Insights: Investing
Editor's note: This article was prepared prior to the horrifying terrorist attacks on America. While these terrible events have had an impact on the economy and financial markets, the author, Mario Gabelli, believes the economic and investment principles detailed here are sound and that the long-term outlook for the media and rural telephone industries remains favorable.
In 2001 we have experienced a "one step forward, two steps back" stock market. For the most part, rallies came on the heels of Federal Reserve rate cuts, and declines coincided with earnings confession seasons -- the three- to four-week period preceding the end of each quarter when corporations announce that operating results will fall short of Wall Street expectations. This tug-of-war between Fed rate cuts and lousy corporate earnings reflects the trading orientation of today's stock market and illustrates the emotional fragility of most investors, who are willing to think long-term until short-term economic and stock market trends go against them.
At Gabelli Funds, we don't think of stocks as pieces of paper to trade based on short-term economic trends or the vicissitudes of the market. We view stocks as pieces of businesses we would like to own over the long haul. So, our mind-set is to ignore the "white noise" of economic and market static and focus on the fundamental strengths of individual companies. If we can buy stocks of terrific businesses at opportunistic prices and there are catalysts in place that we think will produce value in a time frame that allows us to earn an acceptable rate of return, we believe our investors will be satisfactorily rewarded over the long term.
Consistent with this investment philosophy, I have always resisted making economic and market forecasts. I have had the privilege of participating in Barron's "Year-End Roundtable" for 20 years. In the early years I sat on the sidelines while my Roundtable colleagues talked about the economy and the market. I saved my energy for discussing individual securities I believed represented exceptional investment opportunity. In recent years, after some arm-twisting from Barron's editors and the realization that my firm's constituents wanted to hear my thoughts, I have offered some opinions on the economy and market -- presented with the caveat that opinions are like armpits, most everyone has a couple of them.
So, let me talk briefly about the big-picture issues capturing everyone's attention today. Those expecting me to pinpoint a market bottom or predict where the S&P 500 will be a year from now will be disappointed. However, I will venture a few not so daring but sound observations. First, Fed rate cuts will eventually revive the economy. It takes time for them to work their magic, but eventually the rabbit emerges from the hat. Investors appear to have forgotten that it took a long series of Fed rate hikes in 1998-99 to slow a runaway economy. The multiple rate cuts we've seen this year (with a few more likely to come in the months ahead) will put the economy back on solid footing and corporate profits back on a growth path. My second observation is that bear markets end often when you least expect it. Investor sentiment is usually an accurate contrary indicator. Currently you can't cut through the despair with a chain saw. Historically such periods of investor despair have been an ideal time to invest in equities.
What should you buy? Now I'm on more comfortable ground. One of the ways we have been able to generate good returns for our clients over the years is by focusing on industries undergoing meaningful change. This change has often been in the form of a significant shift in an industry's regulatory environment. One of the best examples is the very generous returns we received from investing in cable television stocks when the industry was deregulated in 1984. Freed from pricing regulation, cable TV companies' operating results improved considerably, and attracted a lot of investor attention. The deregulation of the cable TV industry also spawned consolidation and many of our largest holdings were taken over by competitors at handsome premiums over our investment cost.
Today we see a similar opportunity in several media sectors. On March 3, 2001, the U.S. Court of Appeals for the District of Columbia Circuit ruled that federal regulations preventing companies from serving more than 30 percent of the nation's cable television or satellite television markets violated the First Amendment right of free speech. The court also struck down rules barring cable television companies from controlling more than 40 percent of the channels and programming assets they offer to the public. This was a big win for big cable companies that can realize additional economies of scale via acquisitions. It should also reward investors who own smaller cable TV and cable network stocks, such as Cablevision (CVC, NYSE, $39.70) and its recent cable network/programming spin-off Rainbow Media Group (RMG, NYSE, $19.60), potential targets in the next round of consolidation in the industry. (All prices as of press time.)
The court's decision may also be the death knell for other restrictive Federal Communications Commission (FCC) regulations, such as rules preventing broadcasters from owning TV stations reaching more than 35 percent of the total population. Potential takeover targets among small group broadcasters include Paxson Communications (PAX, ASE, $7.87), Granite Broadcasting (GBTVK, OTC, $1.39) and Young Broadcasting (YBTVA, OTC, $17.96), all of which have broadcast properties in the San Francisco market. These companies would be nice bite-size acquisitions for larger competitors in the San Francisco market such as Disney's ABC, General Electric's NBC, Hearst Corp.'s Hearst-Argyle Television, and Tribune Co. We may also see rules barring companies from owning television stations and newspapers in the same markets eliminated. This could eventually put newspaper publishers such as Journal Register (JRC, NYSE, $16.58) and Pulitzer (PTZ, NYSE, $45.40) in play.
In addition to the benefits of further consolidation in the media industry, media companies' operating results should improve significantly in the year ahead. The 2002 Winter Olympics are being held in Salt Lake City, enabling prime time, live action broadcasts of popular events like figure skating and ice hockey. This virtually guarantees a much bigger domestic television audience and higher advertising rates for broadcasters and cable television operators than when Olympic Games are staged halfway around the world. These profits will show up in better first-quarter results. Political fund-raising reform notwithstanding, with control of the House and the Senate up for grabs in next year's midterm elections, sizable political advertising spending will be another benefit for broadcasters, cable television operators and newspaper companies. This provides the underpinnings for better earnings comparisons in the third and fourth quarters of 2002.
Rural telephone companies (wired and wireless) make up another industry group offering exceptional potential in the year ahead. Although the overwhelming majority of the U.S. population are served by the Baby Bells and large independents, hundreds of rural telephone companies operate in America today. They are largely free from competition in their markets and solidly profitable, but have limited opportunity for significant growth. So consolidation in the rural telephone business makes sense. Although many smaller rural telecommunications companies are controlled by family managements that may resist selling out, they are likely to get some tempting offers from larger rural operators looking to extend their franchises. In August Alltel offered to buy Louisiana-based Century Telephone (CTL, NYSE, $30.10) in a deal valued at $43 per Century Telephone share. Century management wasn't interested, but might be motivated to sell by a higher offer. Even if no deal is in the cards, we believe Century Telephone will continue to grow earnings and intrinsic value at an attractive rate over the next several years. Much the same can be said for Commonwealth Telephone (CTCO, OTC, $37.80) and Telephone & Data Systems (TDS, ASE, $90.40).
In conclusion, investors today are faced with an easy choice -- fretting over the short-term prospects for the economy and the market, or taking the longer view that recessions and bear markets present excellent long-term investment opportunities. It always takes courage to invest in depressed markets, but if you focus on fundamentally sound businesses trading at bargain prices, your courage is generally rewarded.
Mario J. Gabelli is the founder and chairman of Gabelli Funds Inc.