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Take some new paths to avoid rocky road ahead

Oct 21, 2002  •  Post A Comment

The change and turmoil driving companies to distraction today is just a warm-up for what’s ahead in 2003.
Chances are, it’s going to get worse before it gets better. But there will be plenty of business opportunities for players who view change as a positive challenge rather than doom by devising new approaches to old problems. Some trends already are becoming clear.
Chief among them is broadcast and cable entities creating vertical platforms across which they can move content, advertising, promotions and expenses to better minimize costs and maximize profits in a difficult economy.
Economic and advertising growth next year will be at best moderate and fragile, forcing companies to use existing resources and assets in new ways. AOL Time Warner’s Turner cable and WB units; Fox Entertainment Group’s TV stations and cable services; and The Walt Disney Co.’s ABC TV broadcast network, stations and branded cable channels are already hard at work doing this within their own operations. After all, why shouldn’t ESPN’s 39 percent ad growth help more directly offset what is expected to be another year of $500 million-plus losses at the ABC TV Network?
It is the same principal that is driving lucrative TV station duopolies, in which a company’s second station in a sizeable market generally achieves 60 percent cash flow margins, compared with up to 40 percent cash flow margins for a typical single station, due primarily to improved cost amortization. Others now are embracing that business model.
As the deal market picks up and players begin to capitalize on new deregulation, broader, intra-industry sector alliances will aim to accomplish the same vertical mining of assets on a much grander scale. Owners of cable systems and television stations will selectively align with or acquire each other in regions where dominant cumulative market share and shared costs can translate into instant profits. Although such deregulation was passed earlier this year virtually unnoticed, this could be one of the more important new business developments of 2003.
As cable and broadcast television reach parity in such important areas as content costs, audience reach and revenues, they will increasingly become as much complementary partners as competitors.

Cable networks now growing primarily through price increases, at a time when advertiser and viewer share gains are limited in a saturated market and are seeking other new ways to do business or to realign their companies. Suddenly, binding the common interests of Universal’s film library with Liberty Media Corp.’s Starz/Encore pay-TV service and Vivendi Universal Entertainment’s general-interest USA cable network looks pretty appealing.
That likely merger, considered the shape of some things to come, will be aimed at maximizing revenues and better amortizing the cost of Universal’s film production and library and other content across a broader revenue base.
That’s the same logic driving NBC’s proposed $1 billion acquisition of Bravo, since the cable service would be a dual-revenue cable outlet for NBC’s branded product and 18 to 49 upscale demographic.
Costs of creating hit content
Behind all of this intriguing movement is the nagging question of how many ways a diffused television market can profitably be divided among viewers, advertisers, content providers and distributors, which is causing media companies to rethink conventional economics.
It is necessary because very little has changed about the cost or risk of creating hit content that can be profitably leveraged. An average 70 percent of network costs are programming related, and those costs escalate an average 7 percent to 10 percent annually.
One hit prime-time series can boost a broadcast network’s adults 18 to 49 audience by about 0.1 rating points, generating about $55 million in incremental revenue (or 2 percent to 3 percent of a broadcast network’s revenue base), 80 percent of which falls to the bottom line over the course of two seasons, according to Morgan Stanley analyst Richard Bilotti. Cable networks can see $44 million in annualized revenue for similar ratings.
But getting there has become more difficult in an increasingly fragmented market, which is why Mr. Bilotti expects company-specific ratings gains will be more important in the future than audience migration among competing networks.
Historically, fewer than 10 percent of series stand a chance of graduating to hit status. A series that makes it into syndication can generate an average $40 million to $80 million in revenue, up to 40 percent of which falls to the bottom line, Mr. Bilotti said. Those economics were the argument for financial-interest syndication rule repeal six years ago, that has given broadcast networks the right to shoulder all of the cost and risk of producing a majority of their series, only to realize little return.
Aggregating
Having cut much of their own cost structure to prudent levels, one of the only elements of the equation media companies still can control is the base over which they mine their assets, spread their costs and generate revenues.
That base can be expanded through very selective mergers and acquisitions, asset swapping or partnerships, although nothing will or should mirror the unwieldy transitions of recent years. The need to be part of a more rational aggregated, integrated whole will be the catalyst for other changes as well.
For instance, all media companies are increasing the ways in which they sell and price an aggregate ratings and audience reach to advertisers in an effort to generate greater revenue. A controversial idea when Turner Broadcasting first touted it nearly a decade ago, selling aggregate ratings and reach will become routine by the next upfront. This is becoming critical for AOL Time Warner as its America Online unit advertising and e-commerce revenues, which have been nearly one-fourth of the company’s total, are evaporating.
The “cume” practice gives everyone an edge in a market where ratings and shares are routinely single digits. In the current fourth quarter, AOL Time Warner has an aggregate prime-time rating of a 3.7 for adults 18 to 49 (2.3 for Turner cable networks and 1.4 for The WB). Disney has an aggregate 4.9 rating (3.3 from the ABC Network and 1.6 from its cable channels). Viacom is the big winner with an aggregate 7.1 prime-time rating (2 from its cable networks, 3.4 from CBS and 1.7 from UPN). Fox has an aggregate 5.2 rating (4.6 of it from the Fox TV network), Mr. Bilotti said.
New equity partners
Cable and broadcast players also will be widely experimenting with video-on-demand in 2003 to develop new formulas to generate new revenues and stem subscriber and viewer losses. It already is leading to some new working relationships between companies such as Comcast Corp. and NBC, who are masters at selling off of and operating off of different kinds of combined platforms.
Such pursuits also will prompt some cable operators who have seen 70 percent of their market value destroyed in this year’s brutal stock market to go private, allowing them to recoup and re-emerge with less debt in an improved public market.
This means that heavily leveraged candidates such as Cablevision Systems and Charter Communications will align themselves with new equity partners that might even be major content suppliers or other distributors. For instance, a public Time Warner Cable spinoff would be a vehicle for acquiring either Cablevision or Charter and bringing them into the AOL Time Warner content loop.
The same would be true of a potential Cox Cable spinoff that would also grow through acquisition. In both cases, cable companies would create more formidable platforms to compete more aggressively and cost-effectively with the biggest challenger of them all in 2003: a domestic satellite giant created by morphing Hughes Electronics’ DirecTV with either EchoStar Communications or News Corp. In either case, the emerging satellite giant becomes a mega-platform over which to better amortize costs, take risks and generate revenues. Sound familiar?