From Kagan Research

With UPN and The WB fading to black after bleeding a sea of red, their chapters in network TV history come to a close and their successor, The CW, begins a new one. The story line for the next chapter seems to be that these times call for Quality Over Quantity!

But first, here’s a brief history. UPN and The WB launched in the 1994-95 season, following in the footsteps of Fox Broadcasting, which debuted in 1986. But the odds were long, as Fox, cable networks and Internet media were already fragmenting audiences.

“In the history of the two, only The WB reached positive cash flow, and for just a single full year,” Kagan Research said in its newsletter TV Program Investor. “In 2003, we estimate the net brought in about $11 million in cash flow. As ratings declined and programming expenses rose in the year that followed, profits tracked the viewership downward” in subsequent years. Cash flow represents core profitability, without dilution from amortization, depreciation and interest expense.

The WB faced the economic strain from its aging hits going into decline, such as stalwart “7th Heaven,” which nearly was canceled (but will continue on The CW). When the merger of The WB and UPN was announced in January, UPN was ascending with “Everybody Hates Chris” and “America’s Next Top Model.”

The combined gross ad revenue of UPN and The WB has been running just under $1 billion annually, according to Kagan Research (in contrast, the Big Four networks rake in around $16.5 billion in gross ad revenue). News reports indicate their successor, The CW Network, took in $650 million in ad buys in the just-concluded upfront selling season, a promising start. Of course, also filling the void is News Corp.’s MyNetworkTV, aiming for $50 million in upfront advertising. It employs a less-expensive program strategy with a station lineup consisting mostly of former UPN and WB affiliates.

Looking ahead, The CW’s 13-hour program schedule for prime time represent a 43 percent contraction (from 23 hours to 13) from the combined schedules of its two predecessors (excluding daytime and weekend slots). Meanwhile, Kagan Research estimates that total program expenditures will shrink just 20 percent because of the higher costs associated with seasoned series like “Smallville,” “Gilmore Girls” and “Girlfriends.” So while eliminating duplicative overhead achieves economies, The CW will at the same time be a bigger spender with more money invested in each prime-time program hour than either UPN or WB alone was ever capable of investing.

The extra programming gloss-representing the strategy of quality over quantity-will come in handy in a lot of ways:

Pre-merger, program quality and associated audience levels enabled The WB to average just $65,100 per prime-time commercial last season and UPN only $47,200, according to Kagan Research [TPI, Sept. 30]. Comparable slots sold for $168,320 on the Big 4 networks.

Higher-quality programming on The CW should stem audience erosion to other media better than either UPN or The WB could have done alone.

The payoff for top-quality programming is magnified by growing revenues from ancillary sales on DVD and digital downloads.

Cable systems could be more agreeable to paying carriage fees for The CW’s local stations, if the stations don’t invoke must-carry. The CW will represent more bang for a cable operator’s buck than UPN or The WB separately.

The third point is significant in that new revenue streams are developing for TV’s most popular TV programs with little offsetting costs. Two months ago, Disney reported its pioneering TV program download deal with Apple’s iTunes generated more than 5 million sales, which presumably brought in $7 million in program rental revenue. The ancillary revenues tend not to be calculated in network profitability analyses that pop up in the business press.

The CW executives are projecting sizable profits in the first year, an ambitious goal. The Big 4 networks achieve only modest cash flow margins that range between negative 3 percent and positive 11 percent. TV Program Investor forecasts a modest cash flow initially for The CW, a vast improvement to an estimated combined $127 million 2005 cash-flow deficit for UPN and The WB.

Kagan forecasts The CW’s cash flow will steadily grow year by year, reaching $67 million in five years. If that is achieved, it represents a cash-flow margin of around 7 percent five years out, stellar by today’s network performance.

“Owning half of a profitable network is a better proposition than owning the majority of a network which swims in red ink,” noted Kagan senior analyst Deana Myers. “When co-owners CBS Inc. and Time Warner Inc. negotiated the merger creating The CW, that vision certainly drove both parties.”

“Of course, profits on the network level are only part of the story,” Ms. Myers added. “Significant cash flow will likely rise from the O&O stations, which tend to have margins in the 35 percent to 40 percent range for The CW, and in the backend for hit shows.”