Cable Must Change Biz Model To Enhance Revs

The lucrative general-interest cable networks, which carried many media conglomerates through the painfully protracted decline of the broadcast network business, may be the next casualty of a digital revolution that plays to niche interests.

Weakening ratings and revenues at some leading cable networks are a problem for Time Warner, NBC Universal, Viacom and Walt Disney Co., which have relied on branded platforms, such as TBS, TNT, USA and MTV, to bolster their balance sheets through downturns in their film, publishing and broadcasting businesses, as well as the economy.

It was just a matter of time before general entertainment cable networks that most mirror the major broadcast nets would be hurt by the backlash of increased audience and advertiser fragmentation across a broader digital landscape. Other change agents: consumer preference for more engaging content; the continuing 9% slide in overall cable network ratings; and the shift in TV ad pricing to collective ratings that reflects short-term program replays and DVR viewing--a practice that negatively impacts cable networks and helps broadcasters.



Bernstein Research analyst Michael Nathanson estimates that change in ad currency could shift nearly $500 million in ad spending away from cable to broadcast, in what is a combined ad market for both of about $36 billion.

As a result, the decades-old cable networks model of cheap programming and high margins is undergoing a structural change. Cable networks are having to increase their spending on original content, despite flat operating margins, Nathanson said. From 2008 onward, he is assuming flat operating margins for cable networks, which will pull down earnings at all media conglomerates--save for News Corp., due to its increased Fox News Channel affiliate fees. Nathanson's biggest related revision has been at Viacom, resulting in a $1 reduction in its target price.

Some of the obvious solutions: investing more in compelling original content; pushing for higher affiliate fees from cable, satellite and telecom operators; and constructing new commercial pods with less clutter while providing for more product placement.

However, Goldman Sachs analyst Anthony Noto argues there are no short-term economic solutions for programming costs growing at or above the rates of revenue for many cable networks and limited prospects for long-term affiliate fee increases. For now, even new ways to monetize the Internet don't help. "Pricing pressure on advertising is a potential risk as the size of the Internet audience reaches the equivalent unduplicated scale of the cable networks, but at cheaper price points," Noto says.

Media companies have been trying to put the brakes on cable network ratings declines with a smattering of original series, like "Amazing Grace" and "The Closer," which were well received this summer. Such original fare also is a hedge against the shrinking availability and effectiveness of off-network syndicated series and films, which comprise as much as half the schedules of cable networks such as TBS and TNT.

Even so, Turner cable networks will have flat ratings and revenue growth in 2007, partly due to difficult comparisons to the year-ago syndication of "The Sopranos" and stand-alone sales for the now defunct WB Network. As with many other cable networks this fall, there is talk at Turner about the level of scatter market inventory sales and risk of missing ratings guarantees. All is reminiscent of the broadcast networks' long-running dilemma.

Analysts point to the cable network-related financial bind at Time Warner and Turner as being indicative of the quandary also plaguing many of its peers.

Noto estimates that the higher cost to produce original series and the $1 billion HBO paid Universal for the exclusive rights to an eight-year film package will drive content costs 12% higher, which will not be offset by growth in ad revenues.

Former HBO chief Jeff Bewkes, the Time Warner COO, who is expected to succeed Time Warner chief executive Richard Parsons, should ramp up more of the edgy original fare that he used to revive HBO a decade ago, while finding new ways to extend its cable brands into booming global digital sectors, like mobile. Still, the company should budget for financial hits en route. For now, Time Warner is expected to have a 7% rise in overall revenues to $47 billion in 2007, thanks to the growth of its cable systems. Sans cable, Time Warner's overall $31.4 billion in revenues in 2007 will reflect a 4% decline in business contributions, led by a 34% drop in AOL revenues and the absence of growth at its publishing and cable networks, according to Lehman Brothers analyst Vijay Jayant.

Time Warner is being bolstered this year by the cyclical uptick in its filmed entertainment division and the strength of Time Warner Cable. If Bewkes decides to completely spin off or sell Time Warner Cable, AOL and even Time Inc. publishing, it would be imperative to improve the stand-alone financial health of the company's remaining cable networks and filmed entertainment operations.

But even as part of a sprawling conglomerate, the declining fortunes of Turner's cable networks smarts--especially as they are the second-largest contributor, behind cable systems, to Time Warner's overall earnings.

The cable program networks also are a revenue anchor as the single biggest contributor--at 60%--to subscriptions, which comprises more than half of Time Warner revenues. They also contribute 37% to advertising, which contributes nearly 20% to Time Warner's overall revenues. The cable nets contribute only 7% to the content, which comprises only about 25% of Time Warner's total revenues.

UBS analysts Michael Morris and Matthieu Coppet say the strained economics of the cable networks is part of a larger problem at Time Warner, which is the company's "failure to strategically position its content assets for growth in expanding international and new digital markets."

"We are more concerned about Time Warner's operational growth potential than we have been in the past," the analysts say--in part because the company is not aggressively gearing up for the intensified content wars with new or old media rivals. It goes way beyond the cable networks' continued reliance on syndicated fare and film packages, or their standing in domestic ratings. It's about "an international strategy that is too conservative, relative to News Corp., Google and Yahoo."

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