Extended war could take toll on shares

NEW YORK — Just when the whiff of an advertising recovery seemed like it might boost big media out of a bear market, entertainment stocks are bracing for war.

Wall Street media watchers, sobered by yet another jumpy trading sesh Tuesday, are busily sizing up which stocks are most likely to feel the pain of any revenue shortfalls due to ad-free, round-the-clock war coverage and/or a slowdown in corporate and consumer spending. On top of such sector-specific woes is the general pinch of a jittery market, where investors tend to stay on the sidelines.

The increasing likelihood of hostilities will leave few sectors of the economy untouched, but for big-cap media players like Fox and Viacom – easily the strongest recent performers of a broadly under-performing bunch – a drawn-out war with Iraq could significantly undermine near-term growth prospects.

That’s because more than 45% of these two companies’ revenues come from advertising, compared to roughly 7% for the typical cable operators. And although Disney derives less than 25% of its sales from advertising, some 40% of its operating income comes from the highly sensitive theme parks business.

Danger in long war

The big risk to media valuations, according to Lehman Brothers, is a conflict that extends beyond three months. A short war of a few weeks, on the other hand, is likely to have little effect on media revenue or stock valuations.

But few market makers are prepared to predict just how long a conflict will last and the extent to which ad spending will stall once bombs start dropping over Iraq.

“The problem is that we really don’t know how long a war will last,” Soundview Technologies analyst Jordan Rohan said. “(Unlike the Gulf war) we’re fighting more than one enemy this time … fear of retaliation on U.S. soil will linger even after a military campaign brings down Saddam.”

In his pre-war planning, Rohan divides media stocks into those that will face a brief earnings disruption due to a war, such as ad-exposed Fox, Viacom and Clear Channel; those that could contend with longer-term problems such as Disney with its theme parks biz; and a third group, including financially challenged AOL Time Warner, whose values have contracted for reasons unrelated to war.

Cable companies, whose largest revenue chunk comes from subscription fees (and which have the highest 3-year growth schedules), are considered safer bets, as are DBS companies.

“Cable stocks are definitely defensive in this climate,” Rohan said, despite the fact that their high debt levels make them prone to an overall market contraction. Lehman Brothers doesn’t believe consumers will cut their discretionary spending in a short or even medium-term war, and thinks they may actually spend more time watching cable news nets or getting information online.

Debt deepens downturn

Still, heavy levels of debt tend to magnify the impact of any financial or market downturn, which puts a firm like AOL Time Warner at risk, despite the fact that its movie and subscription TV and online business should not be particularly harmed by war.

Some investors believe that current trading multiples of the majority of media stocks already reflect wartime discounts.

Also, using the Gulf War as the obvious comparison, Lehman Bros. notes that media stocks tend to underperform ahead of conflicts and outperform during conflicts. Following 9/11, subscriber churn at satcasters Echostar and DirecTV actually dropped as viewers remained glued to TV coverage of the terrorist attacks and subsequent war in Afghanistan.

And even if wartime curbs movie consumption at the box office, homevideo/DVD rentals and sales traditionally pick up the slack, as they did post-9/11.The S&P Media index is down 12% in the last six weeks on escalating war fears, with many stocks trading near their 52-week lows. Outperformer Fox, currently enjoying a ratings and box office boom teamed with big margin improvements at its TV stations, is the one exception. Cable stocks, which got off to a great start in January, have since been underperforming the big indexes by 5%, driven down primarily by investor concerns about rising programming costs.

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