Advertising: The “Golden Age” of TV Enters its Golden Years

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US TV advertising has crested and is beginning its inevitable decline. In an era of rising transmission fees and a vigorous market for content licensing, media companies have been reporting disappointing revenues for their TV network units – the result of poor ad sales. The networks drove through rate increases during last May’s Upfronts at the cost of reduced volume, a strategy that appears to be backfiring after poor ratings during the Fall season and a correspondingly weak scatter market. Meanwhile, Nielsen, whose methodology we believe is significantly biased toward over counting, acknowledges declining viewership for channelized TV, while advertisers decry the accompanying deterioration in the attentiveness of that audience toward their commercials. These viewers are migrating to streaming video, in their living rooms as well as on their mobile devices, and advertisers are shifting their attention to digital as well. The extraordinary trajectory of online advertising, reflected in the double and triple digit ongoing growth in ad revenues at GOOG, FB, and TWTR, has begun to eat into TV’s piece of the pie. Big advertisers, in traditional categories like autos, consumer products, telecommunications and financial services, are explicitly stating their intention to shift budget dollars from TV to digital, while broader surveys of marketers suggest the same thing.

US TV ad spending has been decelerating. 2014 US TV ad sales were up 3-4%, in an Olympic and election year, after 2-3% growth in 2013. This is a deceleration from 6-8% growth in the 2012 election year and 4-5% in 2011. Ominously, 4Q14 sales were down ~2% YoY, as weak Upfront sales drove dependence on the scatter market during the fall season, exacerbating the deterioration in TV ad pricing, which was off 1% for the year and down more than 12% since 2009.The falling rates have been offset by increasing the number of ads shown, up 6-8% in the same 5 years, and by a growing number of TV households. The increasing advertising load has the unfortunate side effect of potentially alienating viewers who have other options, and of raising the likelihood that ads will be ignored or skipped.

Active TV viewing is clearly in decline. In 3Q14, Nielsen finally acknowledged the obvious – US per capita TV viewing is in decline. Still, we believe Nielsen’s methodology seriously overstates both the size and quality of the TV audience. Even with the reported downturn, Nielsen still estimates that Americans actively watch over 5 hours of TV every day – an increase of 12 minutes since 2010. Meanwhile, streaming video has more than doubled to nearly 45 minutes a day over the same timeframe, a trajectory corroborated by multiple sources and inconsistent with Nielsen’s story of a growing TV audience. Moreover, it has grown increasingly likely that users assumed to be watching, because the TV is on, are not actually paying attention. The quality of attention is particularly suspect for commercials – DVR users – nearly a third of the prime time audience – routinely fast forward through ads, while live viewers use the increasingly ample breaks to peruse alternative media online.

Broadcast TV audiences continue to decline. Nielsen’s Broadcast Primetime C3 metric (inc. 3 days of DVR/on-demand viewing) for the Fall season was down -9% YoY and, over the last decade, the C3 ratings have fallen more than 41%. This has seriously eroded the major selling point for broadcast TV as the only medium able to reach a 10%+ swath of Americans at the same time. 10 years ago, 8 different weekly series averaged better than 20M viewers a week. Today, only sports and one-time events can hit that mark. Broadcasters complain that growing use of DVRs makes the C7 metric, which would increase primetime ratings by ~3%, more appropriate, but buyers, given that 35% of ads are time sensitive and the propensity for time shifted viewers to skip ads, have resisted. Only GroupM, representing a pool of advertisers, has agreed to C7 and then, in exchange for a sharp discount on pricing.

Streaming is already >12% of US video viewing and growing prodigiously. NFLX delivers nearly 2.1B streaming hours/month in the US. Assuming each stream is watched by an average of 1.5 people, spread over the 262M Americans living in HDTV equipped households, NFLX is alone accounting for 12 hours of monthly viewing per person. YouTube, which streams more than 1.5B hrs/mo in the US, likely has fewer viewers per stream, but still counts for at least another 6 hrs/mo per person. Add in Amazon, Hulu and other smaller streamers, and total US online video viewing likely exceeds 22 hrs/mo, tops 12% of total video consumption, and is growing at a better than 30% annual rate. With big investments in high quality original programming and with access to online content getting much easier, the pressure on channelized TV will get worse and the temptation for advertisers to shift their budgets toward the Internet will grow. It will also raise the stakes in negotiating for new content, raising costs for networks even as online content shrinks their audience.

Advertisers shifting budget to digital. SMI reported 4Q14 digital ad spending up 15% YoY, compared to a -2% hit to the TV spend. Online media have introduced richer ad formats and more sophisticated targeting and tracking mechanisms, while audience measurement and ad tech companies have delivered improving tools to evaluate effectiveness. Meanwhile, moves by MSOs and TV networks to introduce new technologies to blunt the online advantage, like digital ad insertion, have been painfully slow. We believe that the inevitable future growth in online ad spending will come directly from TV ad budgets, portending a slow but inexorable slide in revenues for network ad sales.

The May Upfronts could be a significant negative catalyst for media stocks. While networks declared victory at the 2014 Upfronts on CPM increases, sharply lower volumes left them vulnerable to the scatter market, and thus, 4Q14 revenue declines. We expect this year’s Upfronts to be demonstrably weaker. Advertisers may draw a line in the sand vs. the network push toward C7 ratings and their lower quality audiences, yielding both lower pricing and volume commitments. With this, we see the risk to reward ratio for advertising driven media stocks – e.g. SNI, DISCA, CBS, FOX, VIA, etc. – as distinctly unfavorable. We continue to prefer digital advertising, with GOOG, FB and TWTR viewed as structurally advantaged.

For our full research notes, please visit our published research site.

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