Shares digital

The internet weaves a tangled web for many sectors

by Russ Mould

This year’s annual Communications Market Report issued by UK regulator Ofcom two weeks ago (14 August), offered further evidence of the internet’s continuing spread. Helped by a rise in the average broadband speed from 3.6 megabits per second (Mbit/s) in December 2006 to 5.9 Mbit/s by March 2008, 13% of all UK households now take bundled, or ‘triple-play’ phone, broadband and television services from communications providers.

Shares (15 May and 3 July) examined these themes and identified potential beneficiaries of the internet’s impact on how telecoms and technology firms have to adapt.

The web’s ubiquity today means it is not just the technology industry seeing barriers to entry torn down and new business models emerge. Industries as diverse as media, retail, gambling and even forestry and paper are all undergoing a digital revolution. Just as in technology, long-established winners are now losing out to a breed of new web-based upstarts. Firms that have successfully reconditioned their businesses include Reed Elsevier (REL), while minnow Publishing Technology (PTO:AIM) could prove a key facilitator of change in the media industry. Retailer N Brown (BWNG) has adapted well, while media stocks such as Trinity Mirror (TNI) and Johnston Press (JPR) will continue to find the environment difficult, even if their depressed valuations discount a lot of bad news.

Retail

Amazon.com’s $35.1 billion market capitalisation, the equivalent of 34 WH Smiths (SMWH), is testimony to the power of internet shopping. Stay-at-home buying could take an even greater share of the market in the event of prolonged oil price strength, if recent footfall data from leading retail chains is any guide. John Lewis admitted to sharp drops in footfall in late June at its Bluewater and Trafford centre stores but noted online trade remained healthy. A survey from Experian (EXPN) suggested shoppers were being deterred from travelling to out-of-town shopping centres by the price of petrol, and were fulfilling their needs online instead.

N Brown, which caters for a more mature and often more generously proportioned client base, reported sales growth in the 17 weeks to 28 June of 12.3%. Although N Brown was traditionally a catalogue retailer, online sales grew 45% year-on-year and reached just under a third of group sales. This has two benefits. Firstly, there is a cost saving, which is being reinvested in additional marketing. Secondly, online orders are generally a quarter higher than the average.

Pure online retailer ASOS (ASC:AIM) shines out like a beacon in a sector that has witnessed little but carnage. General Retailers ranks 40th and dead last among the sectors making up the FTSE All-Share, with a 35.2% year-to-date drop, yet ASOS shares have surged by 29% this year. In the 13 weeks to 27 June, sales growth accelerated from 85% a year ago to 95%. Even average basket per shopper rose from £42.80 to £53. A prospective price/earnings(PE) ratio of 27.9 is more problematic for investors, as it leaves no margin for error, but the company’s niche and its model are serving it well.

Gambling

The days when punters could only bet in dingy, smoke-filled betting shops are long gone. Irish bookmaker Paddy Power (PAP) has invested aggressively online and reaped the rewards in 2007 with a 20% rise in amounts staked and 36% increase in gross win from its internet betting operations; 44% of group operating profit was generated online in 2007. Online betting exchange Betfair has revolutionised the gambling industry. Excellent liquidity, crystal clear transparency and internet punter expertise means Betfair’s online ‘back’ and ‘lay’ prices are very influential and have, to some degree, cramped the percentage ‘overround’ bookmakers build into their prices to guarantee themselves profits.

William Hill (WMH) suffered a major embarrassment last year when technical difficulties with a new online platform knocked £10.6 million off earnings. An inadequate ‘in running’ offer, which allows punters to bet once a sporting event has started, cost the bookie dear and forced it to scrap a £26 million in-house programme and buy an off-the-shelf solution instead. A change in how starting prices are calculated, under the auspices of the Donoghue report has offered leading bookmakers some respite, as overrounds have gone back up, but the presence of Betfair will continue to keep them honest.

Media

The sector hit hardest by the internet is arguably media.

Last week’s disappointing results from newspaper publisher Mecom (MEC), which drove the stock down 16% in one day even after it had already fallen 56% during the year, again highlighted the challenges facing the sector. Social networking sites have replaced newspapers and magazines as a source of news and entertainment.

Media consumption may have expanded in terms of hours, but the internet has fragmented both the source and identity of the creators of the content. Small ads for property and jobs have moved online, hammering firms such as Johnston Press. Social networking audiences can be hard to pin down, as they focus on their own, specialised content featured on individual homepages or blogs, making life hard for advertising agencies.

Paper and pulp stocks, such as Mondi (MDNI) have also been caught in the cross fire between the internet and print newspapers and magazines.

‘Europe’s most structurally challenged sectors – print-based media and their second cousins, paper producers – have signally failed to get their acts together during the past four years of above-trend economic growth. With EU-27 growth now forecast to slow in 2008 and 2009, what is to become of these basket cases?’ demands Nick Stevenson of equity strategy think tank Mirabaud Securities. ‘Changing habits on the part of customers – both B2B and B2C – suggest a large part of the value-added that used to be channelled from, say, corporate advertisers to newsprint producers by way of newspaper and magazine publishers has migrated elsewhere. And it is never going to come back.’

Nor is it just print media that are facing the threat of the internet. Ofcom’s report revealed the web attracted more advertising spend than ITV (ITV), Channel 4, S4C and Five combined in 2007, the first time this had happened. The internet’s £2.4 billion advertising income may still lag newsprint’s £4.7 billion, but given the 70% compound annual growth in web advertising seen over the past five years, it will not take long to catch up.

Yellow Pages publisher Yell (YELL) has begun to adapt to the new world order as 16% of sales now come from internet listings – against barely 4% at Mecom, for example. Publishing giant Reed Elsevier has totally revamped its portfolio since 2000. Heavy investment in workflow publishing, the sale of its American Harcourt Schools business, the planned sale of the print magazine titles of its Business Information division and £2.1 billion acquisition of US firm ChoicePoint have increased online exposure to around two-thirds of sales and cut advertising expenditure to barely 5% of revenues.