The Trouble with Big Media

If you had to guess which companies would do best in the age of information, you'd probably pick America's biggest and best-known media firms, right? Over the past 15 years, the global spread of personal technology--from laptops to satellite dishes, from cell phones to the World Wide Web--has expanded the market for information into what is rapidly becoming the biggest business on earth.

Yet a careful look at the financial performance of this much-hyped sector offers some surprising cautions for any investor looking to take a profitable ride down that information superhighway.

In the media game, as elsewhere in business, bigger does not automatically mean better. In a time of rapid change, pursuing so-called economies of scale through the merger game--the abiding preoccupation of the media industry for more than a decade now--can in fact be downright ruinous. After all, what good will it do to own all the cable companies on earth if people wake up one morning and switch to satellite TV?

That is one important reason that both Tele-Communications Inc. and Time Warner, the two largest cable operators in America, have suffered weak stock prices. Both companies borrowed heavily to become giants in the cable game, only to discover that upstart satellite-dish companies are eating their lunch. Too bad, because the two companies are stuck with the debts they took on to pay for that growth--growth that no longer produces the profit that justified borrowing the money.

These are not isolated problems. Media companies as a whole have performed respectably from an investor's point of view over the past ten years. However, an analysis of the ten largest U.S. companies with holdings in various media shows that, as a group, they've done dreadfully. And these ten companies control about 30 percent of the business. The two things that characterize these outfits: bloated, heavily indebted balance sheets and overpaid, self-enriching bosses.

At first blush returns look OK. Between 1987 and 1997, during the greatest bull market of this century, the companies of America's information industry, in the aggregate, gave investors a 14.7 percent annual return on their money. That's pretty good by any standard closely tracking the 14.8 percent return for the companies of the S&P 500, and much better than the 8.2 percent annual return for the entire stock market.

But if we look at just the ten largest multimedia companies, a completely different and more disturbing picture emerges. During the same period, these operations gave investors an average annual return of 6.5 percent, a figure sweetened by the strong performance of Disney, the biggest of the ten. And don't forget, these ten companies alone accounted for about one third of the market value of the entire industry. An investor would have been better off buying a ten-year U.S. Treasury bond than this portfolio.

In the main, the growth of the American media industry has been financed with borrowed money--for big companies and small companies alike. Borrowed money accounts on average for 87 percent of the shareholder equity in firms ranging in size from pipsqueak outfits you never heard of to giants such as the Washington Post Co. (which falls just short of making it into the top ten).

Yet the top ten outfits are much more heavily indebted than are the rest of the field, with borrowed money accounting for more than 92 percent of their shareholder equity. And the interest payments on that debt load, which looks to total an estimated $44 billion at latest tally, continue to put a crimp on earnings and stock prices.

Poor management puts another drag on stock prices. One good way to see that is through changes in the top ten's so-called operating margin, i.e., how much pretax profit a company earns in its day-to-day operating business. In 1988 the top ten companies in the field had an average operating margin of 23.7 percent. That means that for every $1 they collected in revenues, they wound up with just under 24 cents of operating profit. In 1997, the average operating profit stood at 18 cents on every dollar of revenues. A lesson? The bigger a company gets, the harder it becomes simply to run the business.

Yet that hasn't stopped folks from pocketing unbelievable fortunes for themselves in the process. In 1988 total cash-and-stock compensation for the five top employees of each of the ten top media companies in America were valued at about $67 million. That seems rather generous in its own right, but it pales in comparison with the estimated $380 million figure for 1996--a sum equal to 12 percent of their companies' total net profits for that year.

Michael Eisner, chairman of Walt Disney Co., walked off with $8.5 million in cash in 1996--plus, as part of his new long-term contract, a stock options package then valued at $195 million. By contrast, Disney's stock rose only 14 percent that year even though the Dow Jones industrials average rose 28 percent.

The lesson for investors in all this? If you want to put your money in a media stock, forget about the companies that have dominated the media game for much of this century, and certainly in the postwar era. Look instead for a smaller, nimbler operation--one whose bosses don't spend all day arranging merger deals that fatten their wallets at the expense of their shareholders. Besides, who knows, if you're lucky maybe that start-up company will get bought up by one of these supersize outfits, and you will wind up laughing all the way to the bank.

You can reach Christopher Byron by e-mail at [email protected].