Bigger is better in a soft market

Sep 10, 2001  •  Post A Comment

At a time when media companies should be aggressively budgeting for growth and expansion in 2002, they instead are fixed on anemic ad spending that won’t likely improve in the United States and elsewhere for a year.
Just how much a protracted advertising recovery impedes strategic growth among all sizes and types of media companies is anyone’s guess, since they all base their spending on cash flow and revenues.
But there are signs that media conglomerates are charging ahead to seize investment and acquisition opportunities-many of them in international markets despite cautionary signs.
For instance, AOL Time Warner and News Corp. are maneuvering for limited government approval to deliver their television programs and movies to cable subscribers in China. The trade-off may be U.S. carriage of Chinese government-sanctioned newscasts and cooking and language programs on the growing digital spectrum of Time Warner cable systems and News Corp.’s satellite services.
That may be a small price to pay for getting a foothold in China’s burgeoning commercial TV market, with 1.25 billion people and what has been high double-digit growth for all forms of advertising, including TV.
AOL sees the same growth potential in Latin America, where its Internet service just topped 1 million subscribers and ad spending (more than 60 percent of which goes to television) is expected to grow 6 percent in 2002. Ironically, separately traded AOL Latin America stock has declined 19 percent on concern of a slowing economy and ad market there. AOL’s alliance announced last week with the Cisneros Television Group to provide online and television content for children to AOL subscribers in Mexico and Argentina could bring AOL TW a step closer to a bigger role in Spanish-language media and a Telemundo deal.
Think globally, act profitably
Indeed, the attraction and pressure to engage in globalization is increasing as overseas markets develop and take on economic steam.
With AOL already accounting for nearly half of all Internet advertising and dominating all nononline ad platforms, the company recently made the smart move of forming a global marketing and advertising group to forge business outside of the United States during this down time.
John Malone’s Liberty Media Corp. is betting on future growth in Germany and other parts of Europe, where Liberty has invested more than $8 billion to partner, buy and build cable systems featuring much of its own content. The short-term prospects have been dulled by predictions from JPMorgan, whose recent Global Media Outlook calls for declining 2001 ad spending in Europe and recession-riddled Japan.
JPMorgan also expects things to get worse before they get better in the United States. It further lowered its 2001 outlook, calling for a 10 percent decline in U.S. television broadcasting ad spending, heavily skewed by a 14 percent decline in this summer’s broadcast network upfront ad market. Even cable upfront ad spending could be off by as much as 17 percent, JPMorgan concedes.
ABN AMRO last week also lowered its 2001 U.S. total ad forecast by $10 billion to an overall decline of 5.4 percent from a year ago-from an original call earlier this year for mere flat growth.
More important, ABN AMRO now says, “The duration and magnitude of the advertising weakness will be worse than consensus expectations.” In defiance of historical trends, ad spending will continue to decrease as a percentage of gross domestic product, which will increase little more than 2 percent next year, the investment banker predicts.
With total television ad spending down more than 7 percent this year by ABN AMRO’s conservative estimate-and likely to grow less than 2 percent next year despite a boost from the Olympic Games and biennial elections-media company expansion and growth plans should be modest to nonexistent.
Grim outlook
Merrill Lynch economists went even further in a report last week in which they lowered their ad spending estimates for this year and next, and said that “heightened layoffs and weakened consumer confidence will put more pressure on ad spending” and overall reinvestment.
Perhaps even more alarming, JPMorgan and other industry analysts now are painting a uniformly grim picture of this year’s fourth quarter, in which the broadcast networks and TV station owners have already placed so much faith. With as much as 40 percent of their inventory left to sell outside the upfront, even the broadcast networks will be lucky to suffer only for a 5 percent decline, JPMorgan forecasts, for overall television ad spending in the fourth quarter, compared with an 8 percent decline in the third quarter and a 13 percent decline the first half of 2001.
That means hopeful broadcast companies could be in for a rude awakening at year-end and become even more uptight about investing in their growth next year. They could continue to squeeze their costs, trying to cut their way to prosperity.
“The networks that post the strongest results early in the season will likely be the recipients of ad dollars placed in the fourth quarter,” said Lehman Bros. analyst Stuart Linde. “A poor start could damage hope for scatter beyond the fourth quarter into the first half of next year.”
That could be especially bad news for broadcast TV station groups that predominantly rely on network programs to generate their ratings and advertising revenues. These broadcasters face a mid-2002 government-mandated digital conversion deadline that on the average costs stations between $2 million and $4 million to meet-with no sure way to generate revenues, since the consumer marketplace has yet to convert.
With broadcast digital conversion costs pegged at more than $16 billion industrywide, the only business model mentioned so far that could immediately generate revenues is leasing some of the new spectrum to outside companies for services such as broadband datacasting.
The Catch-22 is that cash-strapped broadcasters, many of which are straining to make debt payments, need to experiment with ways to build new business lines and revenue streams from the digital spectrum. But few right now are willing to make such investments when they are stretching just to make ends meet.
Fee-based services offering datacasting, pictures and other digital content have been discussed by some group broadcasters.
But it is the media conglomerates-with their clout, financing and content resources-who will be the first to dabble in any meaningful way in mining the broadband spectrum. That was evident in last week’s anticipated announcement by The Walt Disney Co. and News Corp. of a jointly created video-on-demand service, Movies.com.
Other media giants such as Sony Corp., Viacom and AOL Time Warner also have plans to repurpose their existing entertainment, news, live sports, music and other content on dedicated channels supported by both advertising and fees, which they can afford to front while they are waiting for the consumer marketplace to catch up and financially support these new services.
For instance, broadcast networks hosting NFL games could sponsor a subscription service like DirecTV, or Viacom’s CBS could use the spectrum to launch a branded Paramount or Blockbuster video-on-demand service, analysts said. These media conglomerates can simply tap their own content and connections to get things started at a minimal cost and loss.
The strong survive
Clearly, the nagging advertising weakness is touching some media players worse than others.
AOL’s better-than-expected online subscriber growth and some recent surprising gains in the devastated online advertising market paint a slightly more optimistic financial picture for AOL Time Warner, which relies on advertising for only 24 percent of its overall revenues. That’s one-half to two-thirds the advertising dependence of most other media players.
With subscriptions providing at least 40 percent of the company’s revenue and proving a more consistent and stable annuitylike source, AOL Time Warner can afford to take more growth risks that support its businesses. Those sam
e moves may work against other media players who simply are not buffered enough to make their own growth bets during an advertising downturn.
For instance, AOL Time Warner’s interest in bidding for the Telemundo network and TV stations, while related to its growing Latin American interests, would substantially increase its foothold in U.S. broadcasting, where it now operates The WB Network. Bidding against NBC, Hispanic Broadcasting and Viacom could boost the sale price and general value of Spanish-language broadcast properties well beyond their traditional highs. And it could set a new bar for other broadcast properties and impact the trading of stations for the next several years.
But Telemundo’s $3 billion-plus price tag would be a relatively small bet to make by a company that still expects to generate as much as $50 billion in free cash flow within the first several years of its existence.
Although its stock falls short of telling the tale, having declined 30 percent in the last 40 trading days, AOL Time Warner is one of the few rare beneficiaries of these contemptuous times when the advantages of scale and diversity clearly win.
While the advertising slump will shape media-company reinvestment for the foreseeable future, there are a number of other major change agents also at work that will prompt companies to do deals even when they think they can’t afford to. Here are some examples:
* Globalization: News Corp.’s eventual Liberty Media-backed acquisition of Hughes Electronics and its DirecTV will be the ultimate globalization play that sends other major media players scrambling for a more aggressive expansion strategy. News Corp.’s ability to connect an unparalleled number of worldwide viewers, advertisers and content and service providers will make it the ultimate gatekeeper.
* The economics of consolidation: Especially in these financially challenging times, companies are feeling the need to combine their slow-growing and faster-growing businesses to better amortize and cut costs. The next wave in industry consolidation at all levels will be a powerful force for cash and stock deals in the next year. The most obvious is the sale of AT&T Broadband to what most likely will be Comcast Corp. for a slight modification of its initially rejected $58 billion buyout offer. While other cable consolidators could include Cox and Adelphia, most of the other merger and acquisition activity will occur on the broadcasting front in anticipation of more ownership deregulation.
A number of broadcasters whose balance sheets and debt payments have been strained by the weak advertising market could sell out. They include Young Broadcasting, Granite Broadcasting, Benedeck Broadcasting and Sinclair Broadcast Group. NBC, Viacom, Disney, News Corp. and AOL Time Warner are expected to be major broadcast consolidators, buying up many of their most attractive affiliated single and group stations.
* Digital as a growing force to be reckoned with: The pressure is on for all media companies to explore and develop new businesses off the new digital spectrum. At issue is the ability of broadband services to bypass the already overloaded Internet and bring new services and content more directly to broadcast and cable viewers. Many companies are at the very least seeking strategic partners to seize these opportunities. The challenge will be to develop and launch new pay services that will immediately flourish in an unfolding interactive broadband marketplace. Live sports, music and games are the most likely jumping-off points.
* The Internet is still a draw: Media companies are moving past the recent Internet bust to begin embracing the potential of online marketing and communications through more conservative partnerships and internal experimentation. But there are a few big deals still to come. For instance, Yahoo!-even at its still relatively high market value-is considered an acquisition target for Sony Corp., Vivendi Universal, Viacom, Disney, Microsoft and even Germany’s Bertelsmann AG, all of which seek a bigger place at the interactive television table. Indeed, the joint alliance between Sony and Yahoo! to develop online content is considered by many in the industry as the first step toward a corporate marriage. While media companies have severely reduced their Internet investments, the AOL Time Warner merger remains the new industry standard.
* The strength of cross-platform marketing: Once again, AOL Time Warner is demonstrating in these difficult times that there is strength in numbers. The more major media platforms you have to bundle and sell, the better your business. That strategy already has driven many unlikely companies together in partnerships.