By John Janedis, Wachovia Capital Markets, LLC
Operationally, last year was disappointing for the industry, in our view, as ad revenues sank much further and more quickly than anticipated, in a decent macroeconomic environment.
As we start 2008, the challenges that the industry has faced – both secular and cyclical – over the past several years should continue. Traditional media is under attack from the Internet, which has impacted pricing power, delivery methods, commoditization of news, and cost structure, etc. of the business model.
Heading into 2007, we predicted a newspaper ad revenue decline (including online) of -0.6%, significantly better than our current 2007 estimate of -7.4%. The stocks performed poorly as well, declining on average more than 50% (excluding Tribune and Dow Jones), following a 14% decline in ’06.
Fortunately, expectations for the industry are low for 2008. We are expecting a 6.1% decline in total newspaper ad revenues in 2008. Risk to the downside is more likely than to the upside given recent trends, and a broader economic recession could drive industry revenues even lower.
Local to Remain Soft
Historically, local advertising has had less volatility than the other major ad categories. With softness in real estate having a ripple effect across several local ad categories in many markets, the timing of a recovery is unclear. If the weakness remains confined to existing markets, we could see improvement by late 2008; however, if it spreads, the category could post mid single digit declines and not recover until 2009.
Classifieds Remain Weak
Broadly speaking, the Internet continues to chip away at the traditional dominance of newspapers in the classified category. Longer-term, we view this as one of the biggest threats to the newspaper franchise, though newspaper companies appear to be investing in competitive offerings across verticals.
Help Wanted. We often wonder if the category is a leading indicator of the broader economy. In 2003 the category started to improve ahead of the government labor statistics. More recently, we’ve seen deterioration, suggesting further weakening in the U.S. economy this year. We forecast a 15% decline in the category, but note partnerships with / ownership of online recruitment sites should help growth rates.
Auto. Pressures within the industry have led to dramatic pullbacks in the category, which is now at levels not seen since the early 90’s. Ongoing dealer consolidation and other industry issues will likely further pressure revenue growth this year, translating to a 15% decline in ad dollars.
Real Estate. The CA, AZ, FL, and NV markets, along with the Internet have put significant pressure on the category, which based on our research, had been among the largest (and in many cases THE largest) driver of ad growth for the industry in 2005 and the first half of 2006. Migration to the Internet and the housing slump likely will continue to pressure revenues this year as demonstrated by an -18% expectation.
Trends here continue to be volatile. We expect continued weakness, though consolidation-driven reductions (among advertisers) in ad budgets should be less of an issue.
Newsprint Not Helping Costs
The downturn in advertising over the past few years led to a decline in newsprint prices. However, recent consolidation among suppliers and mill closings should translate to a better balance between supply and demand this year, with prices up 5-7% per metric ton.
Looking for New Revenue Streams
On a positive note, we viewed 2007 as “The Year of the Partnership” with newspaper companies linking up with each other, Internet/technology companies and others in an effort to drive revenue growth, offer better technology backbones to customers and cut costs. Combining with entities that are often viewed as competitors, such as Yahoo!, Google and Zillow, is a big step forward in thinking, in our view.
With the pressure on the traditional revenue streams, 2008 would mark the first full year that the industry will work to monetize the partnerships. E-commerce, local search, and other new Internet-centric revenues should start to have a modest impact on total ad revenues. We expect Internet ad revenues to account for approximately 8.6% of total industry revenues this year, approaching 10% in 2009.
This year should be interesting for the industry. We believe companies will focus on productivity improvements and cost reductions. We expect to see more partnerships with Internet companies (and Internet “tuck-in” acquisitions) and potentially partnerships with other newspaper companies in contiguous markets to reduce costs. Until revenue declines trend closer to zero, margin pressures will likely continue and broad investor appeal will remain elusive, in our opinion.