A federal court has put new Federal Communications Commission ownership rules on hold, but that is not stopping some savvy TV station operators from expanding their business models to create new revenue streams designed to offset losses in network affiliate fees, local ad sales and other business lost to cable operators and other competitors.
This is the first of a two-part series looking at how two broadcasters are weathering the changing market. In Part 1, we look at what is happening to mid-to-large-market broadcasters, represented by Hearst-Argyle Television. In Part 2, next week, we will explore the plight of broadcasters in smaller markets, represented by LIN Television.
Both companies continue to aggressively mine major-market TV station duopolies and would benefit from stalemated deregulation but do not want to be dependent on change that is out of their control to preserve and grow their valuations and balance sheets.
While other broadcasters wait for the financial windfall of deregulation, Hearst-Argyle Television has begun reaping the returns from new businesses.
Creating Value
Their moves so far include taking advantage of duopoly opportunities and partnering with broadcast networks in an effort to capture additional revenue streams, all of which are already contributing tens of millions of new dollars to their bottom line.
These new businesses can provide critical supplemental income and profits while broadcasters wait for revenues from digital technology. Broadcasters remain unsure how to mine the digital platform, which has cost them billions of dollars to build under government mandate, as they seek to reduce their dependence on advertising and network programming.
An estimated $4 million to $6 million from each new business venture may seem minor to a thriving media concern with nearly $300 million in annual cash flow. But collectively, these new revenue streams help to offset lost network affiliate cash compensation and ad revenues during sudden downturns.
In the vortex of transforming change, it is a start.
“To the extent we’re creating value out of whole cloth, it’s good. These are real businesses-the best examples out there of how we’re trying to expand on our core competencies and leverage what we’re good at even before digital kicks in,” said David Barrett, Hearst-Argyle Television president and CEO.
For instance, the Internet Broadcasting Systems network is a private undertaking by Hearst-Argyle with NBC, Cox, Post-Newsweek and McGraw-Hill that provides stations with national and local content on branded local Web channels. The cash-positive business, to which Hearst has contributed $25 million, will be profitable for the full year 2003, sources said.
Hearst-Argyle also has a 20 percent equity stake in NBC Enterprises, to which it also has contributed its Boston-based production company. Recent syndication launches include “The John Walsh Show” and “The Chris Matthews Show.” The production, distribution and syndication partnership with NBC and Gannett creates the framework for what some in the industry see as the potential formation of a super TV station group in a deregulated environment. That would only be enhanced by NBC’s proposed merger with Vivendi Universal’s studio, TV production and cable network assets, Mr. Barrett said.
It is not to be confused with corporate parent Hearst Corp.’s unrelated entertainment and syndication group that oversees its cable network investments.
A handful of other ancillary business activities mirroring those of its peers-which include providing local marketing agreement service to four NBC-co-owned Paxson Communications stations-also collectively generate several million dollars of annual profit. That will contribute to overall earnings before interest, taxes, depreciation and amortization estimated by analysts at about $267 million on nearly $700 million in revenues in 2003.
Generating More Revenue
“We come at this with a point of view that we have a balance sheet and a management team and an appetite to be a consolidator, and that causes us to look at opportunities,” Mr. Barrett said.
Hearst-Argyle does not report or elaborate on the financial details of these ancillary businesses. With relatively low debt, Hearst can easily absorb the 4 percent, or about $30 million, of its annual revenues that will disappear by the end of the decade, which would have been network compensation under the old formulas. But it is not content to just do that.
Hearst-Argyle and NBC have been working diligently in recent years to leverage the network-affiliate relationship in new ways that will generate more revenue to both. Some of what they have forged comes out of a futures committee devoted to ways to generate new revenues for all concerned, said Mr. Barrett, the former network affiliate chairman now on the National Association of Broadcasters board. It is exploring a number of initiatives that will use the digital spectrum and extend existing Internet applications as well as ongoing marketing activities for the Olympic Games and other NBC big events.
“There is no better, more enduring viewer proposition or advertiser proposition than that of broadcast stations and networks,” Mr. Barrett wrote in his letter to shareholders in the Hearst-Argyle annual report.
At the same time, the veteran broadcaster conceded that deregulation has not brought about the lucrative business opportunities that were expected. “Deregulation is cresting and that is probably the most important thing on the agenda right now,” since the revenues that would be generated from a digital spectrum still are years away, Mr. Barrett said.
However, some kind of digital must-carry initiative is critical even now, he added. “We’ve got to get focused on the digital carriage issue as an industry,” he said. “The cable MSOs are being persuaded they need high-definition product to generate additional revenues. We happen to be the license holders of that high-definition product in these local markets. And that creates another wave of opportunity or discussion with the cable operators.”
Mr. Barrett said that although broadening duopoly rules can provide immediate, meaningful relief, broadcasters’ continued duopoly value creation efforts are essentially on hold for at least one year.
“Because the industry is as regulated as it is, the importance of this regulatory change can’t be overstated,” Mr. Barrett said. “What I hope is a new standard for radio-television cross-ownership, a new standard for TV duopolies and a determination about the ownership caps will stimulate the business.”
Analysts said more liberal duopoly guidelines will be a catalyst to major market consolidation and result in an explosion of megamergers involving the Hearst-Argyle, Post-Newsweek, Belo, Scripps, Gannett, Tribune and other major TV station owners. A company such as Hearst-Argyle could even secure a strategic station alliance with a major broadcast network such as NBC, with which it has unusually close ties, even in the wake of NBC’s proposed merger with Vivendi Universal Entertainment.
More liberal duopoly rules would be especially valuable to Hearst in the top 13 markets where it has TV stations and generates more than two-thirds of its revenue. Having a second station in those markets, especially if it were two of the top four market players, would be a gold mine. Key markets where the company could expand include Houston, San Francisco, Seattle, San Antonio and Albany, N.Y.
Though there is widespread speculation on Wall Street that Hearst-Argyle could eventually seek powerful distribution scale merging with the TV station groups of Gannett, Belo or NBC, industry executives such as Mr. Barrett point out that such consolidation seems even more unlikely anytime soon given the latest deregulation snags and the FCC’s recent probe into big media mergers.
While Hearst-Argyle has limited its comment on recent negotiations with cable operators, industry sources said the company has successfully opened the door on digital-related matters, such as requesting
carriage of its complete digital signal, even though cable companies remain stalwartly against anything that smacks of routinely paying for carriage. Sources said Hearst-Argyle is expected to join other major broadcasters, including Belo, in pushing for a congressional mandate of cable cash compensation for broadcasters during the current session.
In a conventional carryover, Hearst-Argyle continues to be compensated by Lifetime, in which it owns a stake, for local cable system carriage.
Local broadcasters such as Hearst are watching closely how cable gatekeepers are behaving now that they have local market monopolies and whether there will be any opportunities to develop a second revenue stream. “There is nothing digital on the horizon in the next 18 months that would generate meaningful revenues or profits for broadcasters, but that doesn’t mean there eventually won’t be,” Mr. Barrett said.
Hearst-Argyle also is among the major broadcast groups benefiting from the growing disparity among various-size TV markets and local vs. national broadcasters. Local broadcasters even the size of Hearst-Argyle have lowered quarterly revenue and cash flow estimates to reflect the adverse impact of war-related advertising and programming cancellations, comparisons with year-ago political ad spending, and the dominance of national ad spending. That should be offset by 2004’s biennial elections and Olympic spending, which collectively represent 12 percent of Hearst-Argyle’s revenues.
“I think it’s true that the national broadcast networks are enjoying stronger business activity right now than local stations, but I’m not alarmed about that,” Mr. Barrett said.
However, the recent decline in unit spot TV prices, below that of network unit ad prices, could stimulate local ad sales the remainder of this year.
“The local station business is a lot closer to the cash register. A lot of the national spending is all about image advertising. If local advertisers sense that traffic is off, they can make adjustments. Local advertisers are much closer to the consumer and more sensitive to where the local consumer is. But there has been more of an ebb and flow recently than I have ever seen in my time in the business,” he conceded.
Simply put, “Advertisers find it easier to walk away from local broadcasters than from networks, especially in a tight market that is leading to the upfront,” Mr. Miller said in a report earlier this year.
But as a broadcaster with its affiliates almost evenly split between NBC at the top of the heap and ABC at the bottom, Hearst-Argyle still is able to sway toward the positive because of its top markets and its strong local news presence. Its high definition and digital efforts have matched the related aggressive efforts of both networks.
Broader Perspective
Despite ABC’s lingering ratings weakness, Hearst-Argyle last year reported that eight of its 27 television stations posted record bottom-line results and that its 12 ABC stations posted network revenue growth of 8 percent in 2002 and broadcast cash flow growth of 14 percent.
Its ABC affiliates maintained 42 percent margins even though the ABC Television Network ratings declined 20 percent. As a result, Mr. Barrett said he continues to lobby his controversial proposal that ABC forfeit the last hour of its prime-time schedule to its affiliates, who could more profitably and compatibly program the 10 p.m. Eastern time slot as a lead-in to their late local news.
Overall, Hearst-Argyle’s ABC affiliates generated 45 percent of its revenues and 41 percent of its broadcast cash flow last year. By comparison, Hearst-Argyle’s NBC affiliates posted 20 percent revenue growth and 39 percent broadcast cash flow growth, on 51 percent margins in 2002. They comprised 46 percent of the company’s revenues and 51 percent of its broadcast cash flow.
“I hope people take a broader perspective of what our business is all about. In the past three years, and nearly parallel to the bear market, our 27 stations have generated nearly $2 billion in sales and kept about 43 percent of that, or about $900 million, in cash flow,” Mr. Barrett said.
“We’ve done the whole digital transition thing and still paid down $400 million in debt and additional $200 million in equity-this through one of the most difficult economic times in recent history,” he said. About 83 cents of every new dollar Hearst-Argyle add go straight to its bottom line, demonstrating the strength of the business model.
“The business model of local television stations is as good as they come. We take in a net dollar, and in a tough time, we keep 43 percent of it. Fifty-five percent of our revenue is local,” Mr. Barrett said.
“The aggregate income generated by our local TV stations in last five to 10 years is more than any other medium, including cable. We and other major broadcast groups like Gannett, Belo … LIN are aggregating the most attractive, largest mass audience in these local markets, and we are finding solutions for advertisers and attracting new customers and making it work,” he said.