Cornerstone Capital’s sector strategy model is overweight on the MSCI ACWI Consumer Discretionary Index, which contains a number of global media industries including Cable & Satellite (9% of the index’s market cap, the second largest weight after Auto Manufacturers), Movies and Entertainment (7% weight, fourth-largest in the index), and Casinos & Gaming (4% weight, tenth largest). So, in aggregate, these three media industries account for about 20% of the Consumer Discretionary Index.
THE “OLD” MEDIA MODEL
Up until the latter part of the twentieth century, media companies in general engaged in the creation of content, and then distributed this content to offer a platform to advertisers and generate revenues from consumers. However, reflecting technological innovation, the nature of content and its distribution mechanisms have been evolving rapidly. The rise of social media has created a brand new medium for consumers themselves.
When business models in the media sector were built around the generation of advertising sales and consumer revenues, stock market valuations were driven by a number of metrics that were continuously tracked for around a half century. These metrics included: movie and television ratings, market share, time spent viewing/listening, average revenue per user (“ARPU”), subscribers and circulation. As technological innovation impacted the sector and media expanded to the Internet, other metrics were tracked, including unique visitors, page views, and number of users. The newest suites of tools look to further make sense of our multi-channel world, tacking on Twitter mentions, video ad exposure and content viewed across mobile and tablet platforms.
VALUING THE “OLD” MEDIA MODEL
Given that the primary assets of media companies have largely been intangible and embodied in the form of intellectual property rights, it made sense to base valuations on the expected future profits that the control of such rights might convey over time. Estimated free cash flow discounted back to a present value has been the preferred metric used to estimate the value of this profit potential.
Note that Price-to-Earnings multiples were often not meaningful, given that many of the “old” media companies regularly reported significant losses. The reason is that, as noted above, the primary assets of media companies are largely intangible. Under international and U.S. accounting standards for acquisitions, all acquired intangibles assets (e.g., goodwill, programming and publishing rights) are recorded at their fair value on the balance sheet. Acquisitive growth has long been a key growth driver for the sector, so that the amortization of intangible assets has weighed on net income in the sector.
Price-to-Free Cash Flow (P/FCF) multiples became the most popular determinant of relative value among media stocks. This reflected the adding back of amortization of intangibles (for the reasons outlined above) and stock based compensation expense. Media companies have been among the biggest issuers of stock-based compensation — six of the 10 highest-earning U.S. chief executives in 2013 were in the media industry. Investors were typically most interested in those companies that had low P/FCF multiples (or the equivalent, high free cash flow yields).
Another metric that has been widely used to value companies in different segments of the media sector is the Enterprise Value-to-EBITDA (EV/EBITDA) multiple. (EBITDA is essentially net income with interest, taxes, depreciation, and amortization added back to it.) The attraction of this metric is that it can be used to compare companies with varying capital structures since it takes debt into account in the numerator.
THE “NEW” MEDIA MODEL
As noted, P/FCF and EV/EBITDA multiples were used almost exclusively to value the “old” media model that was dependent on advertising fees and consumer revenues. Technological innovation has upended that model in two significant ways:
• Consumers are increasingly able to bypass media distributors and access content directly. In other words, consumers can “pull” the television shows and movies they want, when they want, rather than having it “pushed” at them. Think of the offerings from Hulu, Netflix or Amazon Prime.
• Today, the average consumer, particularly the younger demographic, is quite accustomed to getting content free online (via PC, smartphone, tablet or other device).
However, it is still the case that the primary assets of media companies — “old” and “new” — are largely intangible and embodied in the form of intellectual property rights. Moreover, in contrast to tangible assets in the media sector (e.g., a communications network or a chain of movie studios), intellectual property is both created and experienced in the human mind. So, among the most valuable assets of media companies, are the minds of their employees (in addition to brand values, libraries, franchises etc.)
INCORPORATING ESG FACTORS INTO MEDIA SECTOR VALUATIONS
In the first iteration of the sector equity strategy model (introduced in the May 2014 Journal of Sustainable Finance & Banking), we utilized ESG metrics calculated by MSCI. Figure 1 illustrates that, according to a Deutsche Bank analysis of that data,18social factors are particularly important in the Consumer Discretionary sector, which includes Media.
This is largely consistent with the analysis above (although the importance of Environmental factors in the media sector are likely overstated in Figure 1). Superior management of human resources (the “S” in ESG) is critical to long-term success in media, an industry that is reliant on the intellectual capital and continuous innovation of its workforce in order to compete through the production and distribution of valuable content.
With regard to the Governance weight, given that acquisitive growth is a key long-term growth driver for the sector, watchful corporate governance is critical since acquisitions are subject to the approval of corporate boards. Media companies acquire assets for various reasons, but principally to get hold of employee talent and intellectual property on which the companies depend for the creation and distribution of valuable content.
As we continue to incorporate ESG metrics into our valuation framework, we will increasingly be placing a heavier weight on ESG factors that are critical to specific industries, such as human capital management and corporate governance in the media sector.
Michael Geraghty is the Global Markets Strategist at Cornerstone Capital Inc. He has over three decades of experience in the financial services industry including working as an investment strategist at UBS and Citi.