Media companies have not rested on their laurels
For the first decade of this century, the media sector was out of favour with investors, and for good reason. In the late 1990’s media share prices rose exponentially as they formed the M in the 'TMT' bubble (technology, media and telecommunications). Hopes that any business with a website or content would generate substantial internet revenues and profits were soon dashed as reality took hold.
There have indeed been big winners like Amazon and Google but the internet has also delivered a massive challenge to information businesses. Telephone directories have been side-lined by internet search engines and classified advertising for jobs and cars has shifted online at a tremendous pace. Display advertising in newspapers has partially moved online and many other revenue streams have faced significant new competition.
So it is a fair question to ask: why have we been investing heavily in the media sector in the past two years? As with most strong ideas, the answer reflects a number of themes that have come together to provide, in our opinion, a very exciting investment opportunity.
Firstly, the media companies have not been resting on their laurels. Several of them have changed significantly in response to the new environment. Change has involved acquisitions of new businesses and disposals of challenged assets. Change also includes developing those businesses that are well positioned and shrinking the more troubled subsidiaries. This restructuring has transformed certain businesses. By way of example, in the Past four years Daily Mail & General Trust has sold or closed 41 businesses, raising £351 million and acquired 27 more, for £170 million. Key disposals have included all or part of the Evening Standard, Northcliffe (local newspapers) their Australian radio assets, Teletext and many publications and exhibitions.
The second attraction of media companies, partly as a result of these restructurings, is that many now consist of a collection of strong businesses. They are predominantly selling to the corporate sector rather than consumers, with substantial competitive barriers to entry, such as proprietary 'must have' information, software or key services. For example, despite its name, the Daily Mail & General Trust only makes 27 per cent of profits from consumer businesses, including its eponymous newspaper. We favour businesses servicing the corporate sector at present because most large companies are in reasonably robust financial shape and can afford to spend incrementally on marketing services, exhibitions, PR etc. to try to grow. This is in stark contrast to both the consumer and government sectors where high debt levels are constraining spending.
Another feature of the media sector is the ability to exploit the internet to deliver additional services to customers. This was the hope that drove the TMT bubble and in some cases it is now finally becoming a reality. For example Reed Elsevier, which is amongst the world’s largest academic, medical and legal publishers, is able to integrate its proprietary information and services into the workflow of lawyers and doctors to make them more efficient at their jobs. This opens up new revenue opportunities for the business as well as securing an even stronger bond between customer and provider. Even newspapers can exploit the internet and The MailOnline has become the world’s largest online news site with over 100 million unique browsers a month and £28m of revenue in the last financial year.
The final but critical attraction of media businesses as investment opportunities has been their low valuations. Perhaps because of the earlier excitement about the internet revolution and the subsequent severe hangover, many investors avoided taking a close look at the media sector. As companies restructured the overall financial performance may have been mediocre, at best, even though the quality and growth prospects of the resulting portfolio were improving. This led to many high quality companies trading on extremely attractive valuations.
United Business Media (UBM) is a company that demonstrates all of the above characteristics. Back in 2005 almost a third of profits came from printed magazines. Print now represents less than 5 per cent of profits. After numerous disposals and acquisitions the business has three main activities, all targeted at the business community. Events makes up over 60 per cent of profits. Large exhibitions and trade shows are very important networking and sales destinations for many industries. The big events have huge scale advantages and UBM has some excellent shows. This business is growing fast with 40 per cent of their sales in emerging markets. Cash flow is strong with exhibitors generally paying in advance and there is limited capital employed so financial returns are high. UBM’s other main businesses are PR Newswire which delivers communications services for corporates and a data services business. Both of these are able to utilise the internet to deliver additional services and improved functionality.
In terms of valuation, UBM has been very lowly priced for much of the last two years. We have been able to buy the shares with a single digit p/e ratio, a free cash flow yield of more than 10 per cent and a dividend yield of around 6 per cent. Recently the shares have been strong performers although we still find the valuation very reasonable for a strong, well-positioned business.
Simon Gergel is the manager of the Merchants Trust