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The U.S. Ad Market Is Healthy With Growth Expected In 2019, But Current Trends Are Fragile

The eyes of the industry and investors remain firmly fixed on pending over-the-top subscription video service launches (by The Walt Disney Co., Warner Media LLC and others). Advertising, however, remains healthy as the television and radio sectors have been surprisingly resilient. S&P Global Ratings raised its growth expectation for the U.S. advertising industry and now expects ad revenue to grow 3.4% in 2019 (previous forecast was 2.9% growth). Our preliminary look at 2020 indicates growth of 4.9%. We believe core ad spending, which excludes political and Olympics advertising spending (which we estimate was $3.0 billion and $1.6 billion, respectively, in 2018) will increase 5.0% in 2019 (previously up 4.3%) and 3.6% in 2020. We consider this a surprisingly healthy rate as it exceeds our U.S. GDP forecast of 2.5% in 2019 and 1.8% in 2020.

Does this mean investors shouldn't be concerned about advertising trends in 2019? We believe these positive trends are fragile and are concerned that economic uncertainty resulting from global trade wars and political instabilities could hurt advertising in the second half of the year. These may not cause an economic downturn (that's not incorporated into our base-case scenario) but it may affect consumer sentiment and lead advertisers to reign in marketing plans.

Packaged Goods Companies May Finally Increase Marketing Spending

For several years, key consumer-facing sectors have confronted difficult industry-specific trends, resulting in cuts to marketing spending. Many large packaged goods companies, most notably Kraft Heinz, have embraced "zero based budgeting". This strategy, which has evolved into a strong cost cutting mindset, requires budgeting from a zero base every year and justification for every cost. This emphasis on cost cutting affected marketing budgets and reduced ad spending. Earlier this year, Kraft Heinz acknowledged it had underinvested in its brands and cost cutting had stifled both product innovation and growth. Whether this recognition reverses ad spending trends by consumer product companies is still unclear (after all, this sector remains under secular pressures as consumer purchasing behavior evolves away from traditional packaged goods companies' products).

Sector Forecasts: Internet Now Accounts For 40% Of Overall Advertising

Our individual sector ad revenue growth rates vary greatly, from 16% gain for internet to a 25% decline for directories (see table).

Table 1

Growth Expectations
Sector 2019 2020
Digital (%) 15.7 11.5
Local television (%) 0.5 (2.3)
Network television (%) 1.5 (0.5)
Cable television (%) 2.0 1.0
Total television, excluding political & Olympics (%) 0.9 0.4
Local political advertising (mil. $) 875.0 3,050.0
Total television (%) (3.7) 4.6
Radio (%) (1.5) (1.5)
Outdoor (%) 4.0 2.8
Magazines (%) (10.0) (10.0)
Newspapers (%) (15.0) (15.0)
Direct mail (%) (4.0) (4.0)
Core advertising (%) 5.0 3.6
Advertising, excluding Digital (%) (4.6) (0.3)
Total advertising (%) 3.4 4.9
U.S. GDP growth (%) 2.5 1.8
U.S. consumer spending (%) 2.5 2.0
Source: S&P Global Ratings' estimates.
Internet

We are raising our expectations for internet ad revenue growth to 15.7% from 14.4% in 2019 and to 11.5% from 10.9% in 2020 due to robust, albeit slowing, mobile advertising growth, tempered somewhat by 3%-4% declines in desktop advertising. Over the past three years, mobile advertising increased at a tremendous rate to about $74 billion on an annualized basis as of year-end 2018 from $33 billion in 2016, and it now represents more than 66% of total Internet advertising, according to Magna Global.

We estimate Internet advertising will surpass total off-line advertising by 2021 (it accounted for 40% of total ad spending in 2018) as the secular trends that have been driving internet advertising growth persist. We expect social and video to exhibit the highest growth rates (about 18% to 20% in 2019 and about 15% in 2020), surpassed only by emerging digital forms of advertising such as podcasts. Longer term, increasing regulations and greater privacy features such as the ability to delete one's history could limit targeted advertising and slow digital advertising growth.

Television

Core TV advertising across all three key platforms (broadcast network, cable, and local) performed better than our expectations for the first half of 2019, as the sector has benefitted from a healthy domestic economy. Both broadcast network and cable advertising have held on to positive growth as strong pricing in the scatter market from limited ad inventory counters continued double-digit declines in audience ratings. Local advertising remains robust as well, though we harbor concerns that economic weakness or political instabilities could temper or reverse these trends. We expect core TV ad revenues (excluding political and Olympics advertising) to increase 5.0% in 2019 and 3.6% in 2020.

Despite the challenged ratings environment across all of U.S. television, strong pricing trends continue to support modest overall growth and we expect this will continue in 2019 and 2020. The scatter market remains frothy through the first half of 2019. Networks have limited advertising inventory to meet advertisers' needs as a result of media companies having to put aside greater inventory ("make-goods") to make up for declining audience ratings. As a result, overall cost per thousand viewers (CPM) pricing for available ad slots has been growing at a double-digit percentage pace (over last year's rates).

Larger cable network groups are shifting more inventory toward addressable advertising, which garners higher CPMs then traditional linear TV advertising. Companies like Viacom, which has invested heavily in its Vantage platform, are experiencing improving growth trends as addressable/digital advertising growth begins to offset declines in linear cable TV advertising. However, we believe there is a limit to the extent that higher pricing can offset declining ratings and we expect networks focused on sports and news to fare better in the longer term as viewing of general entertainment programming shifts to OTT platforms.

How Does This Work?

National broadcast advertising is sold in two ways. First, during the "upfront" selling season in the late spring and early summer, when broadcast and cable network operators present their upcoming schedules to advertisers. The goal is to get advertisers to commit to placing ads prior to the coming broadcast season (September through May the following year). These commitments incorporate audience guarantees and are priced at a discount to current market pricing. If the broadcaster cannot deliver the guaranteed audience levels, it must provide additional ad inventory, at no cost, to the advertiser (so called "make-goods"). The second option is via the scatter market. This a year-round market in which advertisers buy ad space close to air time. Inventory sold through the scatter market is priced at current market rates and doesn't usually include audience guarantees. Generally, 70%-75% of broadcast network ads are purchased in the upfront and remaining 25%-30% through the scatter market. For cable network operations, the split is more even.

Broadcast network TV

We expect overall broadcast network advertising to fall 6.1% in 2019 (an improvement from our previous forecast for a 7.1% decline). Excluding our estimates for the Olympics and World Cup from the 2018 comparison, core TV advertising will likely increase 2.0% (down from 3.0%). Our forecast reflects the following factors:

  • Double-digit pricing growth in the scatter market due to continued high demand for ad inventory;
  • Low-double-digit percentage declines in audience ratings for the four English-language networks (ABC, CBS, Fox, and NBC); and
  • Upfront ad commitments for the 2019/2020 television season up low-single-digit percentage due to higher ad volume (mid-single-digit percentage) and CPM pricing (in the teens percentage range).
Cable network TV

The resiliency in cable TV advertising was surprising. We expect cable TV advertising revenue to grow 1.0% in 2019. Core cable TV ad revenue, which excludes about $380 million in Olympics-based advertising spending in 2018, will grow by about 2.0% in 2019, an improvement from our previous expectation for 1.5% growth. Still, longer term, we believe the cable networks, especially those without news or sports, are more vulnerable to cord cutting and audience declines than the broadcast networks.

Local TV

We expect core TV ad revenues, excluding political, to modestly increase by about 0.5% in 2019 given less displacement from political advertising. We expect the pace of core advertising revenue growth will be slower in second half of the year given rising geopolitical risks, a potential slowdown in the economy, and early political advertising dollars associated with the 2020 U.S. presidential election. Many local TV broadcasters noted advertising growth from the services category. In addition, auto advertising, which had been a troubled category, has sequentially improved since reaching a trough in the middle of 2018.

Our forecast is lower than our 2.2% U.S. GDP forecast given local TV's modest exposure to the negative ad trends affecting the entire television industry. Broadcast television is not experiencing the same level of secular pressures as cable networks because it is less exposed to substitution from Internet-based content because of its live content, therefore resulting in a slower decline in audience ratings.

Radio

Despite persistent fears that radio advertising declines will worsen, declines remain modest with an estimated 0.6% dip in 2018. We attribute this to the growing strength of music streaming which, while representing less than 10% of radio ad revenue (according to Kagan estimates), is growing at a mid- to high-single-digit pace.

We expect radio-only ad revenue to decline 1.5% in both 2019 and 2020 (an improvement from our previous forecast of 2% annually), as we believe the low cost of radio spot advertising rates has made radio more attractive relative to more expensive forms of media. We expect radio broadcasters' share of ad budgets and rates will continue to decline, as advertisers continue to shift ad spending to alternative media (primarily Internet and TV), but at a slower pace than we previously expected.

We also believe that growth in digital and live-event revenue will have a substantially offsetting effect on total revenue growth in the industry, and that total radio industry revenue growth will be flat in 2019 and 2020.

Outdoor

We expect outdoor advertising growth of 4% in 2019 -- an improvement from our previous forecast of 2.75% growth given an improvement in national advertising, which benefits outdoor advertising in large markets. Outdoor advertising will likely increase faster than U.S. GDP growth (2.2%) because local outdoor ads are less susceptible to internet and digital substitution. The segment benefits from limited inventory due to local zoning ordinances, which prevents overbuilding, and traffic viewing, which limits internet substitutability. We expect most of the growth in this sector to come from digital billboards, corresponding with ongoing capital spending for outdoor advertisers.

Magazines and newspapers

We expect overall magazine and newspaper print ad revenues to decline by roughly 13% in both 2019 and 2020 as companies continue to battle structural headwinds. By 2021, ad revenues will be half of 2014 revenue. For magazines, we expect ad revenues to decline 10% in 2019 (previously 12%) and 10% in 2020. This is the result of continued weakness in ad pages and CPMs, as magazine publishers continue to face declining newsstand sales, lower total circulation, weaker rate bases, and shrinking retail shelf space as high cover prices push readers to seek free alternatives on the internet.

For newspapers, we expect print ad revenue to decline about 15% in 2019 (previously 12%) and 15% in 2020 because of lower retail print ad spending and continued weakness in classified print ad growth. Digital ad growth should partially offset print ad declines, but it remains a modest portion of total ad revenues.

The Credit Impact

Traditional media outlets that depend on advertising for the majority of revenues and cash flow remain under significant growth pressure as advertisers look for alternatives to reach consumers more efficiently. Ad spending continues to shift away from traditional print-based media (directories, newspapers, and magazines) to mobile platforms, which allow for more efficient targeting of audiences at lower costs--making them more attractive to advertisers.

TV ad spending will likely remain resilient over the next three to five years despite some investor concerns that linear television will soon join print media as a declining industry. As long as brand building remains a key component of advertisers' marketing strategy, which requires reaching broad audiences instead of targeting demographics, advertisers will continue demanding linear TV ad spots. Live television – sports, news, and special events in particular — remains the best media for reaching the broadest audiences, despite continued audience ratings declines. Longer term, linear TV ad pricing will likely face pressures as audience ratings eventually reach an inflection point and advertisers are no longer willing to pay a premium for linear TV's superior reach.

Overall, our ratings on the U.S. media and entertainment industry overall remain broadly stable but are increasingly trending negative because of the continued negative shifts in media consumption and ad spending. Print, publishing, radio, and television media companies face the greatest rating pressures.

We will continue to closely monitor these secular trends and its impact on U.S. media companies' operating and financial performance. We could revise our leverage thresholds or lower our ratings on those media companies that we believe are in a weaker position to address these pressures.

Related Criteria

  • Key Credit Factors For The Media And Entertainment Industry, April 1, 2019

This report does not constitute a rating action.

Primary Credit Analyst:Naveen Sarma, New York (1) 212-438-7833;
naveen.sarma@spglobal.com
Secondary Contacts:Thomas J Hartman, CFA, Chicago (1) 312-233-7057;
thomas.hartman@spglobal.com
Jawad Hussain, Chicago + 1 (312) 233 7045;
jawad.hussain@spglobal.com
Rose Oberman, CFA, New York 212-438-0354;
rose.oberman@spglobal.com
Vishal H Merani, CFA, New York (1) 212-438-2679;
vishal.merani@spglobal.com
Scott E Zari, CFA, Chicago + 1 (312) 233 7079;
scott.zari@spglobal.com

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