Can Anything Spark Media M&A?

Media stocks rallied with the market off the July lows, but the negative narrative of weak discretionary consumer spending and slowing or declining advertising remains the dominant theme. As a result, the gains were quickly given back when the market collapsed last week. Based on monthly trends, third-quarter earnings will be worse than the second quarter, and the outlook for the fourth quarter and the first half of 2009 remains mixed, at best, with no visibility into an ad-spending recovery.

Over the past 25 years, besides operating fundamentals, another significant driver of bullishness toward media stocks has been M&A activity. Just look at today's diversified entertainment companies. Viacom (VIA - commentary - Cramer's Take) purchased Paramount and CBS and split in two many years later.

Time Warner (TWX - commentary - Cramer's Take) was created by the merger of Warner Brothers and Time Inc. and then bought AOL. Time Warner Cable was public once in a prior form and will be public again soon.

Disney (DIS - commentary - Cramer's Take) purchased Capital Cities/ABC and Pixar.

News Corp (NWS - commentary - Cramer's Take) undercut CBS by buying a large group of CBS stations and has acquired newspaper assets around the globe and MySpace. John Malone's Liberty Media has been a non-stop deal machine.

Most all of the deals done in media over the past few decades were done at significant stock price premiums. In many cases, the prices seemed to reflect the trophy aspect of media properties more than fundamentals.

However, often overlooked is the cash-flow generating capability of media assets. Content libraries can be mined again and again as distribution technologies evolve. Additional capital spending related to the libraries is minimal. Distribution platforms can have very high operating leverage as new technologies (think cable broadband and cable telephony) roll out over a network that requires moderate upgrading.

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At time of publication, Birenberg was long Time Warner and Central European Media in client and personal accounts, and AT&T is in a few client accounts, although holdings can change at any time.

Steven Birenberg is president and chief investment officer of Northlake Capital Management, LLC. Northlake specializes in managing equity portfolios using a combination of exchange-traded funds and special situation stocks. Birenberg appreciates your feedback; click here to send him an email.