Thursday, April 20, 2006
By Vitaliy Katsenelson, CFA April 6, 2006 - The Motley Fool
The value guy in me always awakens when I see a stock scratching at multi-year lows, and Westwood One (NYSE: WON) piqued my interest a couple weeks ago. It declined from more than $30 two years ago to around $11 today, trading at about 11 times 2006 earnings. That's cheap -- but is it cheap enough? At first, the company seemed very appealing: It pays a nice 3.7% dividend, and its small capital expenditures help it generate a lot of free cash flow. In addition, Sirius (Nasdaq: SIRI) and XM Satellite Radio (Nasdaq: XMSR) are its friends, not foes. Westwood One doesn't own radio stations; it creates content like traffic updates and Jim Cramer's radio show, selling those shows to both terrestrial and satellite radio stations. However, a deeper look at the company makes me think that it may be cheap for two good reasons: 1. Westwood One has showed little revenue growth over the last five years. Actually, "little" doesn't do it justice -- there's been zero revenue growth since 2002. In real terms (after inflation), revenues actually declined. 2. Instead of reinvesting money and growing the business, Westwood One bought back stock as if it was going out of style. Unfortunately, the stock itself has been going out of style over the last five years, declining from more than 35 times earnings in 2002 to today's P/E of 11. Sadly, the company was buying the stock all the way from the top to bottom, paying an incredibly high P/E multiple in the process. A vexing valuation I can understand when a company buys back undervalued stock and it subsequently gets cheaper; timing those things is very difficult. However, buying back stock that's trading at a very high valuation -- and I'd argue that 25-35 times earnings is high, especially for a company that isn't growing revenues -- and leveraging its balance sheet to support those purchases shows management's disregard for shareholders. All earnings-per-share growth since 2002 came from share buybacks -- none of it was organic. I cannot fault management for this no-growth company's ridiculous prior valuation; investors had everything to do with that. But I can fault management for buying back stock at very high valuations, instead of reinvesting earnings to grow its core business, or paying a nice fat dividend. (The company only started to pay a dividend in 2005.) How much do you pay for this kind of business? Today's valuation assumes absolutely no growth of cash flows -- none! However, in the last quarter, revenue declined 3%. Management has blamed many external factors for stealing advertising dollars and audiences' interest. That's the favorite song management sings when it doesn't want to take responsibility for its actions (or lack thereof). In addition, Westwood One executives noted that the absence of political advertising in the last quarter created tough comparisons with the presidential election year of 2004 – the Super Bowl of radio advertising. Judging by historical revenue performance, revenue does decline in odd (non-election) years between 2%-8%, at least partly supporting management's claim. Management also mentioned that it is investing in new shows that have not yet reached the economy of scale necessary to boost revenues. Will the growth come back? The good news for Westwood One -- and bad news for the rest of us -- is that political advertising will make a comeback with the 2006 midterm elections. But it will only bring revenues up to par, rather than driving long-term growth. Advertising adversity Westwood One's cousins in the newspaper business are facing similar troubles. Despite a readership that was slowly vanishing into the abyss of the Internet, firms like Gannett (NYSE: GCI) and Knight Ridder (NYSE: KRI) were previously able to raise advertising prices. Revenue growth from those higher ad rates helped to mask the gradual deterioration in the underlying business, as advertisers gradually paid more for fewer readers. Westwood One was not so lucky; radio is a more competitive market, especially in national advertising, where Westwood One has a large presence. That limited the company's pricing flexibility. The old joke in the advertising industry is that half of the money spent on advertising is wasted -- but nobody knows which half. Unfortunately for media companies, corporate America is enjoying all-time high profit margins, and they want to hold onto them as long as possible. Companies are desperately trying to figure out which half of their advertising spending is wasted. Procter & Gamble's (NYSE: PG) plans to cut its TV advertising budget speak volumes; P&G one of the United States' savviest marketing companies, and other corporations will likely follow its lead and rationalize their ad spending. The advertising pie's growth is slowing down, even as it's being sliced into smaller pieces by a relatively new breed of competition: Google (Nasdaq: GOOG), Yahoo! (Nasdaq: YHOO), and a small army of Internet portals and search engines, most of which didn't even exist a decade ago. Google's revenues went from $439 million in 2002 to $6.1 billion in 2005; if not for Google or Yahoo!, most of this money would have flown to Westwood One, Gannett, and the rest of the media pack. The story only gets worse. Though we have two ears but can only listen to one thing at a time, in the future, we will be listening to more prerecorded podcasts from the Internet, ad-free satellite radio, and tunes stored on media players like Apple's iPod. None of these will help the growth of the radio-advertising pie. Foolish bottom line Westwood One's revenues may receive a short-term boost from political advertising, the speculation of a takeover may spark interest in the stock, or a hedge fund may try to right this ship by taking it private. Nonetheless, long-term revenue growth is suspect at this point. The company believes that new radio shows should fuel its growth, but history and recent events aren't on its side. I believe long-term revenue growth is very unlikely. Management should admit to shareholders and itself that growth has left the building, and focus instead on creating shareholder value by increasing the dividend, cutting costs, and managing the company as a cash cow. The new CEO appointed in December 2005 may shake things up, but I'll believe it when I see it. Westwood One may appear to be cheap, but it's cheap for the right reasons. Fool contributor Vitaliy Katsenelson is a vice president and portfolio manager with Investment Management Associates, and he teaches practical equity analysis and portfolio management at the University of Colorado at Denver's Graduate School of Business. He also writes for the Financial Times and Minyanville.com. He and his firm have no positions in the companies mentioned. The Motley Fool has a disclosure policy.
Vitaliy N. Katsenelson, CFA This article is written for educational purposes only. It is not intended as a recommendation (or advice) to buy or sell securities. Author and/or his employer may have a position in the securities discussed in this article. Security positions may change at any time.