Big media's reversal of fortune

Slowing DVD sales, ad forecast erasing sector's first-half gains

Wall Street continues to turn sour on media and entertainment stocks heading into 2008, even with several sector biggies already seeing their stocks near 52-week lows.

After gains in first-half 2007 for many sector biggies, the second half has brought a reversal for many, with Sony and Viacom the big exceptions among the conglomerates.

Bear Stearns' Spencer Wang on Monday became the latest analyst to turn bearish on the sector as he cut his rating on the overall industry from "market weight" to "market underweight," citing slowing DVD sales and slipping TV usage of younger demographics.

The DVD malaise along with lowered advertising market expectations are key factors that have driven media and entertainment stocks lower in recent weeks.

"The biggest problem is slowly eroding expectations" across the industry, said Lawrence Haverty, portfolio manager at Gamco Investors, pointing to the ad and DVD concerns as well as a reduced likelihood of big buyouts amid the global credit crunch.

Shares of Time Warner, News Corp., Disney and CBS Corp. have declined during the second half and are close to their year lows.

Smaller firms with a pure-play entertainment focus also suffered.

For example, Lionsgate shares closed at $11.03 on June 29 but finished at $9.55 on Monday — down 13.4% since the midyear point and off the $10.73 price as of the end of 2006.

Similarly, DreamWorks Animation's stock finished the first half at $28.84, down slightly from its 2006 closing price of $29.49. But since the midyear point, it has declined 12.3% to $25.29.

Not all stocks have been depressed. Sony's American depository shares are up 6.7% in the second half. The stock has benefited from a continued turnaround in the conglomerate's electronics business, a strong boxoffice and a recent investment from Dubai. Viacom shares also have bounced higher amid Wall Street confidence that the company's cable networks are gaining ratings momentum.

Goldman Sachs analyst Anthony Noto was one of the first on Wall Street to downgrade the entertainment sector in the fall. He established a "cautious" rating on the industry in September. He followed that up with a report last month that said there have been numerous company and macro-economic data points since then that have only strengthened his conviction that he made the right call.

A decline in DVD sales momentum is one negative trend that observers have pointed to of late, and things could get worse from here.

"The DVD market is rolling over and is down 3.5% year-over-year through the third quarter," Wang noted in Monday's report. "With little traction on HD so far, pricing pressure and less penetration opportunity left, we believe that the decline in the DVD market will accelerate in 2008 and beyond."

Pali Research analyst Richard Greenfield echoed Wang's bearishness on the DVD market in the U.S. In a blog post Monday, he said that his prediction that 2007 would be the first year of decreased consumer spending on DVDs "appears to be coming true."

Hollywood had hoped the strength of this summer's boxoffice would boost DVD trends, but "we believe the failure of several key fourth-quarter DVD titles (such as "Spider-Man 3" and "Shrek the Third," among others) will result in a modest decline in 2007 consumer spending on DVDs," Greenfield said.

Overall, the standard-definition DVD business has matured, catalog sales are "now falling rapidly," plus TV-DVD sales, which had so far been a pocket of strength, "have reached a plateau," he added.

Wang also fears that TV networks will start losing more audience reach. "Erosion is more pronounced in the younger 18-49 demo, likely due to broadband penetration now exceeding 50% of U.S. homes," he said. "This could negatively impact ad spend on TV over time."

Beyond the DVD and TV usage concerns, the sector also has been thrown into disarray by other factors, including the writers strike.

Longtime media analyst Hal Vogel said the strike could lead to a further disintegration of the ad market. "It may play havoc with the upfront market and opens the possibility that loyalty of viewers will be diminished or lost" further, he said.
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