Shares digital

As media underperforms the market yet again, Russ Mould takes a hard look at the sector to see what’s happening – and where investors should be looking

After a promising start to the year, the Media sector has begun to underperform the wider UK equity market yet again. This is despite a reasonable economic backdrop, plentiful merger and acquisition activity and the prospect of the Olympic Games, European Football Championships and US Presidential elections all boosting advertising spend in 2008. If this weakness persists it will make it the eighth consecutive year of underperformance, dating back to the collapse of the TMT bubble in 2000.

‘Years of sector underperformance fuelled by the disruptive impact of digitisation on traditional business models shows no end,’ confirms Mark Beilby of investment bank Dresdner Kleinwort.

Yet 2007 had begun so promisingly. America’s Tribune newspaper group was snapped up by entrepreneur Sam Zell for $3.9 billion, Canada’s Thomson (TOC:NYSE) swooped for information provider Reuters (RTR) in an $18.3 billion deal and Rupert Murdoch reaffirmed his faith in newsprint when he bought the Wall Street Journal’s owner Dow Jones for $5 billion. Media industry moguls clearly thought sector valuations were cheap and cash flows still plentiful. Equity investors have refused to follow their lead.

One concern is the macro-economic environment. After the summer’s credit crunch, consumer confidence indicators have begun to weaken in Europe and the USA, a trend which could hit consumer publishers, broadcasters and advertisers if it persists. Another is technological change. A recent survey shows European internet users now spend an average of over 14 hours a week scouring the web, compared to 11 hours watching TV.

‘Consumers are changing their habits rapidly,’ affirms Dresdner Kleinwort’s Beilby. ‘We have moved from a ‘push’ environment, whereby it was possible for media groups to ‘push’ media out in one distribution lump leaving consumers with the option to accept or reject only what was available, to a ‘pull’ environment, where consumers ‘pull’ down the exact media they wish to consume.’

The third is the rise of social networking sites. Facebook, Bebo, MySpace and YouTube have, for many, replaced TV, radio and newspapers altogether. The rise of user-generated content, and a growing desire among consumers for content that is free, strikes at the very heart of traditional media models.

Of course, such disruption does create opportunities for the fleet of foot. Publishing Technology (PTO:AIM) was created via a reverse takeover of Ingenta in February and handles online publishing and web pages for book publishers.

‘Playing online is a must in publishing in the next five years,’ explains chief executive George Lossius. ‘It is the burning issue.’

Blinkx (BLNX:AIM) was spun out of Autonomy (AU.) in May and has quickly established itself as a leading video search engine. The San Francisco firm is well positioned to benefit from the fragmentation of media models.

Michael Grade’s turnaround plans for ITV (ITV) have been badly holed by the phone-in scandals, while radio and newspaper stocks still look set to struggle, even if a planned £95.1 million rights issue should buy SMG (SMG) vital breathing space. The best big cap bet looks to be Reed Elsevier (REL). Reed may not be immune to any macro-economic downturn but it has solid defensive characteristics and has plans to return $4 billion to shareholders in special dividends and buybacks next year, once its planned sale of Harcourt Education has been cleared by regulators.

Shares says:

BUY ITV, Publishing Tech., Reed Elsevier

HOLD Blinkx