We downgrade our recommendation for Scripps Networks Interactive Inc. (SNI) to Neutral following our assumption that the company may face margin contraction in 2010 due to increase in cost of advertising revenue. 

The company’s fourth-quarter earnings of 52 cents per share beat the Zacks Consensus Estimate by a penny. 

Scripps Networks completed the acquisition of majority stake in the Travel Channel, which we believe will be positive for the company’s long-run growth. Management decision for geographic diversification, new acquisition, and re-branding of FLN channel may also help the company to maintain its future growth. However, we also believe that these positives are already reflected in the current valuation leaving little room for above market gain.
 
Approximately 80% of Scripps Networks’ revenue is derived from advertising spending by corporate sector in the U.S. Advertising spending is sensitive to economic conditions, and tends to decline in recessionary periods. During 2009, advertising revenue increased significantly due to robust rating and an improving scatter market. However, management indicated that the company needs to spend more on marketing in order to attract new audiences which may restrict margin expansion in 2010.
 
Ongoing global economic recession has significantly hurt the company’s Interactive Services segment. In the fourth quarter of 2009, this segment generated $49 million revenue, a decline of 25% year over year. Segment profit was down by more than 50% year over year in the same quarter. Shopzilla’s results were negatively affected during 2009 by a challenging retail market, which is holding down volume and cost per click prices and a less favorable sponsored-link contract with Google. Management admitted that the company needs to do some restructuring of this business.
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