Interactive media steals the show

Study: Digital a bright spot in slightly underperforming media sector

By two important financial metrics, the overall media and entertainment industry has been underperforming the broader U.S. economy since 2003, according to a just-released study from Ernst & Young. But interactive media has been running strong.

The study, "Spotlight on Profitable Growth: Volume 2," found that EBITDA, or operating cash flow, growth in M&E — as it calls media and entertainment — had a compound annual growth rate, or CAGR, of 15%. That's below the 17% boasted by the broad-based S&P 500.

The other metric, EBITDA margin percentage, is 22% for M&E but 23% for the S&P 500.

EBITDA margin percentage is EBITDA dollars divided by revenue dollars and is a way for measuring how efficient companies are at converting sales to profits.

Ernst & Young uses EBITDA because it's a widely used metric by analysts and investors for determining the financial performance of media companies.

The report studied 75 leading M&E firms that, in aggregate, generate more than $100 billion in EBITDA annually.

While slightly underperforming relative to other U.S industries, M&E does well when compared with the rest of the global economy, said John Nendick, Ernst & Young's global leader for M&E.

Looking at 11 individual sectors within M&E, "interactive media is the headline," Nendick said. The sector's EBITDA dollars will have experienced 41% CAGR from 2003 through year's end, the study estimated, while margins have improved from 20% to 34%.

Driving such performance is the migration of advertising and marketing spending from offline to online media and the fact that there will be more than 1 billion Internet users by year's end, about triple where the figure was seven years ago.

Satellite TV, at a 35% CAGR, is second to interactive media in that metric, and its margins have expanded from about 14% to 23%. Cable networks and cable operators also score well.

Ernst & Young said much of satellite's success is in rising ARPU, or average revenue per user. "ARPU growth should continue over the next two years, driven by growth in premiums such as HD and DVR packages," the study found.

The conglomerates are in the middle of the pack of sectors, with 13% CAGR and margins that will have expanded from about 17% to 21% by year's end. Conglomerates, of course, have a harder time showing large CAGR because of the rule of large numbers and their presence in a range of subsectors.

The push into interactive can help. "Several conglomerates have recently become significant buyers of new interactive media companies, hoping to leverage those investments across their traditional businesses," the study indicated.

Showing the least CAGR is the video game sector, at -6%, as growing revenue thanks to higher sales of games seem outpaced by growing expenses. The sector also is at the bottom of margin percentage, going from 14% to 7%. Nendick, however, expects improvement as the hardware upgrade cycle matures.

Radio is the only other sector among the 11 studied with negative CAGR since 2003. But while CAGR is at -3%, it still boasts big margins, if not margin expansion. Margins there have fallen from 43% — an industry high — to 38%.

Ernst & Young makes no stock predictions based on its data, but judging from performance over a similar time frame, investors mostly have preferred high CAGR to high margins.

That's why the stocks of radio broadcasters — the sector with the highest margin percentage — have been laggards. As of Monday, Clear Channel Communications was up only 11% since the beginning of 2003, while Cox Radio is down 43% in that time frame and Entercom Communications is off 55%.

By comparison, stocks of those in sectors with big CAGR have generally done well. Even Yahoo, which has gone nowhere for more than two years, is up 219% since 2003.

Naturally, though, sector exceptions abound. For example in video games, the lowest in margin percentage and CAGR, Activision shares have vaulted 475% since 2003. And in satellite radio, a subsector of radio broadcast that has negative margins and declining CAGR, shares of Sirius Satellite Radio and XM Satellite Radio are up 467% and 460%, respectively.