Description

 Description

Arbitron, Inc. provides radio audience measurement and related services to radio stations, advertising agencies, and advertisers in the United States. Arbitron is the only national provider of radio ratings data and is the clear #1 market share leader. The company was founded in 1949 by James Sellers as the American Research Bureau to develop and market a diary-based audience measurement service for broadcasters and it was spun off from Ceridian Corp in 2001. Arbitron is the leading provider of media audience rating services for radio broadcasters, measuring radio audiences in 300 U.S. Markets sold through various reports including its flagship product, the Radio Market Report.  Arbitron enters into multi-year contracts with radio stations/networks which contain annual price escalators in the low single digits.  Arbitron is essentially the "Nielsen Media" of radio, and has dominated the radio measurement industry.  The Company provides audience measurement services for over 50 national network radio programs.  Audience rating services accounts for almost all of its revenue. Arbitron also provides qualitative audience data including demographic/socioeconomic profiles, retail shopping patterns and media usage habits for almost 300 Markets.  

Arbitron's core audience measurement system is based on diary service, where thousands of participants in each market are paid to provide a journal each day which provides detail regarding their radio listening habits.  While there are many inherent flaws in this system (i.e. survey participants wait until the end of the week to complete their diaries, making them subject to memory and obviously less accurate than real time entries), this has been around for decades.  Recently, Arbitron has developed a new electronic radio ratings system called PPM or the Portable People Meter that is intended to replace the diary-based ratings in the important markets over the next several years. The PPM is a portable, cell-phone sized device that electronically tracks exposure to radio as consumers wear this device throughout the day.  This is a much more accurate system which also enables the company to charge radio stations/networks rates that are 65% higher (with annual price increases of 4%) than with the conventional diary-based system.  However, there have been some challenges to the adoption of the PPM by minority (particularly Hispanic) radio stations.  We believe that such challenges have limited merit and the full scale adoption to the PPM system is inevitable and will take place within the next few years. 

Additionally, in November 2008, Nielsen Media made a surprise announcement that it would enter the radio measurement industry by using a system that would attempt to compete with the diary-based system.  While I believe that Nielsen's product will have limited impact on the market or Arbitron's opportunities, Nielsen did win a few small-market contracts, which are immaterial, yet represent the first time Arbitron has experienced any competition in a very long time.  Accordingly, the recent competitive threat, along with the rapid slowdown in radio advertisement sales, the delay that Arbitron experienced in getting Clear Channel to enter into a new contract when their existing contract expired, and the challenges surrounding the PPM transition, has contributed to a 67% (1-yr) drop in ARB's stock price.  In my opinion, Arbitron's stock now represents excellent value and should appreciate substantially over the next 12-18 months. 

Investment Attributes

• Dominant leader in radio measurement. For the past 50 years, Arbitron has been the de facto standard in the radio ratings industry.   It has been virtually a monopoly for years.
• Cheap valuation. Stock trades at 11x P/E 2009E and 8.5x P/E 2010E, which are substantially lower than its historical multiples. On an EV/EBITDA basis, stock trades at 6x 09 and 5x 10 (based on consensus numbers). As PPM continues to be implemented, the company's earnings and free cash flows will accelerate, making the stock even cheaper.
• Significant Growth in next 3 years. Street forecasts Rev and EPS growth of 6.5% y/y and 6% y/y in 2009, respectively and 8% (Rev) and 28% (EPS) in 2010, and 8% (Rev) and 22% (EPS) in 2011, primarily driven by its portable people meter (PPM) initiative.
• PPM initiative. The main driver for growth is Arbitron's rollout of PPM. The PPM is used to measure an audience's exposure to audible programming, and is being used to replace Arbitron's traditional diary method. Broadcasters encode content in such a way that it can be detected by a pager-like device worn by panelists. Because of the added costs to implement the new technology, Arbitron has contracted price increases of 65% for PPM markets, with annual 4% price increases. To be clear, these long term contracts have already been agreed to and signed.
• Nielsen competitive threat overblown. After a 45-year absence, Nielsen, known for measuring TV ratings, re-entered the radio ratings business in November 2008. Clear Channel Communications, the nation's largest owner of radio stations, and Cumulus Media said they signed with Nielsen because of improvements made in their audience recruitment measures. Cumulus announced that Nielsen will provide audience measurement and ratio ratings in 50 small- and mid-sized US markets, and Clear Channel Radio will subscribe to Nielsen's service in 17 markets. However, both of these deals are in small-and mid-sized markets and the sampling (based on a sticker diary system) is less frequent than Arbitron. It's hard for us to believe that the quality of service will be better than Arbitron, and in fact we have heard from industry participants that the product is inferior, both in terms of frequency and accuracy. The first Nielsen reports are expected sometime this September. In any event, it is likely that Clear Channel and Cumulus signed these contracts to gain leverage over Arbitron in contract renegotiations.  Recently, Clear Channel entered into a new contract with Arbitron regarding most of the country, including all of the major markets.  Lastly, Nielsen does not have a product to compete with the PPM.
• Significant stock buyback remaining.  The Company has approximately $100 million remaining on its stock buyback authorization.  This amounts to almost 25% of the market capitalization of the company.  With its PPM development costs behind it and the recent collapse of the stock price, it is our belief that the Company will be more aggressive with their buyback.

 Investment Considerations/Issues

• Competition from Nielsen. The November 2008 announcement by Nielsen to enter the radio market was a significant headline and major blow to Arbitron's stock price. As mentioned above, Clear Channel and Cumulus Media signed with Nielsen for some of their small- and mid-sized markets.  It is possible that Nielsen can obtain more contracts, particularly in the next few years before the complete adoption of the PPM.
• Univision's recent decision to not encode its radio signals. In June 2009, Univision said that it refuses to encode signals in new PPM areas, such as New York, Miami, San Diego, and Phoenix, because it is not satisfied with the PPM sampling methodology. The issue has not been resolved yet, and we await further information on this issue.   However, the issues that Univision raised are based upon the fact that the PPM shows them with lower market share than under the less accurate diary system.  See the point immediately below.
• Ongoing concerns about sampling quality of PPM and ability to accurately cover minorities. Univision is not the only vocal opponent to the PPM technology. This has been an ongoing issue since its first trials in 2000/2001. In October 2008, the attorney generals of New York and New Jersey alleged false advertising and deceptive business practices related to the PPM service; the lawsuits were settled three months later, but Arbitron had to agree to a number of conditions designed to substantially improve the methodology used. In addition, on 5/18/09, the FCC issued a Notice of Inquiry to Arbitron regarding the PPM technology accusing it of undercounting minorities. On 7/1/09, Arbitron wrote a letter to the FCC stating it doesn't have jurisdiction over its PPM system. The issue has not been resolved yet, and we await further information on this issue. On 5/29/09, Arbitron released April 2009 PPM data, which failed to meet previously set targets. For example, Arbitron did not achieve the minimum sample size for PPM markets in Los Angeles, Chicago, Detroit, and Long Island (Nassau-Suffolk). In LA, the 18-34 African-American sample size was 64% of the target, vs. the minimum goal of 75%. In Detroit, the sample size demo was 59% of the target vs. the 70% target. In Nassau-Suffolk, the 18-34 Hispanic sample size was 57% of the target vs. the minimum of 80%. In our opinion, securing the proper sample size is only a matter of time and will not prevent the adoption of the PPM.
• Cost of reaching cell phone only households is higher than wireline households. Given that there is no directory for cell phone numbers at this time, the cost of obtaining survey participants that do not have wireline (landlines) is naturally going to be higher, at least for a while.  While Univision is certainly making claims based on the fact that minority households are less likely to have landlines and that the PPM sample sizing is going to be skewed, the issues are no different for its diary based system.  Because there is a secular shift to families having only cell phones over time, this is one of the reasons why the company includes price escalators in all of its contracts.
• Recent radio advertising sales dollars is declining significantly/Threat of disintermediation of traditional radio. This is a long-term problem that will not affect Arbitron significantly in the next 5-7 years.  Arbitron receives a fee for its audience measurement services regardless of whether stations have good or bad years.  However, the radio industry is in a state of transition-to the extent that the nature of radio and radio listening changes so substantially that radio stations are rendered meaningless, a completely new method of gauging listenership may be needed which could force Arbitron to undergo massive changes to its system and encounter unforeseen and significant competition.  While Arbitron is working on several next generation systems for measuring radio listening which includes media other than radio broadcast stations, there may be many others that are much further along.  Additionally, to the extent radio completely migrates to the internet over time, Arbitron's current products could be rendered obsolete.  If consumers completely turn away from radio, there will be no need for Arbitron's current products and services.
• Increase in capitalized costs and the decrease deferred revenue. Concerns over these accounting related items have been illuminated by one analyst in particular that works for an independent research firm.  While these are always good places to look for signs that GAAP earnings are not telling the true story, we believe, in this case, that these issues relate primarily to the transition to the PPM and delays in renewing its Clear Channel contract (which was recently renewed).  Interestingly, the analyst that authored the report did not speak to the company.

Thesis

Our main thesis on ARB is that the current concerns regarding the emergence of the PPM and the Nielsen entry as a viable competitor is significantly overblown. This is based on our discussions with the company and our many conversations with people in the radio industry, most of which have no ties to Arbitron. The following are our conclusions based on our due diligence: 1) Nielsen entered the radio ratings market more as a favor to their customers and is not aggressively entering the market; 2) the switch to PPM is inevitable and the current concerns can be overcome with better execution; 3) radio, while struggling, is not a dead medium and that Arbitron will continue to sign highly profitable contracts in the foreseeable future. 

1) Nielsen Threat. From our discussions with radio industry experts, we heard that Nielsen did not initially bid on the Cumulus and Clear Channel RFP. Rather, Nielsen did it more as a favor to those customers. In addition, we believe Nielsen's sticker diary system is inferior to Arbitron's diary system, both in terms of quality (sticker system creates bias due to radio placement) and sampling frequency (1-2 times per year vs. ARB's 2-4x). Another point is that historically, there seemed to be a tacit agreement (our opinion) between Nielsen and Arbitron not to enter the other's market. If Nielsen aggressively enters radio, there is a real possibility that Arbitron could enter television with its PPM device. That's not an easy task, but the threat would be a huge blow to Nielsen, whose television business dwarfs any potential opportunities it could generate from an aggressive push into radio.  Finally, if you look at the radio market opportunity for Nielsen, it's a very small dollar amount - on the order of $10 million for the two recent deals. Why would a company with annual revenue of ~$5 billion risk their television ratings franchise for such a small amount on the radio side? To us, it makes no sense for Nielsen to go after Arbitron due to the potential for reciprocal competition in their main market. 

2) PPM Transition. Again, based on conversations with a wide range of radio industry participants, it has become clear that PPM is inevitable. The technology more objectively measures radio listening patterns and frequency - the panelist is wearing the device and does not have remember and jot down later (often a week later) what s/he has listened to. One drawback is if the panel member chooses not to wear the device. In addition, we hear that advertisers definitely need and would like more objective data as justification to buy advertising, and the overwhelming opinion that we heard is that advertisers want PPM to be rolled out. In terms of better sampling minorities, we think ARB should be able to bridge the gap with increased spending and better execution.

 Valuation

From an earnings power perspective, we ran a sensitivity analysis that goes through Revenue, EBIT, EBITDA, EPS and FCF projections for 2011. We chose that timeframe because that is when the initial PPM into 49 major metropolitan cities should occur. We used 2006 as the base year because that was the last year without any PPM revenues.  We modeled out the PPM launches by # of cities per year though 2010. The main sensitivity variable is EBITDA margin. Management comments are that they expect ARB to get back to 35% EBITDA margin, which was achieved in the past. We assume a more conservative EBITDA margin, between 24-30%, which corresponds to EPS of 2.29-3.02 in 2011 (vs. consensus at 2.44).  See the charts below.  Accordingly, we believe that, today, Arbitron is worth $23 to $28 per share; a multiple far less that it received at just about any time in the past.

Based on our revenue calculations above, we then run Ebitda margin sensitivities to estimate a range for EBITDA, EPS, and Free cash flow and then we calculate EPS again assuming the company executes its full buyback at $23 per share-a level significantly above the current stock price.  It should be noted that the company's Ebitda margin has averaged about 35% in the past-we are obviously making very conservative assumptions as the Company spent significant amount of money starting in 2005 developing and rolling out the PPM, which has depressed their margins.

It should be noted that we assume a price compression of 10% for Arbitron's base business even though it has been increasing due to annual price increases.  Also, for purposes of being conservative in our forecast, we did not assume the 4% price increases for the PPM business as specified in the Company's contracts.  Lastly, we assume no increase in revenues for their ancillary businesses.  Our EPS numbers increase by approximately $0.35 to $0.52 (depending upon which margin scenario we assume) if we were to factor in the 4% price increases set forth in their PPM contracts and assume no price decline for their traditional diary system.

The street consensus P/E and EV/EBITDA multiples are below (including 2008 and LTM multiples).  Importantly, we modeled Arbitron more conservatively than the analysts as we wanted to insure a margin of safety as best as possible.

Catalyst

1.  The rollout of the PPM throughout major markets which will continue to positively impact operating results.

2.  The resolution of legal challenges relating to the PPM.

3. The realization by investors that Nielsen will not take meaningful market share.

4. The company will meet its financial guidance on a quarterly and annual basis.