Fear Factor: Strikes, Slowdown Spell Disaster

The economic slowdown and subprime-induced credit crunch will take a negative toll on media and entertainment industries long considered to be insulated from such events. These forces also could slow the robust rollout of digital interactivity. The big question in both cases is--how much?

That confluence of factors is being compounded by the writers' strike and other union walkouts, as well as the continuing decline and changed measurement of ratings. All are playing havoc with already fragile cost and growth projections. The growing uncertainties weighing on companies dependent on advertiser and consumer spending are beginning to cast a long shadow on the media and entertainment outlook for 2008, even with the political elections and Olympic Games. As early as next week, advertisers, agencies and networks will begin scrambling for adequate compensation for the new season series ratings and viewers not delivered prior to and during the strike. There also is growing ambivalence about viewers who may be lured--permanently--to other entertainment and media options once the strike is settled.



In that regard, this work stoppage is looking to be more foolhardy and ill-timed a move for traditional media, such as the television networks, whose business models are under severe assault.

Early hints of vulnerability have come from media company executives during their recent quarterly earnings calls. EchoStar reported its highest-ever churn of 1.94% in the third quarter, blaming its difficulty in attracting and maintaining subscribers on the subprime mortgage fiasco. While financially squeezed consumers will still pay for cable or satellite and pay TV, Citi Group analyst Jason Bazinet said the mounting foreclosures would result in the increased number of "boomerang" adults moving back home with their parents and accounting for fewer subscriber households.

The subprime woes will likely impact the mix rather than the magnitude of TV net ads, Bazinet said. EchoStar's churn over the next year could represent 21% of national home foreclosures--which has prompted analysts to downgrade or lower its target price for the stock, even though the company remains a likely takeover by AT&T. All of the leading cable operators have reported a loss of basic subscribers in stark contrast to dominant satellite provider DirecTV, which has been adding subscribers at an accelerated rate. Sub-prime exposed wireless carriers, such as Sprint and Leap Wireless, also are posting weaker-than-expected subscriber results. Some analysts take this to mean that the overall Pay TV industry is slowing.

Walt Disney executives last week acknowledged the prospect of potential writers' strike-related losses in the present quarter and early in 2008 in the case of a protracted walkout.

In the latter case, the impact on television would not materialize until 2009, although costs would be reduced to offset related losses, Disney officials said. Although a strong advertising market has aided in taking care of some carryover makegoods from last year, Disney does not expect a difficult makegoods situation this quarter. However, with more returning television series, production costs have been higher. The longer the strike, the bigger the restitution all television networks will have to make to advertisers who are not getting the viewing levels and first-run series they paid premiums for in the upfront.

The situation is being exacerbated by the continuing drop in prime-time household and demographic ratings, given the extended electronic portable people meter ratings and Live+C3 configurations.

In addition, many of the primary categories of advertisers, such as already hard-hit financials and retailers, could find it cost-effective to shift more of their marketing spend to the Internet and other interactive platforms. That could be a wild card over the next 12 to 18 months.

Whether the broadcast networks and their corporate parents are willing to acknowledge the looming risks, "the relationship between ratings and network revenues appears to have broken down in recent quarters," due to mounting makegoods, falling ratings and a strike-disenfranchised prime time season, according to Bernstein Research analyst Michael Nathanson. The disconnect between prime-time ratings shortfalls and advertising growth at CBS and ABC in particular have not been fully reflected.

"Clearly, the marketplace has been artificially tightened due to makegood inventory being sold instead of paid back," Nathanson said. "The clear winners in this equation will be the cable networks, which sell 50% on their inventory in scatter (vs. only 20% for broadcast TV) and those broadcast networks taking share--so far, only Fox fits the bill season-to-date."

Having to make cash payments to advertisers, due to the lack of available inventory to use for makegoods, would be a direct bottom-line hit, despite efforts to offset with cost cuts. The WGA strike "could hide a multitude of sins, as the networks could fold these makegood losses in under the banner. In that light, the strike might be a blessing that puts the makegood genie back in the bottle," Nathanson said.

Through the first four weeks of the new TV season, the Big 4 broadcasters posted a 13.2% decline year-on-year (using C3 this year vs. Live Program last year), with CBS showing the largest decline at 20.9%, Nathanson said.

Disney also could be penalized by the stagehand strike in New York, which has shut down its profitable Broadway plays. Concerns about consumer-driven goods and services of many media and entertainment companies being hit by a slowdown in consumer spending is a growing concern on Wall Street, where investors have bid down such companies' stock price in recent weeks.

Even News Corp. Chairman and CEO Rupert Murdoch, whose Fox Broadcast Network has the ultimate anti-strike program in "American Idol" and whose primary occupation will be taking command of Dow Jones and The Wall Street Journal by year's end, concedes that the market volatility and digital transitioning are leaving a lot of factors up for grabs. "Right now, all the economic indicators are that next year could be rough," Murdoch said last week. He has declined to provide financial guidance to Wall Street until the economic picture becomes more clear.

To be sure, the next round of quarterly earnings are expected to reflect an increased pullback in consumer and corporate spending, as well as the adverse financial impact of the WGA strike and the struggle to develop new business models. The financial impact of a strike that lasts through year's end will cut into 2007 and 2008 forecasted revenues and profits.

Broadcast networks potentially could be hit the hardest. They will have to provide cash or inventory makegoods to advertisers on series that underperformed upfront ratings guarantees at the start of the fall TV season, or those have since disappeared without a stockpile of new episodes to air during the 2-week-old writers' strike. The tight inventory created by aggressive upfront and scatter ad sales. Beyond the balance sheets are the strategic deals, which many media and entertainment players still are hoping to do next year. The bad news is the private equity, venture capital and others with money to burn are sitting tight, while the public markets and valuations shake out. The good news is, when strategic deals present themselves, financing and more reasonable multiples should abound.

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