-day marketer-side media directors will be increasingly over-ruled if cost savings are to be had. Whether or not they are, we think that procurement teams will expect savings, and demand their agencies organize in a manner which accomplishes these goals. Happily for the agencies, fewer entities negotiating with media owners puts the agencies in a better position to do so. Further, we think agencies will aim to focus on driving prices down because we expect that a growing share of their compensation will become tied to the savings they produce.
But Why Will It Happen Now? Our view is in some ways controversial, because it runs in the face of a fairly important fact: Publicis' media agencies are already larger than GroupM in the United States, and they don't centralize their negotiations at this time, so why will this change? Our view is that there were risks involved with centralization before now, and the benefits were less pronounced than they will be with the company's new heft.
Previous attempts to centralize negotiations would have faced some risk that clients who disliked the approach might leave their agency for another. But with the bulk of the market embracing one model, and expectations that other agencies will also merge and face internal disruptions of their own, there is no real benefit to changing agencies because a marketer dislikes the buying model. There won't really be much choice outside of the global holding companies for many marketers, as there are only a handful of large independent agencies, but none operate on a global or pan-regional basis. On that basis, the media agencies will choose to organize in ways that they think are most profitable for them, which we think will involve more centralization and more efforts to drive media costs down. Most critically, a trend that has been taking root in recent years is becoming increasingly important all the time: procurement professionals are increasingly powerful players inside of marketing organizations. Our view is that procurement teams will not only encourage, but demand that agencies organize in a manner which drives down prices.
How Much In Savings Will Agencies Drive With Additional Consolidation? We can only speculate to what degree agencies can reverse the inflationary trends that have ruled the television industry since its inception. Some content will still matter (especially sports), and so agencies will have a limited ability to walk away from negotiations in their entirety, a fact that media owners will try to capitalize on at every turn. But it seems like inflation for the industry might at least be contained to something closer to the consumer price index, and this will have some flow-through effects on budgeting. In other words, in any given year we would expect some containment in pricing, but only a smaller degree of containment of revenue. Thus our guess is that we will see a low single digit reduction in growth of between 1-3% vs. what might otherwise have occurred.
How Much Will This Hurt Media Owners? And To What Degree Will Marketers and Agencies Benefit? Taking that mid-range, if we assumed that advertising at major media owners grew at a pace that was 2% slower annually than would otherwise have been the case, we calculate a 3% decline in current equity valuations. Putting this in perspective, if we consider AMC (AMCX, N/R), CBS (CBS, Buy), Comcast (CMCSA, Buy - covered by our colleague Jeffrey Wlodarczak), Disney (DIS, N/R), Discovery Communications (DISCA, Hold), Fox (FOXA, N/R), Scripps (SNI, N/R), Time Warner (TWX, N/R), Viacom (VIAB, Buy), the $480 billion valuation of these companies would be negatively impacted to the tune of $15 billion by such a decline if the negative impact hit each company's advertising growth rate equally.
To derive this figure, we calculated market-implied growth rates embedded in terminal values we calculated on a standardized basis for periods beyond 2017. We then assumed that half of every dollar generated from advertising would otherwise have flowed through to free cashflow (effectively assuming that contribution margins from ad revenues are 70-80% and that taxes eat up 30-40% of this amount). We further accounted for the share of revenue the company generates from advertising, and weighted the effects of changes to growth rates for the advertising portion of the business only.
It is worth highlighting that it is not as if this value will disappear: instead, it will reflect value reclaimed by agencies and the marketers they work for, who essentially will be in a better position to receive the same quantity of media (i.e. numbers of impressions) for less money in the future. It would seem more likely than not that larger marketers will extract these gains most directly, although they will likely be paying agencies more for the privilege of working with them, so indirectly agencies will be beneficiaries too.
Can Media Owners Mitigate The Issue? Media owners are unlikely to stand still, of course. We would expect to see media owners extend the degree to which they bundle scarce inventory (football, for example) with that which is not. They can also focus on selling advertisers integrated marketing solutions more than they do now, emphasizing such packages more than "spots and dots" alone. Media owners who are disproportionately focused on marketing solutions which are about more than just GRPs will fare much better than those who are not. Or they can emphasize the degree to which their business mixes are dependent on generating revenues directly from consumers.
To highlight our views in a more visual manner, the above linked PDF show the factors impacting agency holding companies in context of Publicis and Omnicom merging. We then show the consequences of seven distinct buying groups evolving into three (with some smaller independents rounding out the industry at a national level).
Brian Wieser is a Senior Analyst at Pivotal Research Group, where he covers securities which are impacted by the advertising economy, including Facebook, Google, Yahoo, Interpublic, Omnicom, WPP, Publicis, Nielsen, CBS, Viacom and Discovery Communications.
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