Online: Where the Growth is

New Media are luring eyeballs and ads—and the market is betting
big on Google and Yahoo!

More
than 220 years ago, when the British surrendered to the colonials at Yorktown,
Va., legend says Lord Cornwallis marched out to a tune called The World Turned
Upside Down. Today, a media investor knows just how the defeated commander must
have felt. Media's collisions and revolutions are upending our notions about
which companies and technologies matter in the $1.3 tn industry. Downloads are
transforming the music business, and pay-per-view is looming for movies and
cable TV, while advertising is sprinting to the Internet. The media pie is
growing faster than the economy, about 7% a year, according to
PricewaterhouseCoopers' most recent forecast. But what we spend the money on,
and who gets it, is changing enormously. And that means the media world will see
plenty of winners and losers.

The
market is betting hard on Internet companies such as Google and Yahoo! at the
expense of big conglomerates, because New Media are where all the growth is.
Consulting firm Parks Associates forecasts that the Net will double its share of
the US advertising market to 10% by 2010. And that's a conservative estimate.
It assumes Web advertising, now a $12 bn market, grows just 14% a year, about
half the current pace. More aggressively, Piper Jaffray analyst Safa Rashtchy,
one of the first to spot the potential of advertising tied to Internet search
results, says the growth will be more like 20% a year in the US and 40% abroad.
If he's right, the global Web advertising market will hit $55 bn by 2010, up
from $19 bn now.

The
big losers are likely to be cable companies and others that distribute programs
over expensive pipes. Pricing in that business is becoming cut-throat as phone
companies such as Verizon Communications and SBC Communications follow
satellite-TV outfits such as DirecTV into competing with cable. Legg Mason Value
Trust manager William H. Miller III says he acted on this trend in 2004 by
selling shares of Comcast and using the money to add to his Yahoo holdings.

If
you want to bet on the New Media age, the first place to look is Google.
Granted, the search engine was an easier pick eight months ago, when it traded
around $200. Google now trades at 48 times the earnings Wall Street analysts
expect for 2006. Is that too much? Maybe, but not if you think influential
Citigroup Smith Barney analyst Mark Mahaney is right. On December 9 he sharply
increased his estimates by nearly 60 cents a share. Now he says Google will earn
$8.84 a share in 2006, in part because it gained 10 points of market share in
2005. That puts Google's price-earnings ratio at 48. “We are removing what
was an overly conservative bias in our estimates,” Mahaney says.

Slow But Sure

For a broader play on Web advertising, try Seattle ad agency aQuantive. Its
Avenue A/Razorfish unit is the largest agency buyer of ads tied to Web search.
And aQuantive is a leader in pay-for-performance schemes that tie payments for
online ads to the sales they actually generate. It is also in the forefront of
bringing ways to measure and personalize ads to traditional media such as print
and TV. aQuantive is a little expensive, trading at 45 times 2006 earnings
estimates. But Merriman, Curhan & Ford analyst Richard Fetyko forecasts its
profits will grow at 25% a year.

It
seems counterintuitive to bet on change coming slowly than expected, but it
makes sense because some transformations take longer than others. Consider
Netflix. The online video-rental company spent the past year fighting off an
expensive challenge from rival Blockbuster, but good times are starting to roll
again. Analysts say Netflix will make 82 cents a share next year, putting its
p-e ratio at a reasonable 31.

The
threat to Netflix is that video-on-demand could kill the market for DVD rentals.
But CEO Reed Hastings says VOD is materializing more slowly than expected
because of wrangles over getting studios to license more movies for digital
downloads. That makes next year's profits more secure-and gives Netflix time
to get big before VOD does. Someday a phone, cable, or Web media company will
want to deliver movies online. And the 20 mn subscribers, Hastings believes
Netflix will reach between 2010 and 2012 (it has 3.6 mn now)-all in the habit
of paying for movie subscriptions-will come in handy. Netflix could be an
acquisition candidate for a company that wants to distribute movies online or
stay independent and win attractive terms as a partner.

Even
New Media devotees can hedge their risks with some judicious bets on Old Media
companies that are making a decent transition to the new world. One of them is
Walt Disney, whose ESPN.com sports site is much larger than anything Viacom and
Rupert Murdoch's News have at present. It's a leader in rich-media
advertising, which offers video or animation that spiffs up brand advertising.
Plus, sports-related businesses are expected to grow faster than most
traditional media, according to PricewaterhouseCoopers. Another reason to like
Disney: It partnered early with Apple Computer-still the most innovative
player in digital downloads-to offer ABC programs via its iTunes site.

Golden Pages

Believe it or not, among the hottest media bets is the $15 bn-a-year US Yellow
Pages market. Analysts at Kelsey Group forecast that $5 bn of locally targeted,
small-business advertising will move online by 2009. But Yellow Pages companies
have two things Web companies like: Internet-like margins of 40% or more and
armies of local sales reps-which portals don't have-to sell advertising to
small companies that lack tech savvy.

That
makes companies such as RH  Donnelley,
which publishes directories in 18 states, hot properties. Already, private
equity types are sniffing around Verizon's Yellow Pages business, which is for
sale. AT&T is taking its Yellow Pages business national through
YellowPages.com. Even Barry Diller's IAC/InterActive which has an elaborate
local-advertising strategy and a cash-flow-conscious acquisition strategy,
isn't out of the question. Since Donnelley is one of the few pure Yellow Pages
plays, it's a good way to wager on the industry's strong cash flow and
consolidation.

The
media world can be baffling not just because of its size, but also because of
the number and speed of changes. But investors who bet on companies that have
great content and Web advertising-and are selling at reasonable
multiples-should do all right.

By
Timothy J Mullaney