Advertising stocks loving dot-coms
'Permanent shift' good for long term, analyst says

SAN FRANCISCO (CBS.MW) -- Unless you haven't turned on a television, taken a bus, or walked down almost any street lately, you know that Web companies want your attention.

And they're paying advertising companies a lot of money to get it. Even though the trend may not sustain itself, the vastness of the Internet and the need to reach consumers are changing business fundamentals, according to Chris Hansen, advertising and marketing services analyst at Bank of America Securities.

Hansen told Kristen Gerencher of CBS MarketWatch how consumer privacy issues and a bidding war for talent make up two of the riskiest features of an otherwise strong sector.

CBS.MW: How have the stocks been moving?

Hansen: There are a lot of subsectors of advertising and marketing services, but in general the sector's been very strong for a confluence of factors. The one that's getting the most attention now is the incremental dollars coming into the market from all the dot-com companies has kind of created a buzz around the stocks in the last 6 to 9 months.

CBS.MW: That's kind of an understatement. The budgets are out of the stratosphere! Is this any reason for shareholders to be concerned? Is there any chance this will backfire for the ad companies?  

Hansen: The level of expenditures that some of these dot-coms are pouring into traditional advertising is not sustainable. At some point it has to alleviate itself and you won't see the type of venture financing at its current rate continue forever, of which a very significant portion is obviously falling into traditional advertising, whether it's television, radio, outdoor, print, magazine or newspaper.

Probably the most important thing if you're taking a long-term horizon ... is that there's been a fundamental structural shift in the economy. Two big barriers to entry have come down which have great implications for advertising. The first is limited shelf space and the second is limited information.

Five years ago, any commerce company or any vendor could not have direct access to consumers like they do now. Anybody could set up shop on the Internet and begin hocking their goods and services directly to consumers.

Secondarily, consumers have almost perfect information about products and services and it's getting more perfect all the time. Whether you're buying a television or a car, you can get online and compare prices...

The constraining factor has shifted to customer attention and awareness. In a market where anyone can sell, and there's a tremendous amount of information out there, consumers still only have 24 hours in a day. How do you get mindshare? This is the by-product. What you're seeing is all these dot-com expenditures and everybody's just trying to make you aware of who they are.

While the incremental dollars that are coming into the market are certainly having a positive effect on the industry and they're probably not going to continue at their current pace forever, the structural shift in that awareness is becoming an increasingly constraining factor (that) is not going away. It's permanent.

Efficiencies wrung out of these new business models are falling back into marketing in an attempt to stand out in an increasingly crowded and cluttered world. For that reason, I think it's inevitable that marketing, of which advertising is a component, will make up a larger percentage of corporate expenditures going forward. And it's not just the dot-com companies. It's the traditional companies as well. As the dot-com companies try to garner more mindshare, the traditional companies have to fight back.  

CBS.MW: Is there an imbalance between supply and demand?

Hansen: There is a limited amount of supply in what is called mass media with national reach, for example. (In) prime time television there's only so many 30-second spots available, and that is one of the most ... brand-building, awareness-building advertising opportunities available. As the dot-coms have poured a lot of money to try to advertise on television, they're bidding up the rates.

Even though reach is declining for prime time television on the networks, there's a supply-and-demand imbalance, and that's resulting in prices being bid up.

The same thing's true on radio and outdoor. What's happening is that while that money is flowing into those traditional mediums, traditional advertisers are looking at that and saying, "Well, reach is going down and costs are going up. The implication of that is return on investment on that form of advertising is going down. So I'm going to take those dollars out of that form of media and put it somewhere else."

And a lot of the places they're putting it in are forms of targeted direct marketing that allow them to develop better direct relationships with their customers, provide them better feedback -- it's more measurable, much higher return on investment.

So you're seeing this huge trickle-down effect. Although prime time television is a small component of the total advertising marketing services expenditures, it is the most visible -- kind of cream of the crop -- and if that supply and demand imbalance is felt there, it's having a trickle-down effect on all other forms of advertising....

There are a lot of different types of marketing that you engage in as a vendor and that can be from building awareness -- when you use forms of mass media when you're just trying to establish your name and get mindshare -- to very targeted forms of direct marketing when you've accomplished that and you're trying to make consumers aware of a particular attribute of a product or service relative to a competitor or you're trying to establish an ongoing one-to-one relationship with the consumer. There are all different forms of services depending on where you are in your product life cycle and what you're trying to accomplish.

CBS.MW: And ATMs are now getting into the targeted marketing business with the advent of these 'Super ATMs.' See related story.

Hansen: You're seeing it everywhere. You're seeing it on cell phones, on ATMs, I saw a targeted ad in an elevator the other day. So people are being very innovative as to where you can access consumers. You're seeing a lot of innovative type of approaches. 

CBS.MW: What are your top picks?

Hansen: Of the companies we cover in the targeted direct marketing arena, Catalina Marketing (POS: news, msgs). Catalina Marketing is a targeted couponing company. They do Safeway Club Cards here in the Bay Area. They do loyalty cards and thermal printing of coupons at the register based on your prior transactions. They are one of those companies that's benefiting from... as Procter & Gamble looks at the ROI (return on investment) on traditional media and says, 'Reach is going down, fragmentation is increasing, costs are going up, I'm going to take my dollars and reallocate them to places like Catalina.' For the consumer packaged goods industry, it is the only kind of direct feedback mechanism that they have on a real time basis.

They're watching everything you purchase on a card number basis not an individualized consumer basis. They don't know your name and address and phone number and all that type of stuff. They're actually just targeting you based on your card number. But they know everything you've purchased in the last year and they're using that information to figure out what you're going to purchase the next time you come in and how you respond to different types of promotions.

So let's say for example that you purchase Coke but you'll purchase Pepsi if it's 10 cents cheaper versus someone else who will purchase Pepsi regardless of the price. Two different coupons will be issued. The person who will purchase Pepsi if it's 10 cents cheaper will get 12 cents off or 15 cents off and you who will purchase Pepsi no matter what would get nothing. So it's a very targeted high degree of analytics and they're leveraging their existing dominant supermarket business in which they have a 65 percent marketshare into other forms of retail and internationally.

CBS.MW: What's going on with the traditional Madison Avenue firms?

Hansen: What's going on with the traditional agency companies -- it's better to actually say the traditional agency holding companies because companies like Omnicom (OMC: news, msgs), Interpublic (IPG: news, msgs), WPP (WPPGY: news, msgs), they're a collection of not only traditional advertising, traditional Madison Avenue agencies, but also direct marketing assets. So they own a bunch of direct marketing companies, too. In the case of companies like Omnicom, the mix is about 50-50. 50 percent traditional advertising, 50 percent direct marketing.

What's going on with the traditional ad agencies that reside inside those holding companies, they have very long historical relationships at the very highest level of corporations on the marketing side on the CEO level. They also have global reach - the larger ones -- which is increasingly important to the Global 1000 in that they want to see their brand image spread across geographies and they want marketing partners who can help them distribute that message on a global basis.

So they have the de facto opportunity to kind of transform themselves as the advertising and marketing services space directly related to the media world is undergoing this paradigm shift in that television is no longer the absolute center of the world. Interactivity has entered into the fray, not only over the Internet but soon over television, soon over phones, and will change the way people will market to consumers...

A very difficult challenge for these guys (is that) a lot of the young bright strategic branding guys went to work for companies like Modem Media (MMPT: news, msgs), Lot 21 here in San Francisco which is a private company, Bronnercom, which is another private company, or Razorfish (RAZF: news, msgs). The young marketing talent is going to these new interactive shops and the agencies are somewhat handicapped in their ability to buy them for two reasons. One, they'd be dilutive to earnings if they buy direct significant ownership positions in them. And two, the talent probably wouldn't stick around if they did buy them outright.

So you're seeing a lot of innovative approaches where agencies are taking minority positions. And if the divergent valuations we have going on right now between the off-line and online world ever converge, we'll see the agency holding companies get very aggressive in bringing these new assets in-house.

CBS.MW: What are the prospects for mergers and acquisitions here?

Hansen: Huge. They have been huge for the last three or four years.

CBS.MW: What's been holding them back?

Hansen: It hasn't. They've been very acquisitive, just not in the interactive space. If you look at companies like Omnicom, Interpublic, they're very acquisitive companies and they have transformed their businesses from being traditional advertising into most of them in the range of 50 percent, in the case of WPP and Omnicom, 50 percent marketing. They've definitely identified the trends properly and have tried to position their businesses to take advantage of this shift in ad dollars away from traditional advertising toward more targeted direct marketing. It's just in the interactive space they kind of are handcuffed right now.

So you're seeing them do a lot of unique things like if  you look at Omnicom... they made investments in companies like Razorfish, Agency.com, which is coming public here in another two weeks or so, and Organic Online. So they've made investments and taken those companies, introduced them to their clients, and helped those companies build their businesses, but they've done it by not owning the companies outright, but by taking minority and sometimes significant ownership positions in these companies. 

CBS.MW: What are the risks that investors should be on the lookout for?

Hansen: It depends a lot on the type of companies you're talking about, whether it's interactive or traditional companies. I would say the main risk for all these guys right now is a tremendous bidding war for talent, both between the online companies and the off-line companies. It's very hard to keep key employees in a very tight labor market where you have both the online companies hiring at a frantic pace and the offline seeing very strong growth as well. Getting good employees to execute the business opportunities out there is very difficult.

With a lot of the online companies and some of the targeted direct marketing companies, privacy issues are another very important concern. with all the talk about moves toward targeted direct marketing, the key question is how much profiling are we as consumers comfortable with direct marketers having on us and at what point do we overreact?...

CBS.MW: What kind of investor should have advertising and marketing stocks in his or her portfolio?

The outlook in both the near term and the long term in this space is very strong. In the near term, you have somewhere in the vicinity of incremental $6.5 billion committed to be spent by interactive companies on advertising, which are new dollars coming into the market in the next 12 to 18 months. In addition, next year is an election year. You have the Olympics next year and you're going to see a lot of incremental advertising from the millenium. So next year should just be a tremendous year for advertising and marketing services.