Media Stocks: Pandora's Problems, Plus Why Cable and Satellite Stocks Keep Looking Better

By Steve Birenberg

Following a pretty good earnings season, media stocks are back focused on big-picture issues. The news is good if the economy holds together.

There are still a smattering of media earnings to be reported including Carmike Cinemas (CKEC) and AMC Networks (AMCX). Pandora Media (P) also was a late reporter, and the news there was poor as earnings came in light and guidance for the next quarter was 20% below expectations on the top line. I picked up on the potential weakness at the Deutsche Bank (DB) conference I attended the last week of February (see Big-Picture Takeaways From the Deutsche Bank 2012 Media & Telecom Conference). Fortunately, I am short Pandora, which is down 23% today. The big challenge is how quickly the company monetizes its rapidly growing and now dominant mobile listening. Ad revenue per user stalled in the January quarter and guidance suggests that continues to be the case in the April quarter.

Pandora is a great service and users love it. However, the business model is tricky for several reasons. First, there is unlimited inventory of Internet radio which serves to depress CPMs. Second, there is no infrastructure in place to sell local advertising. Media buyers do not receive the normal data they get when placing orders. In addition, Pandora is only beginning to build a local sales force, which is necessary to steal market share from terrestrial radio. Third, due to investment required to build the sales force and content royalty payments tied to listening hours, at current revenue levels there is no operating leverage in Pandora's financial model. This remains a problem until monetization of mobile listening improves. The stall on that front explains the stock's fall today. Pandora is a good example of a company with a product consumers love that may not translate into a good investment.

Other than earnings this week, I noticed several stories that impact the media stock landscape. First, Major League Baseball has expanded its playoffs by two teams. I think this only adds two games to the playoffs but there is big money on the table for the league and the networks. Current playoff rights holders Fox and Turner seem best positioned to broadcast the games but MLB has its own network and ESPN to bid up prices. In addition, NBC Sports Network, although with no baseball programming of note, seems likely to be interested. Sports has been the unchallenged leader the last few years whether at broadcast, national or regional cable networks. MLB is tapping that strength by expanding its playoffs.

American Idol ratings are unexpectedly down sharply. Season to date it's off 30% with some recent shows down 35-40%. CBS (CBS) is regularly beating American Idol on Thursday nights. It is not clear whether it is the show itself or the expansion of voice competitions (NBC's The Voice is doing well and Fox is self-cannibalizing with X Factor). At the DB Conference, Doug Mitchelson, the firm's excellent media analyst, insightfully asked Chase Carey if News Corporation (NWSA) guidance for mid-teens operating income growth in the year ending June incorporated the weak Idol ratings. Doug estimates Idol could provide as much as 40% of Fox's gross rating points. Carey indicated the ratings weakness was included, reducing a key risk point for News Corporation longs, including yours truly. Fox does face a challenge at the upfront given Idol's weakness. The company is also cancelling House and Terra Nova but those programs are so expensive to produce that even poorly rated substitutes will likely help profits next TV season.

One of my investment themes in media is an emerging détente among multichannel TV providers as they all respond to rapidly rising program costs and negligible housing formation with less price discounting (see Is a Bullish Detente Brewing Among Multichannel TV Service Providers?). Also helping the industry is stabilization in video subs. According to Jason Bazinet of Citicorp, total pay subs grew 386,000 in the fourth quarter bringing 2011's increase to almost 600,000. As Liberty's Greg Maffei noted on the company's last conference call, Jason is superb at crunching the numbers. Cable is losing to DBS and especially telco, but given that cord-cutting has been the dominant worry of cable investors, investor sentiment is improving. Cable is increasingly a broadband play and other revenues streams like telephony. Keep an eye on debt levels but generally cable and satellite stocks look increasingly attractive.

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