Analyst Downgrades Entertainment Sector, Stocks of Viacom, Time Warner

Morgan Stanley's Benjamin Swinburne cites a "diminished ad outlook," "eroding subscriber bases" and "foreign exchange headwinds," but upgrades Starz.

Morgan Stanley analyst Benjamin Swinburne on Tuesday downgraded his rating on the entertainment sector from "overweight" to "cautious" and downgraded his ratings on Viacom's and Time Warner's stocks.

He cited a "diminished ad outlook," "eroding subscriber bases" and "foreign exchange headwinds," leading him to cut estimates across the sector and lowering price targets on big sector stocks.

"Media's cyclical (ad recovery) and structural (content monetization) tailwinds have faded," Swinburne argued in a report. "Sources of recent incremental earnings are now driving painful fragmentation — both in ad share and pay TV subs. After five years of outperformance, we move to "cautious" as margins and multiples correct."

Read more Media Stocks 2014: The Winners and Losers

Industry stocks were in-line performers in 2014 and "outperformed the market over the last two and five years nicely," Swinburne said. "As bulls, we argued that changes in consumer behavior, the emergence of new content distribution models globally and opportunities to optimize asset portfolios and capital structures were investment tenets that could drive a multi-year super-cycle in media. We believe the next phase in the evolution of these generally well-run, high-margin businesses will be a challenging period of falling returns."

He added: "The days of pushing through double-digit price increases on its distributors will come to an end. The growth in online video licensing, which has been staggering, has slowed and the related erosion of viewership will accelerate. As a result, the operating leverage that drove margins up (about) 500 basis points since 2010 will likely lead to margin compression. Finally, creating value by spinning off non-core assets and raising financial leverage has been played out."

Discussing cord-cutting, Swinburne said pay TV subscribers were flattish in 2014, but added that "we think cord shaving reduced the expanded basic count by 1 million-2 million." He added: "We think this will continue as consumers face more choices and distributors face more pressure to adopt and make more aggressive carriage and packaging decisions."

Swinburne said he would revisit the "overweight" rating on the sector media "if the group fades to a below S&P multiple," saying he currently prefers cable and satellite TV stocks.

Read more Wall Street's Entertainment Stock Picks for 2015: Disney, Fox, Time Warner

The analyst downgraded his stock rating on Viacom to "underweight," writing: "Ratings erosion has left domestic ad revenues flat since fiscal year 2011. Looking ahead for Viacom and the industry, we layer in subscriber erosion. Despite recent share underperformance, pressure on that key second revenue stream has outsized risk to Viacom shares, particularly if it slows [stock] buyback levels."

Swinburne also downgraded his Time Warner stock rating to "equal-weight," saying in the report's title: "Well done." Explained the analyst: "Our bullish thesis has played out. TW has optimized its asset portfolio, capital and cost structures. Shares have re-rated, and it has outperformed the group by about 35 percentage points in the last two years. This success, along with growing concern over a fraying cable bundle leads us to move to "equal-weight"."

Swinburne said he continues to have "overweight" ratings on the stocks of "2014 laggards CBS and DreamWorks Animation," as well as 21st Century Fox due to its accelerating financial growth. The analyst also upgraded Starz to "over-weight," citing "M&A optionality and premium nets pivoting to OTT."

Email: Georg.Szalai@THR.com
Twitter: @georgszalai

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