Profit from the future of advertising

Spending on advertising has held up remarkably well in these tough economic times. And the good times are set to continue, says David Stevenson.

Widescale phone hacking; long-running payoffs to police; high-profile arrests – among them Prime Minister David Cameron’s former spin doctor. All culminating in the closure of Britain’s top-selling Sunday tabloid, the 168-year-old News of the World (NotW). It’s safe to say the past week hasn’t exactly displayed British journalism at its finest.

But it wasn’t the phone-hacking scandal itself that hammered the final nail into NotW’s coffin. What did for it was the fact that, as the scale of the scandal became clearer, its major customers got jittery about being associated with an organisation with such a damaged reputation. So they started severing their links with the tabloid by cutting their advertising. Losing its advertising revenues would rapidly have made even the mighty NotW a financial non-runner. It was a classic example of the power of advertising. Not because of what the NotW’s clients were selling, but because of the clout they could wield by withdrawing what they spend on advertising.

Even in the face of the tough times the global economy is enduring, that power keeps growing. Worldwide spending on advertising rose by 8.8% to $118bn in the first three months of 2011, according to consumer monitoring firm Nielsen’s Global AdView Pulse report. While online advertising is growing, the main driver of this gain was something of a surprise: good old-fashioned television. Global TV advertising grew by 11.9% year-on-year. What’s more, it increased its share among other traditional media, such as radio, magazines and newspapers, from 63.5% to 65.3% in developed and in many emerging economies. “With $6.50 of every $10 being spent on television,” says Nielsen’s Randall Beard, “it is clear TV remains the most important and cost-effective advertising medium for companies looking to reach new consumers, especially in emerging markets.”

Looking at individual countries, total spending in the US, the world’s biggest advertising market, rose by 5.9% as gains in television, radio and magazines more than offset a 10% fall in what newspapers spend on advertising. But the real advances were in developing markets. In the Asia-Pacific region, total spending on advertising jumped by 12.4%, ahead of 11% growth in Latin America, where Argentina was the star performer with a 37% revenue surge. Even in the Middle East and Africa, spending on advertisements grew by 10%. That was despite revenues in Egypt slumping by 51% as firms halted their advertising during this year’s political upheaval. In South Africa, spending grew by almost 35%.

Only Europe didn’t deliver the goods, seeing just 2.9% growth. But that was no great shock, as gathering financial woes sent spending on advertisements in Greece, Ireland, Italy and Spain into negative territory. But double-digit growth in France and Norway meant that even in Europe there were some bright spots.

Can the ad boom last?

All in all, pretty impressive stuff. So what has driven this growth? Historically, globally spending on advertising has moved broadly in line with global GDP. The outlook on this front has been rather tepid recently. However, the world is becoming ever more aware of the need for good communication. It seems that the message from the Association of Business Media Companies – that “history has proven that companies that maintain or increase their advertising investments in periods of economic downturns increase their sales and share of the market both during and after the downturn” – is hitting home.

Do these spending numbers suggest that advertising is becoming almost recession-proof? Has it morphed into an industry where you can reliably invest through thick and thin? It’s not that simple, of course. Advertising isn’t immune to external turmoil. The impact of the Japanese earthquake and the political turmoil in the Middle East has prompted media agency network GroupM to cut its forecast for global spending on advertising growth this year from 5.8% to 4.8%. But that would still see spending top $500bn this year. With more markets embracing advertising and new outlets appearing all the time, world spending on advertising is likely to keep growing.

Over the next two to three years, developing markets will top the bill. Their share of global spending is expected to rise from 30.9% last year, to 35% in 2013, says media service agency ZenithOptimedia. By that point, China is forecast to become the third-largest market after the US and Japan. Latin American spending on ads is also forecast to increase at double-digit rates in both years, reaching $38bn by the end of 2012, reckons GroupM. While the Middle East and Africa are likely to remain under a cloud, central and eastern Europe could see 12% growth in both 2011 and 2012, rising to a total of $24.8bn.

Indeed, 2012 should be a bumper year for advertisers. For one thing, there’s the next US presidential election. The more a US candidate can spend on his or her campaign, the greater the chance of reaching the White House. So election momentum is likely to drive spending up by 4% this year and next, taking the country’s overall annual spending on advertising to $168bn by 2012. Throw in the 2012 London Olympics and the worldwide advertising market should reach $540bn next year.

But a word of warning. “Without the election, US advertising growth in 2012 would probably be slower than we’re predicting for 2011,” says GroupM chief investment officer Rino Scanzoni. Also, “the elections make heavy use of local TV and radio, so national media may well find 2012 is slower going in any case”. In other words, making money by investing in the advertising sector isn’t as simple as falling off a log. It’s still about finding the areas with the best longer-term prospects.

 

The future of advertising

This is where new media advertising – online and website advertisements – comes in. These are already seeing growth of more than 15% a year, as internet and mobile internet use has soared. In 2011, new media should account for up to 17% of total worldwide advertising budgets. Yet there is still huge potential as opportunities multiply. By next year, this segment of the market is expected to be worth $100bn alone. “Think of all the time you spend in front of the computer. As more media consumption moves online, more advertising will too,” says Dan Frommer for Business Insider.

However, the move online also presents a challenge for advertising agencies. “Advertising, like all forms of media, is being profoundly changed by internet and mobile technology. In fact, the transformation to online from offline is arguably more complicated for advertising because it affects the advertising itself and the media it’s attached to.” In turn, “data and computer science, all of a sudden, are becoming increasingly important to a field that once was dominated by genius ‘Mad Men’. As these automated systems become widespread, they could change the game – both in how much advertisements are worth, and how [we] are involved in their sale,” says Frommer.

So how will this affect the advertisements we see? Advertisers have always liked their jargon. With the advent of online advertising, a new lexicon of buzzwords has appeared. Traditional online advertising has always been based on ‘banner ads’. These are advertisements that are attached to a web page and are meant to attract traffic by linking to the advertiser’s website. “Banners first started in 1994 and are therefore almost as old as the web itself,” notes Mark Suster of GRP Partners. “They were very effective back then, with the original advertisement garnering a 78% click-through rate (CTR).” For every 1,000 advertisements served up, 780 people clicked on them.

“Nowadays, banner ads get, on average, a 0.2% CTR”, just two clicks per 1,000 advertisements, says Suster. “The fundamental problem with banner ads is a condition called ‘banner blindness’, meaning that our eyes are quickly trained to look at what’s most relevant on the page – the content we want to see.”

So how will advertisers address this problem? Through ‘integration’. That’s where consumers ‘engage’ with the product that’s being advertised. This is hardly a new concept. In Steven Spielberg’s 2002 science-fiction thriller Minority Report, Tom Cruise’s character walks through a futuristic shopping mall, while digital signs call out his name and deliver specific advertisements to him. This is where the future lies. “Publishers will continue to make advertising more integrated into their content, so people pay more attention, and so they can charge more for it,” says Frommer. “They’ll also continue to try to make advertisements bigger and more emotional.

“As advertising becomes more automated and driven by data, advertisers will want to collect and access more data about you and your online activity, so their systems can figure out which advertisements are best for you to look at,” he continues. “The explosion of smartphones, tablets, apps and mobile advertising is just beginning, particularly for location-based advertising – that’s the idea that you can get a good deal on food or a fun activity some place right nearby, right now.”

How will it translate into figures? Global internet advertising is forecast to grow by 50% between last year and 2013, says ZenithOptimedia. In China, mobile-phone spending on advertising could rise six-fold by 2015, says iResearch Consulting. That would be truly spectacular.

Even that’s not quite the end of the story. Conventional advertising media isn’t standing still on the integration front. In Australia, for example, TV advertisements are now being set up to relate directly to what’s happening in a televised sports game, as “people have greater recall of advertising when it is closely tied to an emotionally fulfilling moment”, according to advertisement placer Demand Sport. The aim is to extend the project into the entertainment and news arenas too.

Further ahead, we could see cameras in billboards, capable of analysing the sex of a passer-by and changing a display accordingly. Facial recognition software within billboards could map out profiles of passing consumers. Eventually we could see advertisements jumping out from walls or shop windows as widespread 3D holographic projection technology becomes feasible.

Media researcher MagnaGlobal forecasts that this so-called ‘out-of-home’ advertising will enjoy an 8.3% global increase in 2011. That would make it the second-fastest growing advertising arena after the internet. What’s the bottom line for investors? If the economy sees a repeat of the Great Recession, global spending on advertising is likely to be curbed in the short run. Further out, the sector looks set for a sustained period of long-term growth. We look at stocks to buy below.

 

The best bets in the sector

With global spending on advertising growing so fast, you’d expect advertising agency stocks – the companies that sell advertising services – to be among the stockmarket’s favourites. But on balance, that hasn’t been the case in recent years. While the sector has steadily picked up since the stockmarket lows of March 2009, it has still undershot the overall market by 25% since the start of 2005.

Sometimes a sector underperforms because it is too highly valued. Even if the stocks within it are growing quickly, they may be on such extended price/earnings (p/e) ratios that they’ll just mark time as earnings catch up with share prices. This has certainly applied to some advertising-related stocks. But if you’re picky, you can still find decent value in this fast-growing sector. In the long run, there’s money to be made as investors wake up to the scope of internet advertising opportunities.

French advertising services firm Publicis Groupe (FP: PUB) develops advertising campaigns and sells these on billboards, in newspapers and magazines, and in cinemas. It already looks reasonable value on a 2011 forecast p/e of 13.8, which analysts expect to fall to just over 12 next year. The firm’s financial position has also improved sharply in recent years – by the end of 2010 it had eradicated its net debt. That has enabled it to buy Rosetta Marketing, the second-largest independent digital agency in the US, for $575m in cash. This move will take Publicis closer to its three-year target of generating 35% of its revenues from digital (2010 saw 28% of sales from this source).

With around 50% of its revenues coming from America, Publicis would benefit from a stronger dollar enhancing the euro value of its US earnings. The advertising agencies team at JP Morgan Cazenove has a price target 40% above today’s level.

Even cheaper is another, smaller, French firm, the advertising and media consultancy Havas (FP: HAV). The firm’s revenue stream is generated worldwide, though with a third coming from America, it would also get a boost if the dollar bounces.

On a current year p/e of 11.5, forecast to drop to just over ten next year, the stock is clearly cheap. Again, within the last decade Havas has dramatically improved its balance sheet, where it now holds net cash. Further, it’s “one of the few French companies currently undergoing a review of its business”, says Emmanuel Chevalier at CM-CIC Securities. “Valuation-wise, Havas trades at a 20% discount to peers – among listed advertising agencies, it clearly has the highest upside.” His price target is €5, over 40% above the current €3.53.

Moving to this side of the Channel, UK communications giant WPP (LSE: WPP) generates 40% of its turnover from advertising and media management. It’s another major earner in the US (35% of revenues), while almost 30% of sales come from AsiaPacific, Latin America and Africa/Middle East. On an 11.4 p/e for 2011, forecast to fall to just over ten next year, WPP is not a pure advertising play. But it’s cheap – and it will clearly benefit from growth in global spending on advertising. The prospective yield is 2.8%.

Then there’s the mighty Google (US: GOOG). A year or two back, this global technology company – market cap $172bn – fell into the ‘fast-growing-but-too-pricey’ category. However, since the start of 2010, the stock has underperformed the S&P 500 by more than 25% as investors have focused more on recovery and commodity plays.

Now, on a current year forecast p/e of just 15.8, Google is starting to look a good deal again. With the firm’s earnings forecast to soar by almost 60% by 2014, that multiple is set to drop steadily. Meanwhile, Google holds more than $33bn of net cash. The 10% fall in the shares this year could prove a handy opportunity to buy into one of the world’s major growth stocks.

Category: Investing in Technology