After EBITDA, New Yardsticks for Media Firms

Burned by EBITDA accounting, the Street is looking for new ways to value big media firms.

"Over the last two weeks, investors have been grappling with a revaluation of the media sector brought in part by the manipulation of reported EBITDA at Adelphia and WorldCom," said Jordan Rohan, an analyst at SoundView Technology Group, in a research note.

In the late 1990s, EBITDA, or earnings before interest, taxes, depreciation and amortization, became the standard for media and other communications companies, such as cable, which typically did not have earnings that could be used for valuation. Such companies had a lot of depreciation, amortization, and other charges, which left them with negative net income.

Increasing distaste for EBITDA-based valuations, according to Rohan, will result in a "blended approach" that incorporates price-to-earnings and price-to-sales multiples, EBITDA and cash-flow analysis. "We believe this revaluation is appropriate and more adequately characterizes media companies within a valuation range similar to that of other consumer cyclical companies," the analyst said in his note.

Taking Down

Rohan reduced his price target on four media stocks: Clear Channel Communications (CCU Quote), AOL Time Warner (AOL Quote), Disney (DIS Quote) and Viacom (VIA.B Quote). In so doing, he focused on P/E multiples that use 2003 GAAP (generally accepted accounting principles) earnings projections in the denominator.

"Previously, we were using EBITDA multiples to come up with our price targets," said Kiki Li, a media analyst at SoundView Technology Group, who worked on the research report.

But after accounting blowups at Adelphia and Worldcom -- which had $3.8 billion in operating expenses that didn't even register in its EBITDA -- SoundView is going back to the basics.

For Clear Channel, the firm came up with a price target of $40, down from $52, based on a P/E of 31 times 2003 earnings. It kept an outperform rating on the stock, noting its strong cash-flow position.

"In a world driven by maximization of free cash flow and earnings, companies should be rewarded for deleveraging the balance sheet," Rohan said. "Clear Channel is using its free cash to reduce its debt."

Special Blend

Rohan arrived at a $45 price target for Viacom -- down from $54 -- that correlates with a P/E multiple of 32, using 2003 GAAP earnings, a free cash flow multiple of 25, and an EBITDA multiple of 13.5.

"While its valuation appears full, we believe that the company is operating as well as any in its space," said Rohan. "Moreover, Viacom has a pristine balance sheet, which could drive long-term value if the company pursues accretive acquisitions at distressed multiples."

The analyst lowered his AOL price target from $27 to $18 to reflect a P/E of 30 times 2003 earnings. To that, Rohan added $2 in net operating loss carry-forwards, which basically act as tax shields.

"AOL appears to be fully valued," Rohan said. "But to be fair, it is a challenging company to value, due to the capital expenditures, debt and depreciation of its cable assets -- among other things."

Based on a forward P/E of 25, Rohan reduced Disney's price target from $23 to $20. He also noted that its high free-cash-flow multiple is the least favorable of the four media companies he covers.

"Disney's valuation appears relatively full, as the current price is in line with our target," Rohan said. "We would prefer to trim positions on any further strength in Disney shares."