Analysts: CBS In Need Of Core Changes

Many Wall Street analysts are lowering earnings expectations for CBS Corp. as they anticipate the worst for the advertising-dependent, pure-play broadcaster being squeezed by shaky program ratings and a soft advertising market. But those warnings may not go far enough.

Morgan Stanley analyst Benjamin Swinburne is the latest to lower third quarter earnings estimates, noting that CBS' launch of fewer new prime-time season series has been a low-risk turned low-rewards strategy that threatens its core revenues.

But with 90%-plus advertising exposure, CBS is not only more vulnerable than its media peers to a possible economic recession but also to something far more devastating and permanent: the replacement of television's random advertising pricing and placement with more of a fully accountable, front-end automation system being forged by Google.

Having identified the inefficiencies in traditional media ad sales systems--where it has made limited forays such as radio's dMarc and EchoStar Communications satellite TV--Google's overhaul ad buying process is gaining traction. It will be broadly adopted to become a universal system of advertising measurability and accountability within five years, says Bernstein Research analyst Jeffrey Lindsay.

Google's automated process allows smaller advertisers the same targeted consumer reach as big advertisers, and lowers the cost of ad placement while boosting margins. It also allows content owners to charge more appropriate market prices for their inventory while reaching a broader range of consumers. Adjusting to this dramatic change will be essential for all broadcasters and will be especially profound for CBS, given that television advertising represents about 34% of its overall earnings and about 65% of total revenues.

While CBS is extending its content into digital spaces and to more conventional platforms such as DVD and TV syndication, the company's more formidable challenge is managing its way through the complete transformation of its revenue base over the next several years. The structural, economic and psychological upheaval involved in that process cannot be underestimated, particularly at CBS where advertising is so important. For one thing, the ongoing, real-time pricing and placement of ads would require all broadcast content to stand on its own merits rather than having advertisers gamble on series pilots months in advance (as in the TV network upfront) or play catch-up (as in the scatter market).

A stronger scatter market (with prices estimates up as much as 30%, according to some analysts) is helping to offset CBS' softer-than-expected prime-time ratings, which have declined 17% for adult viewers ages 18 to 49--the biggest drop of the Big 4 broadcast networks. CBS' 13% year-over-year total household decline also is steeper than its rivals. Should those ratings declines continue, CBS will need to use more of its scatter inventory for advertiser make-goods, which could clip revenue growth. Even next year's cyclical elections won't be much of a boost. Bernstein analyst Michael Nathanson says CBS' political TV advertising take will be limited by having nine fewer local television stations, and an overall station footprint encompassing fewer gubernatorial and Congressional elections--yielding a total of about $150 million, or about 5.4%, of the overall $2.8 billion election-year ad spending in 2008.

Another historic offset to ad revenues, television licensing and syndication, is expected to be down this year by 12% and up by 11% in 2008 for CBS. Even as content downloads, file sharing, on-demand and home video cut into traditional syndication returns, TV licensing will generate about $400 million in profits in 2007, edging out the CBS broadcast network. TV DVD and syndication comprise 17% of CBS' television segment revenues and 25% of CBS's television segment earnings. By comparison, revenues from new media are just beginning to register.

Disruption of the broadcast networks' costly zero-sum game in prime time could actually translate into some welcome upside for CBS' otherwise challenged broadcast TV fundamentals, which still come down to program performance and leverage. Analysts seem most troubled that CBS' returning prime-time series were down 22% in ratings last season, and that the downward trend could continue or worsen in the 2007-2008 season.

Nathanson recently pointed out how CBS' stock price has been temporarily buoyed by one-time "surprises" such as asset sales, increased share buybacks and dividends, and higher free cash flow due to better-than-expected working capital. When those non-core drivers are excluded, CBS' core fundamentals are seen lagging behind its media conglomerate peers.

Over the next three years, through 2010, Bernstein estimates CBS will have the slowest earnings growth (1.7%) and earnings-per-share growth (5.7%) in the media sector. This compares with larger and more diversified News Corp., the fastest-growing of the media peers, with 10% in earnings and 19.5% in EPS.

These continuing double-digit ratings declines are expected to translate into a 5% loss in CBS Network revenues (excluding the Super Bowl), which could translate into a $170 million profit loss in 2007 and more than $100 million profit loss in 2008, Nathanson estimates.

Even the estimated 4% ratings lift to CBS from the new prime-time ratings currency that includes DVR viewers (Live+3) does not begin to offset the double-digit ratings decline, and the negative quarterly revenue growth that has persisted since the first quarter of 2006. The usual six-month gap between ratings and revenues growth (or losses, in this case) amounts to "a reality gap," or real aggregate decline of 12.8%, Nathanson says.

The bottom line is that there continues to be an underlying loss in organic growth of at least 5% at CBS that is not going to dissipate, and could even double. Eventually, it will have to be countered by something more profound than a temporary uptick in ratings and ad revenues-such as the more precise ways to value, sell and place advertising being developed by Google.

A comment from CBS CEO Les Moonves earlier this week at MIPCOM in Cannes, France about his company's new-media strategy also seems to apply here. "Anybody who is a content provider or runs a network can't keep their head in the sand," Moonves said. "My role as CEO is to be open to what comes through the door." We shall see.

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