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.


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