It is not clear that the lucrative new devices, platforms and services spawned by the digital revolution will pass the test. Despite broad, zealous consumer adoption, it may be too soon for digital to rescue what could be a financial quagmire of historic proportions for some media companies. Granted, even in a mild recession, no industry players will go unscathed.
All manner of media-related concerns--whether broadcast and cable, Internet or print, advertising and commerce--are about to be broadsided by an economic downturn created by the subprime mortgage fiasco, the more brash private equity buyouts and other reckless lending and spending of recent years.
Many traditional one-way media companies in broadcasting and print have no place to hide. The ad revenues that are their life's blood continue to migrate to the Internet and to be fragmented among an array of new two-way marketing platforms. Their content production and overhead costs are mired in legacy operations that cannot be altered overnight, if ever.
In most cases, the shared advertising and other revenues generated by extending their brands, content and services to the Web are insufficient to offset declining or slower-growing core income. For instance, even if Walt Disney Co. reaps more than $1.5 billion in digital revenues--growing at 30% annually as projected in fiscal 2008--it may not be enough to offset any decline in the $3.8 billion (or half) of the company's overall operating income, which has cyclical exposure in an economic downturn. Even newspapers, which have gained $1.9 billion in online classified ad revenues against a $2.6 billion loss in print classifieds since its peak in 2001, are sustaining an annualized overall loss that could jump to $1 billion this year, according to Borrell Associates.
Most media players also lack the necessary level of participation in the global growth markets to offset slowing or challenged core growth in the coming year. News Corp., Google and DreamWorks Animation are exceptions, generating more than 44% of their overall revenues outside of the United States.
The most formidable variable in media's short-term economic equation is the consumers, who have powered the digital revolution and drive two-thirds of the overall domestic economy. The extent to which they curtail spending in retail, auto, real estate and all things digital will determine how challenging 2008 will be, despite the huge infusion of election-year-related ad spending, which may prove more of a boost this round to the Internet rather than broadcast and print media.
An unfortunate casualty of media companies' anticipated knee-jerk response to reining in costs will be the risk-taking, deal-making and innovation that is helping them leverage their wares in the digital marketplace. These economic uncertainties coincide with the unraveling of old business models and the evolution of new business models, advertising spending shift, and the realignment of content and distribution values--all disruptive but necessary--making corporate budgeting more challenging than ever. There is no determining how the rising fortunes of digital interactivity will be slowed by broad-based economic turmoil, prompting Wall Street to wonder aloud about the potential ramifications.
Bernstein Research analysts Michael Nathanson and Craig Bernstein question whether the "surprisingly soft second-quarter results are a harbinger of upcoming economic weakness as consumer spending finally shows signs of slowing," in addition to "the continual structural shift of ad dollars to the Web."
Experts predict that the two consecutive quarters of negative overall ad spending so far this year will worsen, despite continuing double-digit Internet ad growth, which also could be adversely impacted.
Another new Bernstein Research report estimates the potential downside even among Internet giants like Google, Yahoo and AOL could be as much as a 50% reduction in mortgage-related advertising over the next several years. Or it could be a worst-case repeat of the 2000-2004 Internet bubble, resulting in anywhere from a marginal 1% to a 14% revenue hit.
However, an advertiser pullback in response to a decline in discretionary consumer spending would be most devastating to local broadcast and newspaper publishers. Local media are already seeing their ad revenues slashed by troubled regional real estate, mortgage-related lending, home improvement and furnishings, retail and auto, while sustaining a shift of ad dollars to national campaigns driven by the nationalization of domestic brands, according to Lehman Brothers' Anthony DiClemente.
To be sure, the ripple effect from the subprime mortgage and credit crunch will extend far beyond advertising in ways that may not be immediately obvious. For instance, although cable relies on advertising for less than 10% of overall revenues, operators could sustain net subscriber losses in the second half of 2007 as a result of decelerating housing growth, although the impact on cable revenues will be minimal, Bernstein said.
Even film financing is being rocked by the recent decision by Goldman Sachs and Deutsche Bank to withdraw a $1 billion commitment for branded MGM films such as "The Hobbit," "Terminator 4" and the next "James Bond." It could be the start of a broader film financing shakeout that could extend to Time Warner, News Corp. and Disney, DiClemente said.
Finally, the ability for broadcast TV and radio, telephone and print, Internet and other media concerns to buyout, buy up, break up or launch as part of an ongoing restructuring becomes more tenuous as funding becomes difficult and costly, and volatile stock loses its luster as deal currency.
In downgrading the entertainment sector this week to cautious from neutral, Goldman Sachs analyst Anthony Noto cited "fewer operating and financial levers to pull" as subprime-related defaults, the resetting of loans at higher rates and declines in housing values negatively impact consumer confidence and discretionary spending.In turn, it will spill over to advertiser earnings and ad spending on all media platforms, "negatively impacting the economy, the consumer, and ultimately the cyclical revenues streams of media companies."