Wall St. Speaks Out: In God We Trust (Everyone Else Bring Data)

REPORT INCLUDING DISCLOSURES CAN BE FOUND HERE: Madison and Wall 11-7-14.pdf

The issue of secular vs. cyclical shifts of spending in advertising remains as one of the most critical factors impacting media stocks and played out as an important issue this past week over the course of a flurry of earnings reports from owners of national TV properties. For example, price swings such as Discovery Communications' 10% fall-off following the release of its weak third quarter earnings were due at least in part to much softer domestic advertising results and less visibility on the fourth quarter than was expected. Commentary from Fox's Chase Carey regarding cyclical issues echoed points that we have been making in recent months about relative weakness in advertising this year vs. last. However, the notion that a secular shift in ad spending is accelerating still prevails among many, who will point to accelerating growth among digital media owners to support their arguments.

Which view (or views) are right? As the vast majority of media owners have now reported their third quarter results, we can put our own conjecture aside for the moment and first focus on what the data suggests is actually happening:

· National TV looks like it grew by around 1% year over year during the third quarter of 2014 (Viacom has not yet reported, but we are assuming its domestic ad revenues decline by around 4.5% year over year here). This compares with our updated estimates of around 2% growth during the second quarter and 4% during the first quarter, excluding incremental spending associated with the Olympics. If growth holds constant during the fourth quarter and our estimates hold for the other quarters of the year, the full year will post 2% growth on a normalized (ex-incremental Olympics and political) basis. This contrasts with last year's equivalent figure, which was 4.6%.

· On our estimates, total normalized advertising across all media appears to be growing in line with where we forecast it in June: the third quarter looks likely to have grown by 2.5%. The year-to-date figure is much the same, as growth fell off from a 3.2% level during the first quarter and was roughly in line with the ~1.8% growth rate we estimate occurred during the second quarter. This is a slower pace of growth than in 2013, which was 3.2% for the full year

· If these figures hold, it would be accurate to say that national TV advertising lost share of total advertising spending during the third quarter, falling from 22.1% to 21.8% of total advertising. As a percentage of total national advertising national TV would have fallen from 58.0% last year to 57.0% this year. However, it would not appear to be accurate to say that national TV advertising lost share of total normalized advertising during the first and second quarters of the year, at least on the market growth estimates we believe to be most accurate at this point in time.

· Total internet advertising appears to have accelerated during the third quarter vs. the second quarter at least, rising by around 16.5% during the quarter, ahead of the second quarter's 14.0% pace. On current estimates, this represented an expansion from 24.0% of normalized advertising during 3Q13 to around 27.3% during the most recent quarter.

· Print-based media continue to post significant declines. National magazine titles appeared to be down in a mid-single digit range this quarter; yellow pages were down by around 20% once again; local newspapers were likely down by nearly 10% this quarter.

· Among the 20-or-so marketers who provide quarterly data, we can see that total worldwide advertising or marketing spending typically grew last year by high single digit levels. This year comparable figures are in the low single digits.

· If we exclude the six of the biggest web-based advertisers (including Amazon, Google, Priceline, Expedia, IAC and eBay) for whom we have data on marketing or advertising spending, we can instead see mid-single digit growth for the "traditional" advertisers last year and growth ranging from -1% to +1% each quarter this year.

· The web endemics' growth rates have taken the opposite course this year vs. last. For these six companies, median spending growth was 24% over the course of all of 2013, consistent with growth in each of the first two quarters of this year. But during the third quarter, median spending growth by these companies accelerated to 29% year-over-year, and weighted average spending did much the same, accelerating to 30% year over year.

But back to our interpretation(s).

At minimum this data reflects to us that most media owners and most investors expected that 2014 would be a faster growing year than 2013 because logic suggests that an improving economy should cause faster total advertising growth in one year relative to another. Unfortunately this ignored that last year outpaced the growth rate we should have seen by around 2%, making for unrealistic expectations for this year to begin with as well as unexpectedly tough comparables. This strongly suggests to us that there are significant cyclical elements at play. Towards that end, a resumption of spending in the advertising economy above this year's levels still seems likely eventually, in our view. The significant change in spending trends by the brands who are more representative of TV advertisers seemed to be as much in reaction to high spending levels during 2013 as they are to shifts in media preferences. At the same time, the data reinforces our view that a critical source of growth in advertising revenue for digital media owners is digital media spending. With growth levels such as those conveyed here, endemics may be accounting for a rising share of total digital media owner ad revenues.

Traditional marketers are adding to growth in digital media, of course, as they have for many years by now. Unilever said on its earnings call last week that it is now allocating 20% of its advertising to digital media. General Mills has said it will be at the same level this year for its US ad budget. Yum Brands has noted that 40% of its spending on Pizza Hut is going to digital. All of them would have been at 0 some time between 10 and 20 years ago. However, those spending levels don't emerge suddenly at an industry level, and a good chunk of the spending growth to come will still come out of print as much as – if not more than – TV because digital media is generally used to satisfy the goals that print historically accomplished. Magazines and national newspapers still have a good $13bn per year in total ad revenue, accounting for around 16% of national advertising. Declines of share of around 2% per year each year over each of the past five years during which national TV has been relatively stable at 59% of the national figure. Whether or not that share will hold into the future probably depends at least in part on traditional brands resuming spending growth on advertising more generally. The emergence of new mass market brands is important, too, but the timing of those brands' arrivals is always uncertain in advance.

Perhaps most importantly, this data reinforces to us that the changing nature of the broader economy is reflected in ad revenue share gains that digital media owners generate from web-based endemics. E-commerce makes it easier than ever to be a small manufacturer with national scale, supported by marketing efforts that are most cost-effectively executed via digital media. Although we think that significant economic changes, such as a meaningful reduction in the importance of large brands in society will take time to play out and only do so gradually, we are mindful it could be happening at an accelerated pace. This would have more significant repercussions for both digital media and national TV than the shifts inside of any given marketer. But until we see some better data than any we have seen so far to support that view, we'll continue to presume that this change, like most others, remains more consistently incremental.

Brian Wieser is a Senior Analyst at Pivotal Research Group, where he covers securities which areimpacted by the advertising economy, including Facebook, Google, Yahoo, Interpublic, Omnicom, WPP, Publicis, Nielsen, CBS, Viacom and Discovery Communications. Brian can be reached at brian@pvtl.com.

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