• by Joe Mandese , December 9, 2005

At the end of a week of generally mediocre outlooks for one important source of media industry capital - advertising revenues - a dour prediction has been issued for another critical source of capital to fund media industry growth or mergers and acquisitions: credit. Influential credit monitoring service Fitch Ratings late Thursday issued an alarming outlook for the U.S. media industry, raising questions about the ability of big media companies and ad agencies to leverage capital markets to fund deals and other important capital expenditures. "For the U.S. media sector, Fitch Ratings believes that secular issues coupled with strategic and financial policy decisions will continue to trend negatively and will be primary themes in deteriorating credit quality and rating activity for the industry in 2006," warns the company's report.

Despite a generally favorable economic outlook and predictions of moderate advertising growth, Fitch warned that "weakened operating fundamentals" will persist for most big media companies, including questionable uses of free cash flow that are likely to make shareholders happy, but would put creditors at greater risk. Among other things, Fitch cited the media industry's trend of "de-consolidating" to "unlock" shareholder value, as well as the popular use of special dividends and stock repurchase programs that may make stockholders happier, but raise concerns for bondholders and creditors. Fitch singled out the split-ups of Viacom and Liberty Media Corp., as well as the spin-offs of Clear Channel Entertainment, and a portion of Clear Channel Outdoor, as examples that have "resulted in negative rating actions." Shareholder pressure to restructure Time Warner, including recurring dividends, a more aggressive share repurchase program, and the possible sale or spin-off of AOL, were also seen as potential negative credit risks for the world's largest media company.

As a result, Fitch said it expected "financial policies, not M&A activity, to be a main rating concern for 2006."

Fitch also weighed in on the long-term implications for the media industry's other source of capital funding, advertising sales, noting that the dramatic shift from traditional media to the Internet and other digital media is transforming businesses in ways that may be difficult to anticipate from a creditor's perspective.

Fitch warned that Madison Avenue was particularly at risk during this period of change, concluding: "Given the rapid evolution of the media landscape, ad agencies will remain under pressure in 2006 to maintain their relevance by adapting their offerings in favor of the new media alternatives that are gaining acceptance. Advertisers will increasingly expect agencies to demonstrate return on investment to justify expenditures. Also, the agencies could be negatively affected by consolidation activity among the advertiser base and remains exposed to the threat of a cyclical downturn."