The Winner’s Curse: Why Media Companies Really Underperform

Oh, those poor moguls…

Media and entertainment companies, since the internet came on the scene, have been very poor investments.  New media advocates tell us that it’s because traditional media companies are old and slow.  The moguls themselves say it’s because people don’t want to pay for content.

Yet above  the din and mindless babble, the evidence supports only one conclusion: It is the moguls misplaced egos, more than anything else, that does them in.

A Dismal Record

On one point all can agree, media and entertainment has lagged behind the rest of the market.  The chart below shows a basket of media and entertainment stocks vs. the S&P 500.

Even a fairly superficial review will quickly reveal a few things that should be surprising in light of what is widely reported in mainstream media and blathered on about in blogs.

Firstly, the crash in 2000 was far worse for media companies than the recent one.  In fact, media stocks have gained a little ground this time (most probably due to the fact that financial companies have fared far worse). Secondly, the only time that media stocks over-performed was during the dot-com boom.

A Failed Narrative

What is striking about the stock performance is that it tells a story that is diametrically opposed to what the pundits would have us believe – that poor traditional media performance is due to the fact that they “just don’t get it” and are being plowed under by smarter and more nimble digital players.

If the pundits’ story was true, we would expect that media stocks would have gotten killed in the dot-com boom and done even worse now that it’s “all about the conversation.”  In fact, just the opposite happened.

The truth is that while most digital media companies are awash in red ink, traditional media has never been so lucrative.

A Profitable Business

Upon further examination, the real story emerges:  Traditional media companies actually run their business quite well, their problems stem not from ignoring the pundits, but from listening to them and Wall Street too much.

The chart below shows operating earnings (the money media companies make from running their businesses) vs. net earnings (after tax and other charges).

Operating margins for media companies have actually steadily increased since the dawn of the internet. They seem to be getting better at what they do, not worse.  Given what we generally hear reported, this seems almost incredible, but it’s true.

Net margins tell a different story.  Not only have they failed to improve, but every time a downturn comes along net earnings drop like a stone even as operating margins hold amazingly steady.

The Missing Link

So what is holding media companies back?  Is it the journalists that have failed to adapt to the web?  Or the ad sales people who can’t seem to grasp a new business model?  Possibly the programming executives who have a tin ear for what the public wants?

Nope.  As the positive operating earnings trend shows, these guys are doing their jobs and doing them well.  The real problem is the masterminds in the  C-Suite., who use the money their operations generate to go out on crackpot shopping sprees.

This can be clearly seen from impairment charges they have had to declare, which are listed under “non-recurring items” on financial statements.

Here, we see the real source of all the red ink that has made headlines.  Although media company operations have been earning money during the crises, their investments haven’t faired so well.  In CBS, News Corp and Time Warner alone have written off an astounding $48 billion in two years!

Many might say that this is normal in a downturn.  Companies make investments that inevitably go bad.  However, if that were true, we would see even bigger writedowns in technology companies than we see in media.  In fact, quite the opposite is true.

For comparison, here’s the write offs of  Microsoft, Cisco and Oracle; three companies with much bigger market caps than media companies as well as highly aggressive acquisition strategies:

How is it that these companies, who’ve made dozens of acquisitions in an industry of dizzying complexity have had to write off only a small fraction of what media companies have?

How it Happens

Media is a sexy business, with lots of glamorous people and cool parties.  It’s only natural for the people who run media companies to want to be glamorous and sexy themselves.  If you can’t sing or dance, then making risky acquisitions is the best way to get your name in the paper.

These investments are usually in new operating areas (e.g. digital) that are unproven, but seem like they could be the next big thing.  When moguls buy such companies they are hailed for their far reaching vision and strategic brilliance (i.e. Murdoch and MySpace).

Of course, in order to buy companies exciting enough to gain accolades from an adoring business press, they have to outbid other moguls who also want to think of themselves as forward looking visionaries.  Inevitably, they over-pay.

That’s the winner’s curse.

Don’t Seek Out the Unimaginably Brilliant – Avoid the Unbelievably Stupid

All of this could be avoided if instead of trying achieve the unimaginable brilliant, media executives simply avoided doing the incredibly stupid.  Clearly, media is a very profitable business when it’s not screwed up by people gullible enough to listen to investment bankers.

There is, of course, another way.  I previously wrote about unlikely digital heroes who’ve managed to conquer new media through operational strategies, rather than flashy acquisitions.

Time Warner’s in-house digital businesses have performed much better than the properties gained from their ill fated AOL acquisition.  Conde Nast has turned around its digital business without any major purchases (albeit two minor ones) and Naspers proves that an acquisition strategy can work if it’s well thought out and executed rather than ego driven.

Despite what pundits say, media companies are very profitable and will continue to be as long as the people who run them avoid listening to…er…the pundits.  Instead of trying to  become masters of the universe, they should focus on running their business.

As the old saying goes, “pigs get slaughtered.”

- Greg

Note:  A special thanks to the Matthew 25 Fund for helping with the research for this post.

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