Sep 29, 2003  •  Post A Comment

The weakness in local advertising that has quietly persisted for more than 18 months is finally bringing media giants such as Viacom, The Walt Disney Co. and Fox Entertainment Group to their knees. It is a show of vulnerability that was supposed to be averted by their costly diversification plays of the past decade.
As it turns out, big media’s Achilles’ heel is the decline in the fundamental business of selling 30-second spots on their own grass-roots local television stations, whose fortunes remain totally dependent on advertising.
This decline comes at a time when other media businesses-including cable networks, Hollywood studios, theme parks and billboards-aren’t providing enough of a financial offset.
Viacom, which is considered the most sure-footed of the media players, confirmed as much Sept. 24, when it lowered its initially bullish 2003 guidance. It now expects full-year operating income and revenues each to grow less than 10 percent largely because, it said, “The pace of local ad recovery is not as rapid as anticipated.”
The larger concern on Wall Street is that if it can happen to Viacom, then it most certainly is happening to every other media conglomerate with local TV stations. In that case, the big questions are why, how bad will it get and what do they do about it?
Clearly, Viacom and other diversified media players have underestimated local ad sales’ importance to and potential impact on their big pictures. They expected the healthy increases in network upfront advertiser spending and unit prices to trickle down to local TV and radio, which are currently struggling with virtually flat growth in difficult comparisons with last year’s hefty political spending.
Even for the largest network-affiliated TV station groups, economics have been reduced to an artificial lift during the biennial elections and Olympic Games, with little notable growth in between. The all-important holiday-driven fourth-quarter advertising spike hasn’t yet surfaced.
The consolidation of TV stations that might have helped the slowdown with offsetting cost cuts and efficiencies is grounded by deregulatory gridlock. It no longer is possible to grow local TV station revenues fast enough the old-fashioned way since cable operators are aggressively claiming more local ad dollars and ad money, and viewers are becoming increasingly fragmented.
Having analyzed historical data, Bernstein Research analyst Tom Wolzien concludes that while local ad sales typically are slower to recover, there does appear to be a share shift under way to network broadcast and cable television from the national spot ads run by local stations.
“Television advertising moved into uncharted territory over the summer, as emphasized by Viacom’s reduction of guidance,” Mr. Wolzien said.
Indeed, things haven’t looked quite right for a while. Experts have been at a loss to fully explain the strength in national TV upfront ad spending while local TV and other media falter or grow nominally. Although upfront commitments are holding, fourth-quarter scatter sales are slow, suggesting they won’t rise more than 10 percent above upfront prices. Not surprisingly, Mr. Wolzien, like many of his peers, cut his estimates on Viacom to 8 percent growth in earnings before interest, taxes, depreciation and amortization in 2003-almost half of what is expected in 2004, on more modest 6 percent revenue growth this year. Local television station revenues will barely muster a 2 percent increase in 2003, but should grow 8 percent in 2004.
Such uncertainty brings to the forefront a question that media giants can no longer avoid: Just how real and sustainable is this year’s record level of national upfront spending if it isn’t trickling down to local television and radio or other media sectors, and what does it mean for the future of media’s lifeblood?
Just as disconcerting is how little support these media giants are getting from their other faster-growing, fee-driven media businesses, which, according to consolidation principles, are supposed to kick in when revenues and earnings are in a cyclical downturn elsewhere in the company’s portfolio. That isn’t happening to the extent that it should for Viacom and its peers.
Viacom’s MTV Networks are roaring along at 20 percent earnings growth on 18 percent revenue growth in 2003. But that is not enough to offset sluggish broadcast network and TV stations growth in revenues and cash flow of about 5 percent, along with a decline of about 2 percent in radio revenues and cash flow and a whopping 24 percent cash flow decline at Paramount studios and other entertainment operations.
Merrill Lynch analyst Jessica Reif Cohen, who was one of a handful of analysts who began reducing third-quarter and full-year estimates for Viacom earlier this month, last week started aggressively warning about a similar squeeze on overall earnings for similar reasons at Fox and Disney.
Fox Entertainment Group’s 15 percent earnings growth to $1.35 billion on 8 percent revenue growth to $11.8 billion in fiscal 2004 will be largely driven by 19 percent growth in cable network cash flow. That will have to offset sluggish 2 percent growth in both cash flow and revenues at Fox’s entertainment and studio operations, and the continuing anemic performance by its TV network and stations, which will go into a double-digit hike a year from now on the strength of election spending and improvements in its core businesses.
Disney is even more mixed.
Its TV network and stations and theme parks will remain subdued for now, although the company’s overall operating results are projected to improve in fiscal 2004, with operating income growing as much as 25 percent to $3.8 billion on a 7 percent growth in revenues to $26.9 billion. The big caveats: nearly all of that growth is tied to uncertain economic upturn and can be rapidly undermined by the big fall-off in its cable network-affiliate fees that is expected over the next 18 months.
On top of all that, Disney lacks the vertically integrated scale and leverage that ultimately may aid Viacom and Fox, Ms. Cohen said. And at the moment, it does not have the financial flexibility to gain more scale and leverage through acquisitions.
That said, Wall Street generally takes the view that Disney, Viacom, Fox and other media giants have unique and valuable enough assets to eventually return to double-digit earnings. But there are a few on Wall Street who are beginning to say “not so fast.”
They say the bothersome adverse trends and factors coming into play now will continue to have an impact long after the companies’ financial results are no longer masked by a periodic hike due to elections, Olympics or box office and prime-time hits even against a backdrop of lingering economic volatility. They claim a dysfunctional cyclical process is at work and cite a change in industry economics that simply won’t go away.
That schism explains why Wall Street’s response to Viacom’s adjusted guidance has taken some curious turns.
For instance, Goldman Sachs analyst Anthony Noto has upgraded Disney stock to “outperform” on the belief that there is a potential 30 percent appreciation in its stock if there is a rebound in ABC prime-time ratings, theme park attendance and box office hits to offset looming declines in ESPN and other cable network affiliate fees and fluctuations in home video sales.
Banc of America analyst Douglas Shapiro upgraded Viacom to “buy,” viewing the recent 12 percent sell-off in its stock as an opportunity to get in cheap on a well-managed top collection of assets that usually yields the highest conversion rate of earnings into free cash flow-about 50 percent-of any media conglomerate.
But some analysts insist what’s going on now is no economic hiccup, but is indicative of deeper trouble that will persist into a non-biennial 2005.
JPMorgan analyst Spencer Wang said he is troubled by “an implicit lack of margin expansion” in Viacom’s revised guidance, “which suggests expenses will grow in line with revenues” and indicates Viacom is under pressure to spend more on its TV stat
ions, CBS Network and radio programming than anticipated.
“This could suggest that even as gross domestic product and ad growth accelerate into 2004, the positive cash flow impact could be more muted than expectations,” Mr. Wang said.
The bottom line, he said, is that the edge could be off Viacom’s bounding earnings growth for longer than expected. Slower growth generally seems to be the order of the day. Not nearly enough of the consolidated buffer that was supposed to bolster corporate balance sheets during tough times is coming into play.
That sounds like more than an earnings outlook adjustment to me.