Here, he shares his insight on the seismic shifts under way in media and advertising, as well as avoiding risk associated with disruptions.
Do you think AT&T’s move to buy Time Warner is rewriting the media landscape?No doubt, they are getting a lot of mindshare right now. Especially with the Department of Justice’s challenge to block the deal. But let’s not overlook the fact that Comcast bought NBC Universal years ago. That is really kind of the first vertical here.
Now we are seeing Twenty-First Century Fox, Disney and Comcast looking to combine very attractive business assets this year, as well. Certainly, Fox offers eyeballs through Sky, their UK broadcaster. And Disney could use movie content from Fox to compete in the content streaming space against the likes of Netflix.
As an active manager, that makes it really interesting to us. We are always excited about adding unique and different ideas to our portfolios. We certainly are not giddy about the overall media space, or mergers for that matter. But we have found some very attractive ideas.
So what’s driving media’s disruption?A couple of things jumped out as we were analyzing the space.
- The notion of media consumption is changing rapidly, whether that is your kid communicating with friends on Snapchat, or you catching the latest episode of your favorite show on a mobile device while commuting on the train. So you no longer have to wait until 8:00 p.m. on Thursday to watch your favorite show. Nor do you have to watch the normal commercials that you are accustomed to every 10 or 15 minutes. These ads may now be imbedded, but pretty soon you will be able to watch them as one long commercial at the beginning, or no commercials at all for a different fee.
- How you pay to watch content is significantly changing, too. Streaming services like Netflix and Amazon Prime have gathered a ton of eyeballs. People now have lower-cost choices and no longer have to pay $200 a month for cable access to watch programs. Streaming sites are also cutting into the advertising revenue of traditional broadcasters. Meanwhile, Facebook and Google are using data collected from consumers to target ads to specific groups of people.
How might digital’s disruption of advertising play out?It’s a total game changer. Advertising was bifurcated into various channels when we were all kids. There was a different CPM (cost per thousand impressions) for newspapers, magazines, radio, billboards, and television. Generally speaking, TV ads were a way to reach a very broad audience and you could granulize on the spectrum from sales to brand building. That model is vastly different today. In fact, we all know that print and radio ad revenue has been essentially crushed because of digital.
Advertisers’ willingness to spend for mobile ads, we believe, emboldened the growth of Facebook and Google – who now own between two-thirds and three-quarters of the digital ad spend in the US.1 For several years, these two firms have grown their advertising revenues between 20% and 40% per year. The data collection and analysis from these digital platforms allows for the consumer’s every move to be tracked. As a result, they can serve up much more targeted advertisements to an audience who may be more likely to engage and click through. Now with Amazon Prime, DirecTV Now, YouTube Premium, and Hulu in the mix, customers are also feeding high-value data to these video distribution platforms. In our opinion, they may become a competitive force for advertising spend versus Facebook and Google.
Where’s the biggest value in this digital landscape?The value is in content creation, although it is very competitive today. Because you have Netflix spending roughly $8 billion, Amazon $6 billion, HBO $4 billion, and Apple between $2 and $4 billion and you have the traditional TV stations spending.1 You have a real gold rush of content creation at the moment.
Disruptions can cause extreme turbulence, too. How are you avoiding risk?We have a number of risk tools. The first one: Don’t overpay for a stock. It’s that simple. Valuation discipline is paramount. We follow a consistent process looking for idiosyncratic stock opportunities. When, and only when, Mr. Market gives us the opportunity to achieve our return criteria will we allocate capital. At Vaughan Nelson, we trade time for value.
We also rely on proprietary factor-based risk analysis to keep our portfolio diversification and risk profile in the band we believe is optimal for our high active share strategy. We are of the mindset that sector allocation alone is insufficient. Therefore, focusing on exposure to a number of risk factors (company fundamentals, inflation, interest rates, etc.) provides a richer description of a portfolio’s positioning and biases. For us, understanding a portfolio’s exposures helps to construct a diversified portfolio whose performance is not determined by transient factor effects, but instead is earned through prudent stock selection. In essence, a durable portfolio.
1 Source: Vaughan Nelson Research. Annual content spend through December 31, 2017.
Active share is a measure of the differentiation of the holdings of a portfolio from the holdings of its appropriate passive benchmark index. High active share is considered between 80% and 100%. For example, an actively managed fund with an active share of 90% means that the relative security weights of the portfolio are 90% different from its benchmark.
High active share is not a guarantee of outperformance, or positive performance.