MDCA 2Q:08 Revenue Expands 17% Despite The Deepest Advertising Recession In a Generation; Reiterate Buy Rating and $13 Target

Investment Thesis:



We think MDCA will take market share from other agencies as advertisers seek to maximize ROI on advertising budgets and we also expect MDCA's CRM franchise to benefit from a weak US dollar.



KEY Points:



*MDCA's advertising franchise is firing on all cylinders despite a challenging advertising environment.



*MDCA double digit organic revenue growth (almost 15%) surpassed the company's peer group revenue growth (9%) which includes acquisitions.



*Clearly MDCA is taking market share and expect this trend to continue as companies like WPG and OMC are reeling from a difficult economy.



We Note: Rita Spitz an analyst from William Blair Asset Management recently said "You obviously do not know what you are talking about and have no understanding of the ad industry" when I called for a cyclical slowdown in ad industry sales in 1Q:08. Since then my analysis was proven correct and OMC and WPG shares (Rita's largest holdings) are down about 17% as industry growth has declined due to a recessionary US economy and slowing international growth. In contrast to its peers, MDCA shares have held their own despite the recent market turmoil and revenue continues to expand.


It is now clear that Rita Spitz (among others) owes me an apology; but I shall not hold my breadth since arrogance generally trumps talent and common sense on Wall Street.



Recent Events:

*On July 29, 2008 after the market closed MDCA reported a 2Q:08 loss from continuing operations of $0.10 versus our estimate of $0.08 and Wall Street consensus of $0.06.

*Excluding higher than forecasted taxes in 2Q:08 ($3.4 million versus our $1.5 estimate) MDCA's loss from continuing operations was $0.01 or much better than we expected.


*Revenue and EBITDA are perhaps the most relevant metrics used to evaluate MDCA shares as advertising industry accounting practices understate MDCA's profitability. Using these metrics MDCA surpassed our expectations.

*2Q;08 sales of $158 million surpassed our $143 million forecast.

*EBITDA in 2Q was $15.8 million also exceeded our estimate ($13 million) for 2Q:08.

Outlook and Valuation

*We think the outlook for MDCA shares is bright as the company will benefit from stable ad budgets from its family and fast food advertising clients such as Wendy's, Domino's Pizza and Burger King.

*We expect MDCA to benefit as advertisers cut back on costly international advertising to focus on US markets (MDCA derives over 90% of its revenue from North America). In the US the weak dollar will enable international advertisers to purchase more for thier ad dollar thus boosting the ROI for ad budgets.

*On the earnings conference call MDCA gave 2008 revenue guidance in a range of $600-$610 million. While management is calling 10% revenue growth we are raising our 2008 revenue estimate to $614 million (from $604 million) as management generally gives low-ball sales guidance.

*We expect MDCA will post Adjusted EBITDA of $65 million in 2008 and $67 million in 2009 as MDCA lands new accounts and expands sales to existing clients.

*To derive our $13 price target, we apply a 9x EV/EBITDA multiple which may be conservative and is at the low end of MDCA's peer group EV/EBITDA multiple range of 8x-14x.

We also note that MDCA is an attractive takeover target as MDCA's high growth ad agencies offer compelling synergies to strategic industry parners. We think a 10%-20% premium to our target price is probably conservative if a player like OMC or WPG were to target MDCA.

Moreover, any MDCA acquisition could be essentailly self funded as we think MDCA's CRM business is worth $140 to $200 million (1x-1.5x sales) if sold to to a larger call center operator such as IBM or CSC.

With significant upside to our estimates and our $13 target we recommend that investors purchase MDCA shares.

I will have updated financial models available in excel for purchase once MDCA releases its 10Q.

Better than expected merchandise revenue at MSO offsets waning subscription sales. We remain nuetral as we expect publishing ad sales to remain weak.

Thesis:

While 2Q:08 merchandise sales were better than we expected weak ad sales and uncertainty regarding MSO's radio contract will weigh on MSO shares in 2h:08.

Key points:

*Merchandise sales were $16 million versus our $10 million estimate.

*The upside is due to: MSO's recent Emeril acquisition (which was not in our model) and a better than expected performance of the Martha Stewart Collection at Macy's. We note, the Martha Stewart Collection, has trended above plan since its launch.

*MSO's robust 2Q:08 merchandise performance in part seasonal, in our opinion, owing to the synergy between MACY's very strong wedding bridal franchise (roughly 10% of M's non-holiday season revenue) and the Martha Stewart Collection.

*MSO also benefited in 2Q;08 from the US tax rebate(as we predicted the company would as early as December 2008!). According to economic studies roughly 30% of the tax rebate was spent on consumer non-durable items and food, MSO's key merchandise categories.

*Unfortunately while we are impressed by MSO merchandise and broadcasting performance, we predict weakness in publishing and uncertainty in MSO broadcast division will offset solid execution in merchandise.

*We expect investor concerns about MSO's $10 million contract with Sirius Satellite radio, which will expire in 2009 and a decline ad sales will offset any progress MSO makes in merchandise.


*Thus we are cutting our 4Q;08 estimate to $0.35 from $0.40 and only fine tuning our 2009 EPS estimate to $0.57 from $0.55.

Outlook and Valuation

We are disappointed with MSO new guidance and outlook. MSO basically lowered its revenue guidance to $300 million from $312 million (including the Emeril acquisition). Due to a recessionary consumer economy, we predict MSO's new merchandise lines will not offset the contractual decline in mechandise sales. We expect MSO's KMART contract sales will decline to $15 million in 2009 and $20 million in 2008 from $65 million in 2007. While MSO has a history of trying to low ball guidance we think our $304 million estimate (as compared to $327 million in 2007) is reasonable given the 6% publishing revenue decline we expect.

We predict improved operating margins (to 4.5% from 2.5%) will allow MSO to remain profitable and we forecast EPS of $0.27 in 2008.

*We derive our $9.00 price target by applying a 15x multiple to our revised EPS estimate of $0.57 for 2009. The multiple we apply is in-line with MSO's publishing and merchandising peers such as MDP.

Although we really like this company we are Neutral on JRN

EPS declined about 16% to $0.16 as compared to $0.19 in 2007 however, JRN surpassed our $0.10 forecast EPS estimates in 2Q:08.

JRN posted better results from its Palms Springs TV station than we expected.

This supports our overall media industry investment thesis that local content and aggressive brand management are the keys to competing against global media giants.

We think JRN is well positioned to survive the disruption caused by the Internet but we are still gun shy as JRN has exposure to weak media markets in LasVegas and Florida.

More to follow....

Sharp Trader waits on the side-lines as ARB shares tune out

Investment thesis:

We think the introduction of PPM radio measurement will lead to near term disruption in the radio industry which is already realing from an advertising recession. We think an adjustment period is needed for media buyers and broadcasters to get aclimated a dual ratings landscape, Diary ratings will still be the standard in most radio markets through 2009.

Key points:

*While not perfect we think the PPM system has advantages over the old Diary system it replaces. First and foremost, the PPM actually measures radio listening whereas the Diary system has devolved into a measurement of favorite stations and not true radio audience.

*Since the PPM provides an accurate measurement we think the roll-out of PPM technology will happen according to plan but the introduction of PPM radio ratings is still tenuous in our view.

*There is significant headline risk as the roll-out progresses.

*We think the industry and ARB are essentially unprepared for the introduction of PPM ratings. We think ARB and the radio industry needs to address the PPM's short comings and iron out the wrinkles.

*We think ARB's current initiatives to train industry participants have been to little to late.

Thus we think ARB shares are over valued at $47 per share.Valuation:We have a $37 price target on ARB shares and we derive our target by applying a 17x multiple to our EPS estimate of $2.08 for 2009 .

We think a market multiple is reasonable given ARB's monopoly status and long term EPS growth prospects are offset by near term uncertainty.

Recent Events:

*ARB reported 2Q:08 EPS of $0.02 per share which was in-line with our $0.02 estimate but lower than the Wall Street Consensus estimate of $0.03.

*While ARB's results where as we expected we would not buy into any weakness following the earnings call.Other metrics we look at were below our forecasts such as Revenue. Revenues ($78.3 million vs. $80.7 million) were also weaker than we expected as we think media buyers spent less on discretionary services before the launch of PPM ratings.

*ARB did not change its guidance range for 2008 of $1.30 to $1.40 and we think ARB will most likely narrow or lower guidance altogether as the PPM radio ratings system is rolled out to markets in NYC, LA and Chicago.

*We expect PPM costs to escalate as our sources indicate that ARB has delayed PPM roll-out spending and pushed out the introduction of vital training programs into 3Q:08.

Cume versus TSL and GRPs

Due to the success of the Dairy ratings system, most media buyers view radio as a frequency media, meaning they can expose the same person to a marketing message over and over again. Basically the old ratings system exaggerated the amount of time a person listened to a particular radio station or TSL. The industry's reliance on TSL is inappropriate as PPM technology shows that TSL is actually lower which may be bad for radio taking nothing else into account but overall radio's audience cume is 30% to 50% greater.Thus ARB is now telling the industry that radio is a reach media comparable to TV and they claim radio is not only a frequency media but a reach media like billboards or TV.

We think encouraging the use of cume to price radio advertising will be a hard sell. Media buyers s will not pay more for radio advertising in an add recession as they are biased against old media like radio and newspapers . We think media buyers will not readily accept (even if true) that radio has a much larger audiene a notion that goes against the current industry thinking (or better yet; group thinking).

Further complicating maters is GRP or gross ratings points. In most markets PPM ratings yield 30% less GRPs per station because the TSL is lower. That means each station is getting a smaller proportional piece of a larger audience pie. We think media buyers will not appreciate the greater cume and will either buy less radio advertising or pressure stations for lower rates.

Thus the seeds of the broadcaster's dissatisfaction with the PPM system still linger and just cannot go away in our view.Eventually, through the use of analysis and PPM technology media buyers will be able to maximize radio advertising. However we think this process will not happen overnight especially during a deep advertising recession.

Outlook and forecasts:

Our $1.27 EPS forecast is unchanged and below the low end of ARB's guidance -which we think will have to come down as ARB comes clean with investors and increases its roll-out support and training expenses.

Moreover, we think ARB's claims of a recovery to historic margin levels are not realistic as ARB will have to increase R&D and cost of service spending just to maintain its radio ratings monopoly as new technologies will come to market just as ARB's current contracts begin to expire in 2010. We expect ARB's net margins will be in the range of 10%-12% (in-line to the industry average) once the roll-out is complete and not the high teens multiple implied by ARB's Pre-PPM roll-out operating performance.

We would short ARB at the present time since many media company offer dividends and a better combined return than the downside we project for ARB shares. We would reconsider our opinion if ARB shares trade below $37.


Working Excel Based Finacial models are available for ARB

Gold Package:

$5000 for IS IS and CF (save $1000 includes free quarterly updates)

A la Carte

$3000 for IS

$1000 for BS

$2000 for CF

Thought of the Day

We recommend covering the FDX shorty position as Oil is clearly in retreat and we think transports will rally as oil prices decline. During Oil's 35% rally over the last twelve months FDX share and EPS declined roughly 32% and 69% respectively and we think there will be better shorts once the dust settles.

As 70% of the QQQQ ETF is comprised of GOOG, MSFT, YHOO and AAPL we think a QQQQ short is decent hedge for now because 4/5 of these technology bellwethers have just released punk EPS.

We still think a bubble persists in the energy markets as we expect global demand to decline in as bloated current account surpluses in India and China melt as their economies have slowed. Our channel checks with global oil shippers indicate that there may be excess oil supply sitting idle in harbors on the Persian gulf, Puerta la cruz and in the Black Sea.

We still like LEH even though there is just 26% upside to our $24 price target. We at sharp Trader are ccontrarians and we like buying companies that have industry leading name brand franchises and trade at very low multiples to 5 year average and peak EPS. LEH is currently trading at just 2.7x peak EPS and 3.8x its five year average EPS.

While LEH has had a hard time in 2008 this company is still a leader in investment banking and we think recovery EPS in the range of $3.50 and $4.50 is realistic.

Moreover we think LEH M&A, trading and investment banking franchise will post solid results once the credit crisis subsides as companies will likely look to merge and raise equity capital to fund growth initiatives.

To get to our $24 target we apply 9x multiple to our 2010 EPS estimate of $4.00 per share and discount our $36 dollar intrinsic value two years using a 20% cost of equity capital.

We also think is LEH's management cannot make a go of it we think its board will seek strategic alternatives and we think LEH shares are worth $24 to $41 in a sale providing LEH's blance sheet does not deteriorate and their no further need to raise equity capital.

MEG's $0.06 Operating Loss Better Than Our $0.10 Forecast On Cost Cuts As Revenue Declines Continue

*Revenue declined roughly 10% in 2Q:08 to approximately $205 million from $228 in 2Q:07, as result from MEG's Tampa operations continue to weigh on MEG's top-line results.

*2Q:08 revenue was also well below Sharptrader's $217 million estimate, however EPS was better than we expected as MEG's moves to cut costs and lower interest expense($10.5 million vs. our $11.5 million estimate) offset disappointing sales.

*MEG took a hefty $500 wite down on its Media assets which was not unexpected given the current advertising enviroment we do not think the non-cash writedown will impact MEG's debt covenenets but we will be sure to ask the question on the call.

*The silver lining to this write down is MEG will be able to offset gains on its assets with the loss.

*We will most likely fine tune our estimatates following the earnings call and we continue to think MEG shares are cheap at the current $11-11.50 price level.

LEH Follow UP

If they survive (which I think there is a 80% chance of that happening) I think the stock is worth $36 (or 1x Cash) in 18 months or $24 PV today. There was an article in today's post about an LBO and I have betted the price would be the same as the deal price; I think Bain and Blackrock would fund a deal at $27 as they own 20% of the company and insiders own 30%. If they dilute the insiders by 10% then that would end any capital concerns permanently.

Full Disclosure:

Call me Crazy but I bought more LEH at $15.80

How Much?

I think part of this problem we face is due to overly conservative GAAP accounting rule changes by FASB which are forcing firms to mark down their mortgage assets to nearly zero which I do not think is realistic. I think once the write-offs are done then banks will guide EPS higher and stock prices will recover sharply.

I am just kicking myself that I did not find out about this rule change (FAS 157) in November because clearly stocks started to move down as it was implemented. Basically what FAS says is that the owners of bank debt have to write down that asset based to the lower of the last trade are estimated value. Since that market is illiquid the estimated value will always be a steep discount to the last trade which for most instruments is issue price. Prior to 157 firms could mark to market, mark to estimated market value or hold the debt on the books at historical price just like any other asset.

An analogy to how this works is as follows.

Let’s assume you bought your house for $500K (20% down payment) and months later a similar house on your block just sold for $495K.

In the past it would have taken banks months to identify this lower price whereas today that data is kept in an electronic data base and is immediately posted to a bank's risk management system. Due to the lower sale price your lender would have to under FAS 157 will have to write down the value of its loan to your from $400k to some estimated number below $395K. I does not matter what the real value of your home is it will be written down. For example by banker recently wrote down the value of my house to $360k despite the fact three houses on my block sold for 1,000,000, made capital improvements of roughly $35,000 and my credit score is well over 760.

I think a “disconnect” exists between FAS 157 and reality because FAS 157 mandates are too extreme. The problem is if you are an average American the value of your mortgage is most likely greater than what FAS 157 dictates, which is reasonable because as the average American make payment, lets assume at 7%, the Future Value of that 30 year mortgage is roughly $2.7 million. True some loans are worth less due to short term market conditions but in my view short term market home price values should not be used to price thirty year instruments -short term prices should be used for short term loan and vice-versa. Moreover that house you bought will probably be worth roughly $4,000,000 in thirty years (or 2038) based on a real return of just 2% over inflation. Thus the present value of that mortgage asset and house are roughly more like $394k and $656k respectively and not zero and $150K which is what FAS 157 says.

This explains why the private equity guys are raising billions to buy distressed morbtage debt and why the banks are not selling any of their paper as yet.

Full Disclosure:

I sold the last of my FNM at $8.60 yesterday and I swaped it for LEH today, I paid $12.41 for LEH and I would aggressivesly add to LEH at the current price.

Sharp Trader Expects 2Q:08 Operating Loss Per Share of of $0.10 As Compared To Concensus of $0.06 For MEG

Media General is a leading TV and Newspaper operator and we think MEG's EPS will be up in 2008 as MEG has sold unprofitable assets and paid down its debt. We think MEG's turn-around story has gone largely unnoticed by Wall Street and we think MEG's EPS will double -despite a miserable economic backdrop. Our 2008 EPS estimate is $1.17 versus $0.53 in 2007 .


* MEG's guidance is for an operating loss per share of $0.11 including employee severance charges.

*MEG's 2008 EPS guidance ranges from $1.20 to $1.31 including severance charges verus the $0.98 first call estimate.

*Our EPS estimate for continuing operations is $1.17 for 2008 and $1.43 for 2009 as we expect MEG will benefit from its cost reduction program and an improved economy in 2009.

* While we think MEG's revenue from its Florida media operations are still in decline, we think the company has benefited from lower interest expenses and reduced headcount.

*We think MEG will reiterate its EPS guidance for 2008 during the earnings call as advertising revenue ($43+ million) from the Summer Olympics and the US Presidential election should offset the loss of Home and Auto advertising owing to a weak economy.

* We think MEG is exceptionally cheap at $11 per share and we are attracted to MEG's dividend yielding 8.6% at the current price.

*While investors are still be concerned about revenue declines we think any stock price weakness due to weak Newspaper ad sales in Florida is a buying opprtunity.

*Our sum of the parts analysis indicates that MEG is worth $17 to $27 in a takeover and we think both GNI and NYT are potential strategic buyers of MEG as both companies operate newspapers in Florida.

*To derive our $17 target we apply a 12x multiple to our $1.43 recovery EPS estimate for 2009.



11.20
Price Open 11.37
Previous Close
11.20
Day High
10.56
Day Low
1.14
Beta
34.59/7/16/07
52wk High/Date
10.23/7/14/08
52wk Low/Date
241.3 Million
Market Capitalization
22.3 Million
Shares Outstanding
73.00
Volatility Avg(20 day)
196.2 Thousand
Avg Vol (10 day)
30.1x
P/E Ratio
0.36
EPS (TTM)
0.23 (9/15/08)
Declared QRTR Div
8.50%
Yield
8/27/2008

Thought of the Day

I looks like we are in the early stages of a stock market capitulation. Bearish sentiment is virtually absolute, the federal government has launched several investigations of hedge funds as well as futures traders and home prices are now roughly in-line with historical multiples of income.

Moreover new home starts are trending well below 1 million units which is not enough to support the roughly 2% annualized US population growth rate.

_Think about it: in five years the US population will be up to 343 million from 330 million today and we are track to build just 2.5 million new homes. In my view, under building should create a housing shortage in the US.

_Once the credit crisis subsides, I think rental REITS will have a great year in 2009as rental rates rise to accommodate the legions of former home owners that unfortunately had to step away from their homes.

_Real estate cap rates should improve in 2009 as low borrowing rates and higher rents boost operating income.

Sharp Trader Think LEH is a Buying opportunity.

While I think it will take a while for Bank EPS to recover LEH is extremely undervalued and given the Fed's willingness to rescue Investment banks I think LEH share have limited downside risk at these levels as the upside is great.

First, LEH has a great Investment Banking and Capital Markets franchise which should recover early in the cycle. I think this franchise has been overlooked by Wall Street.

Second, even after the dilution LEH has great earnings power

Over the past five years LEH average EPS has been roughly $5.00 per share with peak EPS over $7.00. While LEH's peak EPS will be significantly lower due to equity dillution I think $3-5 per share in peak EPS is reasonable for LEH shares. I also expect recover EPS will be in the $2-3 range. At the current price LEH is trading at just 5x recovery EPS of $2.50.

If we apply a 14x market multiple to recovery EPS of $2.50 we drive a recovery stock price of $35 in 24 months. To derive our target price we dicount LEH shares using a 20% discount rate over 24 months thus LEH's intrinsic value is $24.00 by our model.

Disclosure: I sold my 100 shares of FNM at $9.95 and I am entering a limit order to buy LEH at $10.00. Yesterday I added to my GTN position and I have limit order to buy more at $2.00 As we noted below I have roughly a $7.00 price target for GTN shares.

Thought of the day

If FNM has been in business for eighty years then the average cost basis of its assets reflect mortages that were given to me to buy my $500,000 house as well as my next door neighbor Jeff that bought his house 25 years ago for $40,000.

It seems to me that 9/10's of FNM's loans have to be solid and that the sellers of the stock are in panic mode.

While I think FNM shares are cheap at $12, I would rather be a holder of LEH as I think LEH's exposure to equity trading and investment banking will offset slower growth in fixed income sales.

Full Disclosure: I bought 200 FNM on Friday at $7.49, Sold 100 at $11.50 on Friday and have a limit order to sell 100 at $16.00.

New Legislation in Florida Could Hurt Serveral Media Companies

_There is upcoming legislation in Florida that would remove sales tax exemptions on advertising and media services in Florida.


Companies that could be directly effected by this legislation are:

Media General (NYSE: MEG)
Journal Communications (NYSE:JRN)
McClatchy (NYSE:MNI)
MDCA Partners (NASDAQ:MDCA)

RRST Valuation Will Come To Earth As A Weak Dollar Continues To Pressure Gross Margins

RRST is a global provider of satellite and media outsourcing services to radio and TV channel operators. Prior to launching Sharp Trader I had a BUY rating on RRST however I am now cutting my estimates, price target and reducing my rating to Nuetral (from BUY) as we now think the global media market will follow the US into an ad recession. RRST is a well run company with a bright longterm outlook, in our view, however we thnk near term weakness in the global media market will pressure EPS in 2008.

_Thus we are cutting our price target to $11 from $28 as we reduce our EPS estimate for 2008 to $0.73 from $0.89. Likewise we are cutting our 2009 estimate to $0.95 from $1.25

_We apply a 15x multiple to our $0.73 2008 EPS estimate to arrive are our target.

_We think RRST will face gross margin pressure as the combination of a weak US dollar relative to the New Israeli Shekel combined with rising satellite linkage prices offsets 28% revenue growth we expect.

_We also predict media growth outside of the US will slow following the summer Olympics as high fuel prices limit disposable income in emerging markets in Africa and the Asia.

_Since much of RRST's growth is attributed to emerging markets we think RRST's revenue growth could slow as these markets cool.

_In the long term we think RRST's fundamentals are intact but we would avoid taking a position in RRST today as its shares are illiquid and we see limited EPS growth in the near term.