Making Money in Media How a new round of dealmaking could unlock the hidden value of these stocks
By Michael Sivy

(MONEY Magazine) – Suddenly, media stocks are at the center of a dealmaking frenzy. Comcast has made a run at Disney, Viacom is talking about acquiring a cable-TV company, and Time Warner (owner of this magazine) wants to add to its own cable operations. Many of these big players are also putting assets on the auction block or restructuring in financially advantageous ways: Viacom has said it will shed the Blockbuster video-rental chain, and Time Warner, which has already sold its music division, is rumored to be exploring ways to dispose of AOL.

All of this activity signals a great opportunity for investors. A massive restructuring has begun that should unlock the value of depressed stocks and raise profits for the industry giants. Some individual deals may disappoint, especially if acquirers overpay (always a real risk). But here's why I think the sector overall is ready for a major advance.

MEDIA STOCKS ARE STILL CHEAP Shares are down 40% to 75% from five-year peaks. Although P/Es are high based on current earnings, prices are modest compared with assets and long-term earning power. And since the economic recovery has yet to produce a big pickup in ad spending, media stocks are still due for an earnings upswing.

THEY'RE TRIMMING THE FAT Selling nonessential businesses will allow media conglomerates to rebuild their balance sheets and focus on their most promising markets. That's likely to bolster the prices of stocks that are trading below their breakup value--that is, what all their assets would be worth if each were sold individually.

COMING UP NEXT: SMART MERGERS The industry has finally developed a coherent strategy for M&A. Everyone now sees that it makes great sense to unite film and television production with distribution, preferably through a broadcast network as well as cable channels. But other media properties--such as newspapers, magazines, music and radio--may not be essential. As the media conglomerates free up cash by selling off ancillary businesses, some will start looking for new film and television assets to buy. And the firms that own those assets should therefore be worth more.

What to buy now

There are three basic ways to play consolidation in the media sector.

THE CONGLOMERATES This group includes Disney, News Corp., Time Warner and Viacom. Each company is diverse enough that you could own it as a proxy for the whole sector. Still, some are better run than others. Disney's earnings plateaued in 1997 and probably won't reach substantially higher levels until 2005. News Corp. is so much the projection of 73-year-old boss Rupert Murdoch that it's hard to know how it will fare once he leaves. And Time Warner is still coping with the troubles of its AOL division, which include an investigation into its financial practices.

So I like Viacom (VIAB) best--it simply has the fewest problems. The company has acknowledged that its Blockbuster division has little left to contribute; disposing of it will only enhance the company's balance sheet and earnings growth. CEO Sumner Redstone has mused about buying a cable-TV operator, a move that would diversify Viacom's business mix. At $37.80 a share, the stock trades at 23 times estimated 2004 earnings. That's cheap for this group, especially considering Viacom's 15% growth rate.

THE ENTREPRENEURS Three companies that aren't as dominant as the conglomerates are also likely to be in on the next wave of deals because they are led by dynamic entrepreneurs. Of these, Comcast is the closest to being fully mature: It's the leading cable operator, more than 60% larger than No. 2 Time Warner. What CEO Brian Roberts really needs is to add more content, hence his bid for Disney. By contrast, Barry Diller's InterActiveCorp may not be mature enough. Diller is one of the few CEOs who have managed to assemble successful, profit-making online businesses. But his company has yet to post returns that justify its 31-plus P/E.

My pick in this group is Liberty Media (L), a collection of stakes in TV channels and other media. In fact, Liberty's equity interest in News Corp. rivals that of the Murdoch family (although its voting stake is smaller). Liberty also owns chunks of InterActiveCorp and Time Warner. Analysts estimate that the company, now trading at around $11 a share, has a breakup value of $16 to $18 a share.

ONE-STOP SHOPPING For investors who prefer mutual funds, the purest play on this sector is Fidelity Select Multimedia, which has almost three-quarters of its portfolio in media stocks. A more diverse alternative is T. Rowe Price Media & Telecom, which invests more than 80% of its portfolio in media and telecommunications. Both funds have ranked among the top performers in their sector over the past three and five years. Neither fund carries a load, and their expenses are below average.