Caution sign for media stocks

Ad-dependent companies could absorb a hit in Q4

With the third quarter of trading completed, most big media and entertainment stocks are up year-to-date.

However, industry watchers warn that fears of a recession in the U.S. and elsewhere — along with other macro-economic trends like rising oil prices — could hamper many sector stocks in the final quarter and beyond.

As for the year's final three months, "I expect that most media shares will be doing well just to trade sideways," said Hal Vogel, president of Vogel Capital Management and a longtime media and entertainment analyst.

Similarly, Goldman Sachs analyst Anthony Noto said in a report that at his investment bank's annual industry investor conference last month, "we found the tone of management to be more guarded and measured, indicating in our view a feeling of uncertainty regarding the economy and its impact on advertising."

This could leave media investors cautious, though Noto predicted "a one- to two-quarter lag before the media companies begin feeling the effect of a slowdown," which could see marketers rein in advertising spending — and maybe even see consumers curb discretionary spending on some entertainment options.

Particularly ad-dependent industry players would be the first to feel a stock hit, Street observers say. "A slowdown in economic growth, already being seen here but also in Europe, will slow both Viacom and CBS," Vogel said.

Wall Street sources also argue that big stock buybacks, which entertainment giants have used to return value to shareholders and boost their stocks, are less likely amid the recent debt-market crunch as companies will want to keep some financial powder dry.

As of Friday, which marked the end of the first nine months of the year, the broad-based S&P 500 stock index outperformed The Hollywood Reporter Showbiz 50 index. The two are up 7.6% and 6.4% year-to-date, respectively.

Sony Corp. remains the main outperformer among the largest entertainment biggies, though it lost some ground in the third quarter after ending the second quarter 20.2% ahead. It closed at $48.06 on Friday, 12.7% ahead of its year-end 2006 closing price of $42.64.

Liberty Media Capital, one part of John Malone's media firm, expanded its gains in the third quarter, finishing it at $124.83. That left the stock up 27.4% for the year-to-date period.

Shares of Time Warner lost more ground in the third quarter, ending it at $18.36, down 15% year-to-date. The world's largest media conglomerate's stock dropped 9.2% in the first quarter and made up much of that ground in the second quarter, only to fall deeper in the latest period.

In recent months, several analysts have suggested that TW shares have upside, predicting that the company could spin off or sell such assets as its cable, publishing and AOL units during the next 18 months or so. In recent days, some also have suggested that AOL could spin off only its ad business in an initial public offering.

Thomas Weisel Partners analyst Gordon Hodge in a Thursday report reiterated the possibility of spinoffs and suggested that the company could beat third-quarter earnings estimates when it reports results in a few weeks thanks in part to the success of "Harry Potter and the Order of the Phoenix."

He reiterated his "overweight" rating on the stock, saying there are short- and long-term factors that should ensure its appreciation.

Shares of Warner Music Group remained under pressure in the third quarter, finishing it at $10.10, near its 52-week low of $9.41 and less than half the $22.17 at which it had ended 2006.

Vogel predicts that some media giants will do better than others through the rest of the year. "My guess is Disney and News Corp., long my favorites, will continue to hold on best," he said. "But forget about holding on if oil goes to $90 or $100 in the fourth quarter," though that period usually sees oil price declines amid the end of hurricane and travel season.