• by Diane Mermigas , April 30, 2008

Some on Wall Street and in Hollywood are asking the question out loud: Can Sumner Redstone afford not to reunite Viacom and CBS? CBS' core television and radio may not be able to generate new digital revenues fast enough to offset an inevitable fall-off in broadcast revenues in nonpolitical 2009. That's when the company could go from a slow-growth to a no-growth story.

While Viacom is mining its cable and film assets for new digital fortune, CBS, given its assets, could be headed for ultimate defeat.

Former Walt Disney chairman and CEO Michael Eisner said it is "suicidal" for the two companies to remain separate. "Viacom and CBS should get back together... Together, they're more like Disney or GE," Eisner said Monday night on CNBC's "Fast Money." "I've talked to Sumner a lot... he's got to be thinking about putting it back together."

CBS executives Tuesday pointed to better-than-expected overall first-quarter results--which analysts call an "upside surprise"--as evidence the company is on track. But the results generally were bolstered by one-time additions, such as syndicated program sales and production savings during the writers' strike. Lehman Brothers analyst Anthony DiClemente estimates CBS' core broadcast network and station businesses are declining by 3%. An estimated $225 million in election-year ad spending at TV and radio will, at best, result in CBS' flat performance this year.

First-quarter television advertising declined 15% from a year ago, partly due to the absence of the Super Bowl and shifting NCAA finals. Bernstein Research estimates that political advertising adds only one point of growth, bringing overall organic decline to a negative -6%. Radio revenues declined 6% on a same-station basis, publishing declined 12%, and outdoor revenues grew 3% domestic and 15% outside the U.S. First-quarter operating income rose 10% to $720 million on flat revenues of $3.7 billion.

CBS executives reaffirmed 2008 guidance for 3% to 5% growth in earnings and operating income, helped slightly by revenues generated by its aggressive CBS Interactive. However, Goldman Sachs analyst Ingrid Chung says that will be difficult to achieve, much less sustain in a recessionary economy given overall deteriorating advertising and "negative operating leverage at most of CBS' business segments." CBS executives concede first-quarter results were buoyed primarily by one-time gains of about $250 million from international syndication sales of "CSI" and "Everybody Loves Raymond." Analysts estimate CBS saved about $70 million in original production costs during the writers' strike and will realize about $45 million from recent headcount reduction.

Those savings will not soon repeat, as there is a limit to cost-cutting and syndicated program sales. Although hard-fought primaries and November elections will bolster CBS-owned major market station revenues, TV station owners generally report softer quadrennial-year revenues and fear declining ad sales in 2009.

CBS officials acknowledge a slowdown, but decline details about TV station "pacings" (core ad sales). "It's not as strong as we hoped it would be...it is slower," said CFO Fred Reynolds. CBS preferred to underscore how it has met its primary objective by increasing its dividend a sixth time by 8% to 0.27 cents a quarter--the highest yield for any large-cap media company--to increase returns to investors.

Surely CBS' disadvantages will become more pronounced as the economy weakens and as broadcast networks continue to fight over a declining viewer base and a potential major pullback by advertisers. Without offsetting dual revenue streams from cable, CBS' Showtime pay TV service could be especially vulnerable as Viacom's Paramount and other studios pull their film packages to feed their own new pay TV channel.

CBS President and CEO Les Moonves says he will use CBS' $2.3 billion cash to fund as much as $300 million annually in CBS Films and buy strategic acquisitions, such as The Weather Channel or Rainbow Programming. There also is speculation that CBS could acquire a larger outdoor player, such as Lamar, having recently acquired the largest outdoor company in South American for $110 million.

In brief remarks Tuesday, Redstone said he expected Viacom and CBS to continue to fiercely compete, even in what Wall Street perceives is an increasingly unfair fight. Some on Wall Street suggest Redstone could wait until CBS stock drops below its current $22 a share, making it one of the poorest performers in an overall languid media sector. A consolidation of the companies would be reminiscent of the good old days, with Redstone's longtime lieutenants--Viacom President and CEO Philippe Dauman and Tom Dooley--overseeing operations. Redstone previously said he was not considering such a move.

But he may not be able to avoid reuniting CBS and Viacom as the two companies' value and fortunes continue to head in radically different directions. CBS is expected to have only 2% earnings growth through 2011, compared to a mid- to-high-single-digit growth rate at its media peers. More than 70% of its revenues are tied to terrestrial advertising, its return on invested capital will plod along at a negative-3%, and its exposure to international revenue will remain the lowest of all media companies at a negative-11%. Viacom is expected to report high-single-digit increases in first-quarter earnings and revenues on Friday.

"CBS has the most unfavorable thematic position in a slowing domestic macro environment among the large-cap entertainment," Chung observes. And one pumped-up quarter is not going to change that.