Northlake Media Talk

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July 01, 2009

July 2009 Model Signals: A Shift to Value

For the first time since February, there has been a change on Northlake's Core and Explore ETF models. The Style model has moved to Value after spending 5 months at Growth. The new Value signal is weak, just barley in Value territory on Northlake's 0 to 100 scale. However, five of the nine underlying indicators now favor value and a sixth is rated neutral. The trend toward value has been in place for several months so this move comes as little surprise.

As a result of the new signal, all client positions in the Russell 1000 Growth (IWF) were swapped into the Russell 1000 Value (IWD). The effect on client portfolios is to shift exposure from technology, health care and consumer sectors to financial services, utility, and energy sectors. The shift is anticipating a second half recovery in the economy that favorably impacts the more cyclical parts of the economy.

The Growth signal since the beginning of February was very accurate and contributed favorably to client portfolio performance. While clients owned IWF, it gained almost 19% against an increase of less than 12% for the IWD. This is exactly how the model is supposed to function – capturing incremental performance in a major trend.

There was no change to the signal from Northlake's Market Cap model. It remains firmly in small cap territory although the signal has weakened slightly for two consecutive months. The small cap signal also anticipates better times ahead for the economy and continued improvement in credit market conditions.

Small caps, as represented by client exposure to the Russell 2000 (IWM) outperformed the S&P 500 in June for the second consecutive month. SO far in 2009, the Russell 2000 is up 3.6% vs. a gain of 2.5% for the S&P 500. Thus, the Market Cap model has done its job this year. The small cap signal has been in place since September 2008. During that time, small caps have lagged large caps by a little less than 2%. The small cap signal was early in anticipating an improved economic and stock market environment. Performance especially suffered during the initial portion of the market crash in the final quarter of 2008.

Disclosure: IWD and IWM are widely held by clients of Northlake Capital Management including in Steve Birenberg's personal accounts.

June 24, 2009

Over The Top Video Threat Less Than The Hype

The following commentary first appeared in the "Dow of Steve" blog on SNL Kagan's subscription website on June 17, 2009.

The most significant secular debate in the TV industry surrounds over the top video (OTT). Whether or not consumers cut the cord has significant ramifications for cable and satellite companies, broadcast and cable TV network owners, and TV and movie producers.

Presently, Wall Street is worried about over the top video. The secular challenge to the long-standing TV business model is rising just as advertising is under massive cyclical pressure due to the global recession, which has been especially severe for the auto industry, historically TV's largest source of advertising revenue.

Media companies face other challenges as well but I believe currently depressed price-earnings ratios for stocks with TV exposure reflect a high degree of bearishness about OTT. I believe the worries are overdone as any material impact is many years away. As a result, I currently focus my limited media stock exposure on TV related stocks including Discovery Communications and Liberty Media Entertainment as a proxy for DirecTV. Other TV stocks are on my watch list including CBS and Cablevision.

This blog post was triggered by a recent column by Henry Blodget published on The Business Insider section of Silicon Alley Insider. The title of Blodget's column pretty much says it all, "Sorry, There's No Way To Save The TV Business." Blodget compares the current state of the TV business to the newspaper industry in 2002-2003. We all know how the newspaper industry has imploded just seven years later so the warning is quite dire for TV.

I strongly encourage you to read the whole article including the comment section, which is unusually insightful. Here is a recap of Blodget's argument:

Blodget argues that the very successful TV industry has been built on a foundation that is crumbling. He believes the foundation is built on the fact (1) that there is not much else to do at home that is as simple and fun as TV, (2) that there is no way to get video content besides the TV, (3) that TV advertisers have few other options to reach consumers, (4) that cable and satellite have an oligopoly over TV delivery, and (5) that "tight choke points" exist throughout the TV business model "through which all video content must flow."

Blodget believes that each of these foundations is slowly crumbling and has reached critical mass where the damage to the TV business model is going to accelerate much as it did for the newspaper industry over the past seven years.

Sticking with Blodget's foundations, it is easy to see why he believes there is no way to save the TV business. And OTT is the single factor that is weakening each foundation. Blodget extends the comparison to newspapers by stating that TV executives are responding poorly to the OTT challenge much as newspaper executives failed to counter and adapt the internet revolution.

As I noted, I generally disagree with Blodget. My primary area of disagreement is that I see the timing of material financial impact from OTT as being very extended. SNL Kagan supports this view while noting (subscription required) that OTT will gain share it will come mostly from new household formation that never purchases the cord. In other words, total households receiving TV under current distribution models are going to be stable. Furthermore, as I have noted before, despite the massive increase in internet usage, video games, and home theaters, total TV viewing is still growing.

On their own, these two factors strongly suggest that the outlook for the TV business is not nearly as dire as Blodgett or other OTT advocates suggest. However, there are many other faults in the OTT argument which were neatly summarized in the comments section of Blodget's article by my good friend KG, a hedge fund manager specializing in media stocks since the 1980s.

KG makes five excellent points. First, he notes the "behavioral inertia" related to TV viewing. Couch potatoes are far deeper engrained in U.S. culture than newspaper readers including a generational aspect. Second, as I already noted, usage patterns for TV suggest little impact despite years of secular challenges to TV (fragmentation yes, loss of viewing no). Third, the ability to deliver massive numbers of simultaneous streams of OTT may crash the current wired broadband networks. Current wireless broadband networks have no chance to handle millions of mobile TV watchers. This problem only gets worse as HD TV becomes more engrained with TV viewers. HD files are much bigger than the current experience of OTT. Finally, KG notes that live sports and special events are uniquely suited to the current TV business model which delivers this programming very efficiently to tens of millions of simultaneous viewers.

Building on KG's last point, I believe the delivery of multichannel TV is far more efficient for TV viewers than OTT advocates realize. Yes, today we all pay for a package of hundreds of channels and only watch a handful. However, if each network were forced to go a la carte, which is essentially what OTT promises, few networks could survive. Food Network gets affiliate fees from 90 million households. Its advertising revenue is composed at least partly by companies seeking casual, channel surfing viewers. If Food Network goes OTT or a la carte, it will be forced to finance its operation on just a few million subscribers. Subscriptions fees will have to be $1-2 a month to offset lost revenue from cable and satellite companies. CPMs on committed OTT subscribers will have to rise sharply to produce similar advertising revenue. Without replacing this revenue, Food Network won’t be able to invest in quality programming and viewership could suffer.

And Food Network is relatively cheap to operate. Use the same concept on networks that program dramas or movies or sports or live events and three things happen. First, consumers will find that their a la carte monthly bill for TV viewing quickly rises to $30-50. Second, the quality of TV programming suffers across the board. Third, many networks will not survive enraging their committed viewers.

In the end, multichannel TV is a good deal for consumers – they get the channels they want for a fair price and lots of other channels for "free" – and a good business model that is efficiently delivered for all aspects of the TV business.

I am not denying the secular challenges from OTT and other competitors for the TV viewer. Furthermore, the deep cyclical downturn in the TV business is exacerbating and accelerating the secular challenges. However, conventional wisdom is quickly forming that TV is in material secular decline.

I do not think that is the case, and when conventional wisdom overreacts, opportunity often knocks in stocks. Today, that may be the case for TV-related stocks. If advertising begins to grown again in 2010, the opportunity for investors will be at hand as OTT worries recede against a cyclical upturn.

Disclosure: Discovery Communications and Liberty Media Entertainment are widely held by clients of Northlake Capital Management including in Steve Birenberg's personal accounts.

June 23, 2009

Strong Hints Jobs is Back Working at Apple

Yesterday morning on Twitter I noted that Steve Jobs was quoted in Apple's press release announcing 1 million sales of the new iPhone 3Gs. I quickly completed a scan of Apple press releases going back to late March and found no other instance of Jobs being quoted.

This morning, AppleInsider.com reported the same and stated that this is the first time Jobs has been quoted in an Apple press release since he began his leave of absence in January. I think this is a very strong signal that Jobs has in fact returned to Apple. The extent of his participation is still up in the air as no one knows how much stamina he has following his recovery from his latest health issues. As widely reported, Jobs apparently had a liver transplant a few months ago.

Also worth noting it that there have been several sitings of Jobs on the Apple corporate campus.

Overall, Jobs leave of absence has diffused the impact of his health on the stock. Tim Cook and Phil Schiller both raised their profiles and were easily accepted by investors. Furthermore, the company performed well in Jobs absence on a fundamentla basis with product introductions and strong quarterly results.

I trimmed Apple a few months ago at $133 as I felt the risk-reward was more balanced following the 60% recovery in the shares. I maintain my 2009 target of $150 plus based on the assumption that reported earnings growth resumes in 2010.

June 17, 2009

Apple as Religion

SNL Kagan, which publishes the Dow of Steve blog, recently had an article discussing lower prices initiated by apple in the Mac and iPhone product lines. The article fairly noted that the price cuts were in response to the weak consumer environment and tough competition while also noting that Apple still maintains its premium pricing strategy.

I think Apple's go to market strategy remains smart and still believe upside remains in the shares. Nevertheless, I trimmed positions at $133 as the risk-reward is less attractive following the surge in the stock this year (up more than 50%).

The reason I mention the SNL Kagan is because it contained a really cute quote that made me laugh. The article quotes Martin Lindstrom, brand consultant and author of "Buyology" comparing Apple brand loyalty to religion. "He said that when a study he helped conduct scanned the brains of both Apple fanatics and people who professed a strong faith in Christianity, the same regions in both groups' brains were activated."

Kagan wen on to note that "Lindstrom polled 2,0000 consumers and asked if they would tatoo an Apple logo on their arm. 'And 6.7% of Apple fans said yes.'

Lots to chew on there for Apple lovers and haters and there are plenty of both!

June 05, 2009

Liberty Media Entertainment: New Long Position Provides Cheap Play on DirecTV and Other Goodies

I took a new position in Liberty Media Entertainment Group (LMDIA) today. LMDIA is being acquired by DirecTV (DTV). LMDIA owns 54% of DTV along with several billion dollars in other assets composed primarily of the Starz movie channels, three regional sports networks, and cash. When the deal closes near year end, each LMDIA will have turned into 1 share of DTV and a stub containing the majority of LMDIA's non-DTV assets. I think the stub is worth at least $4 per LMDIA share, so buying one share of LMDIA today at $23.65 nets you $26 (one share of DTV at $22.10 plus the $4 stub).

That is a pretty nice discount on its own but I think there is more upside as both DTV and the stub could have upside. DTV could rise to the upper $20s if my current expectations for earnings and cash flow growth in 2009 and 2010 are met. In addition, although I do not anticipate it will happen there are persistent rumors that DTV will be sold to AT&T or Verizon. The stub, which will consist primarily of Starz and cash, could be undervalued by a few dollars depending on valuation assumptions for the movie channels. I believe my $4 assumption is conservative, representing just 6 times operating cash flow for an asset forecast to have double digit growth for the next five years.

The bottom line is that purchasing LMDIA today provides a nice combination of offense and defense. Offense comes from the fact that LMDIA's primary assets (DTV and Starz) are undervalued. Defense is in the form of the 10% discount at which LMDIA can be purchased compared to today's price for DTV and a conservative assessment of the value of Starz.

I'll post a more complete analysis next week. In the meantime, here is an analysis of the merger I wrote in February when it was just a rumor. Click on the "download file" link to see a full listing of LMDIA's assets.

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