Nov 24, 2003  •  Post A Comment

Television broadcasters, who increasingly find themselves adrift in a multichannel media world, have only themselves to blame and may have only a few years to salvage or leverage their grass-roots franchises.
That is the pragmatic warning from SG Cowen analyst James Marsh in a new report, “Will the Current Ad-Supported TV Model Be Zapped by DVRs?”
Unlike the growing number of Wall Street research analysts who have similarly accepted and focused on how rapidly growing digital video recording technology will compromise broadcast revenues and profits, Mr. Marsh has put his money where his mouth is.
Because he expects a balance sheet threat to materialize by 2005, Mr. Marsh has downgraded four broadcast-related companies and lowered financial performance estimates for the seven media concerns he tracks.
Mr. Marsh made the uncommon move of lowering the ratings on four major broadcast groups-Hearst-Argyle, Gannett, Tribune and Univision-to “market perform” from “market outperform.” He also lowered his long-term estimates for growth in earnings before interest, taxes, depreciation and amortization for those four media companies and three others in his coverage group-including New York Times Co., E.W. Scripps and Emmis Communications-despite what will likely be a profitable cyclical quadrennial year in 2004.
The rollout of DVR-type technology, hastened by its integration in cable set-top boxes as a weapon in cable’s battle with satellite for subscribers, will reach critical mass with 11 percent penetration of U.S. television households by 2005 and 15 percent by 2006, Mr. Marsh said. By that time sponsorships and product placement, or even long-awaited deregulation, will offset the rapid loss of spot television advertising revenues.
“The broadcasters who do not own the bulk of the programming they air [namely affiliate groups] will be most at risk during this transition period,” he said.
As a result, five-year earnings growth for TV station groups could fall from as much as 10 percent to as low as 4 percent, Mr. Marsh said.
“As penetration levels rise, we see commercial ad skipping among DVR subscribers to blunt top-line growth as ratings for commercials diverge from program ratings,” he said. “While we don’t think DVR technology will destroy ad-supported television entirely, it will be increasingly difficult for broadcasters to rein in highly fixed cost structures before their cash flow and revenues growth rates slow.”
But the scariest part about all of this is the lack of response from broadcasters, which do not share Wall Street’s emerging sense of urgency about how DVR-type technology is being adapted more quickly and undercutting their ad-supported economics more quickly than previously expected.
In fact, Mr. Marsh had intended to devote an entire section in his Nov. 11 report to broadcasters’ responses and solutions, only to find there wasn’t much when they were asked.
“It’s reminiscent of rearranging the deck chairs on the Titanic,” Mr. Marsh said. “It scares me a bit because some of the businesses are in a very awkward position. Especially the affiliate groups. After all, the only programming they own is their local news, and they are hard-pressed to do product placements.
“No one seems to be taking it very seriously, but I think behind the scenes they have to be very nervous.”
Mr. Marsh’s forecast and assumptions leave little room for argument: Once DVR technology reaches mass-market proportions, five-year TV ad revenue growth will drop to 3.8 percent from 6.5 percent.
During the same period, total ad-supported TV ratings will remain flat despite share shifts to cable from broadcast. Advertising CPMs (costs per thousand impressions) grow only 3 percent annually, just ahead of inflation. All the while, the average revenue growth of various ad-supported TV platforms remains relatively low even before factoring in the impact of DVR ad skipping. Mr. Marsh forecasts average annual revenue growth of 4 percent for the Big 4 networks, 5.6 percent for national spot, 5.3 percent for local spot, 9.2 percent for cable networks, 9.4 percent for local cable and 6.2 percent for syndication.
With DVR users skipping an estimated 60 percent of commercials-what Mr. Marsh contends is a “conservative estimate”-the collective impact represents a threat to revenue and cash flow growth that cannot be offset, even by the most rigorous cost containment or deregulation.
“The tactics once employed by broadcasters to assure their profitability will lose their effectiveness,” he said. Suddenly, the popular programs the broadcast networks paid a premium to maintain on their schedules as prime-time lead-ins, lead-outs and anchors of nightly schedules are no longer effective. Viewers recording their favorite shows, such as “Friends,” while failing to sample new series such as “Single Guy” destroys the entire broadcast network economic system, Mr. Marsh said.
As if Mr. Marsh’s straightforward assessment weren’t scary enough, it comes amid a prime-time television season fraught with still more unexpected downside.
The loss of key 18 to 49 adults, 18 to 34 males and overall ratings in prime time has nearly tripled this season for the broadcast networks. The scatter and local spot advertising markets are off by as much as 30 percent or more as a result of more than 15 percent more dollars being spent in the upfront market.
Next year’s anticipated boost from election-related and Olympics-related ad spending is a cyclical infusion off of which one can no longer run a business. Even as they crusade for digital must-carry, requiring cable operators to transmit TV stations’ broadcast and digital channels, broadcasters generally don’t know how to use these new platforms to generate new revenue streams that will reduce their dependence on advertising. The rampant, ad-busting use of DVR and PVR technology will force viewers either to pay for programming on a tiered or a la carte basis or to view commercials in a verifiable new way.
Cable operators, already way ahead in the dual-revenue game, are aggressively seeking ways to cap and reverse double-digit license fee increases, as dramatically witnessed by the public tug-of-war between Cox Communications and Walt Disney’s ESPN. They, along with Cablevision Systems and the YES Network, are slugging it out over the formation of a new economic paradigm.
The harder cable operators and satellite providers chase after the multichannel subscriber, the more broadcasters stand to lose in a media landscape in which their ad-revenue-dependent model, while under siege, remains lucrative but vulnerable.
In the past year there appears to have developed industrywide acceptance that DVRs make TV viewing more compelling by allowing consumers to easily find and schedule recordings of preferred programs, and by allowing for easier time shifting of program viewing, pausing of live TV telecasts and the editing of video content, including the elimination of commercials.
“As DVR penetration rates rise, we believe uncertainty surrounding commercial ratings, which is now a buzz, would become a roar,” Mr. Marsh said. His shorthand for the situation: “advertisers’ sticker shock and the big squeeze.”
He cites evidence that DVR users are skipping at least two-thirds of all ads. Fifteen percent DVR penetration implies that 9.1 percent of all ads would not be watched and that advertisers would be overpaying by 9.1 percent, or $6.6 billion as calculated from projected 2006 total ad revenues of $72 billion, he said.
“There seems little doubt that all of these factors-including rising DVR use and ad skipping-will have some impact on the upfront,” Mr. Marsh said, “and that will eventually affect revenues and cash flow.”
The “spiral of death” could rapidly lead to a further deterioration not just in viewing and advertising support but also in the quality of programming. If broadcasters are taking in fewer revenues because they deliver fewer viewers, they will have less money to invest in programming. Broadcasters’ outside promotional costs could rise b
ecause they are “fighting for every viewer,” he said.
Broadcasters already have lost much of the leverage they once had with cable and satellite operators. “There’s never been a period when they have had less influence to extract money from the MSOs, which have never wanted more to reduce the cost of programming,” Mr. Marsh said.
But he warns that investors will not wait until they see some reflection of these negatives in the stock market, and that broadcast stocks in particular could begin to suffer some discounting during the next 18 months. Broadcast company values could fall from current 11 times to 12 times cash flow multiple levels to 7 times or 8 times cash flow multiple levels, Mr. Marsh said.
“The kicker is that no one will probably notice this erosion occurring next year … and by 2005 it might be too late to slow or change things,” he said.