Media companies have been beaten down, but those that have survived the drubbing have decent prospects

Source: Globe and Mail

Here's a vexing notion: small-cap media stocks.

The media business, to put it in the most positive light, is in transition, and many investors are inclined to go elsewhere until some semblance of stability returns. When large enterprises such as CanWest are seeking protection from creditors, why fish in even riskier small-cap waters?

Still, if you are willing to expand your idea of “media” a bit and get beyond print and broadcast content businesses, it could be a profitable excursion.

Before looking at small-cap media stocks in greater detail, it's worth mentioning that the sector as a whole is experienced a quiet revival in 2009. Or maybe not so quiet. Says David Kaufman of Morningstar: “In this year's market rally, one of the most striking developments has been the resurgence of media stocks.” He points out that of the 12 stock sectors tracked by Morningstar, media had the best average return for 2009 up to mid-November.

And in the United Kingdom, the Guardian cited a Grant Thornton Media Watch report that U.K. media stocks outperformed the FTSE 100 for the first time in three years, with 70 per cent in positive territory.

Mark Henshaw, head of media and entertainment at Grant Thornton, observed that the rebound benefited both large and smaller media stocks. He explained several reasons for the turnaround: the effort to cut costs and the adoption of new strategies – such as focusing on digital platforms or switching from daily to weekly editions. This ability to adapt has reassured investors that there are still profits to be made in media.

So why bother with riskier small caps, when it looks as if the big companies have weathered the storm? The answer is simple: it looks as if the days of hunting through the Top 10 for bargains are already over.

Disney(DIS-N), for example, listed at a low of $15.14 (U.S.) on March 10, 2009. It's now trading at close to $30. Same story with Viacom(VIA-N), which was trading at $14.46 on that dark day of March 9 – it's now north of $30. Even Gannett(GCI-N), which publishes USA Today, has soared from a March low of $1.85 to nearly $14.

Small caps, on the other hand, started even lower, and have been slower to recover, but recover they have. Everyone's favourite pick now is Sirius Satellite Radio(SIRI-Q), which, with a market cap of about $3.3-billion, is not really a small-cap stock. But it has been under $1 per share since the fall of 2008, and a year ago on Feb. 11, it was trading at a fraction of a cent. Then Liberty Media's John Malone stepped in with half a billion dollars in loans in return for 40 per cent of its preferred shares. Still, Nasdaq threatened to delist the stock if it didn't get its nose over a dollar, giving it 180 days, a March deadline that it will likely never have to meet. Now it threatens to crack $1 at five times its average trading volume, and analysts are calling it a “buy.”

There are a couple of key trends for 2010 that will point investors in the right direction. Foremost is the continuing influence of the Web to distribute everything from news to video, and the reluctance from consumers to pay for online content. But this is the year, we are told, that media companies are determined to be “the toll-takers for content on the Web in the 21st century,” according to Todd Dagres of venture capital firm Spark Capital.

In the U.S., media revenue will be boosted by a recent Supreme Court ruling that will allow more direct spending on political campaigns that will put an extra $250-million to $500-million into traditional local broadcast TV. But if television doesn't recognize that new content distribution and revenue models are required, that cash infusion could turn into what Advertising Age calls a “dead cat bounce.”

Clearly, the media sector is reserved for investors with a penchant for excitement and volatility. And the price of entry to the funhouse can be relatively inexpensive. The movie Avatar may be the biggest money maker in the history of Hollywood, but News Corp.(NWS-Q) (hardly a small cap) is still cheap at about $15. And you can pick up Ubisoft Entertainment(UBSFF-Q), the maker of the Avatar video game, for under $14.

Being trendy doesn't always translate into profits. But how do you explain Wizzard Media(WZE-N), the world's largest podcast company? Podcasts, for the uninitiated, are web-based audio files that you can download and listen to on your iPod, and Wizzard pretty much has the market cornered, announcing recently that it served 1.4 billion podcast downloads in 2009, a record. And it is poised to support the new iPad tablet from Apple. People are also acclimated to podcasts through iTunes, so the leap to micro-payment revenue is not as vast as that for online news, for example. So why is its share price languishing at 33 cents?

That could all change as a site called SmallCapReview.com has named Wizzard its January stock of the month, which has so far led to a decline of five cents. With a market cap of $18.2-million, Wizzard typifies the uncertainty that swirls around media and content. Its 1.4 billion podcasts are tied to a declining ad revenue model unless consumers can be convinced to pay for them, which they have not been inclined to do, regardless of how little they are asked to pay.

As Walter Cronkite used to say, only time will tell.

© Globe and Mail