Bottom Line Economics: How Bad Will It Get?

With other media companies expected to join Viacom in lowering advertising growth estimates, the industry faces critical questions. How bad will it get, especially for more disadvantaged broadcasters? Could this be the tipping point when television's historical share of domestic ad dollars fails to rebound?

This downturn will be unlike any other. The recessionary pullback in advertising and consumer spending coincides with an accelerated shift of ad dollars to the Internet. The soaring cost of oil and globalization have many companies in a vice, forcing structural, competitive and economic transformation. Wrenching change in industries such as automotive and airlines is changing the way they do business, including where and how they advertise. The deteriorating metrics of broadcast television, like newspapers, is testing traditional pricing and strategies--although cable networks are expected to make a stronger showing in the upfront.

That is why Wall Street was stunned by Viacom CEO Philippe Dauman's announcement that the company has lowered its guidance for second-quarter advertising growth by nearly half (to between 3% and 4%), citing weakness in the scatter market and automotive sector. In less than a month, Viacom's ad business has done an about-face, losing as much as 400 basis points of growth, or more than $35 million in revenues. Dauman said he considers it a short-term issue, but many on Wall Street consider it the beginning of a long-term problem.

"We are concerned that this may be the beginning of a deceleration in national TV advertising driven by the weak economy. National TV advertising has defied gravity for several quarters, due to extraordinarily tight scatter and despite declines in local advertising (newspapers, TV stations) and a deteriorating economy," observed Bernstein Research analyst Michael Nathanson. Analysts fear the next move may be lowering full-year 2008 estimates for U.S. advertising, from 6.2% to 3.9%, per Nathanson.

The angst in auto, retail and financial markets could be a more serious blow to local TV, where such sector advertising comprises 50% of revenues. If Viacom already is feeling pain, smaller and local traditional media could get hammered. Citing the same risks, Walt Disney CEO Bob Iger conceded that the broadcast networks and TV stations are "challenged" businesses whose cost and competitive issue will require more formidable structural changes over time.

At another conference, News Corp. Chairman and CEO Rupert Murdoch reiterated his earlier warning that the U.S. is "in for a very hard time" over the next 18 months, and its recessionary woes are spreading to Europe.

Since Viacom's specialized cable networks are typically less exposed to volatility in categories such as autos, Viacom's move "implies the impact elsewhere could be significant," given the strike-driven audience deficiencies during the second quarter," noted Goldman Sachs analyst Ingrid Chung.

Lehman Brothers analyst Anthony DiClemente said he believes cable networks generally will remain resilient in an economic slowdown--and will have growth of domestic affiliate fees to fall back on. (More than 10% for Viacom's cable networks through 2010.)

While it is early in the upfront selling game, it seems likely that Wall Street's worst fears for television advertising may materialize. A plausible bear case scenario calls for a 14% decline in revenues on flat unit pricing, high single-digit ratings declines sold and a 5% drop in sellout across all networks, according to Merrill Lynch analyst Jessica Reif Cohen. While that would depress revenues and earnings at all television-related media companies, CBS would be hardest hit by a 15% decline in upfront revenues (with 70% of total revenues coming from U.S. advertising and 30% dependent on its broadcast TV network).

The math is simple and unforgiving.

Total U.S. advertising is expected to grow only an average 1.6% to $181 billion by 2011, according to Bernstein. The Internet will continue to grow the fastest--but at a slower rate, or an average 10.4%, to about $35 billion in 2011. Over that time, newspaper ad revenues will average negative growth of -5%, garnering about the same $25 billion in ad dollars that will be sold on local television (with no growth) and national cable (averaging 4% growth) by 2011. The Big 4 broadcast networks' share of ad revenues will struggle to remain flat at just under $15 billion in 2011. Bottom line: all media sectors other than Internet and national cable will lose.

As economic and technological factors continue to take a toll, the new revenues generated in a digital interactive marketplace will not grow fast enough to fully offset losses in traditional revenues, leaving local TV station owners as well as established media conglomerates with income shortfalls that cannot be tempered by cost cuts alone. Cobbling together a target audience reach across multiple platforms will only help stem the tide of losses rather than generate additive revenues. There will be no infusion of political or Olympic ad dollars in 2009.

Continued economic strain also could clip the growth of other media conglomerate businesses, such as theme parks, music, films and the already slowing home video market, which comprises 18% of Viacom's total revenue.

For instance, the film studios have masked what could be an explosive financial problem this year, with film production down 29% so far in 2008 and 31% in the second quarter, due to the possibility of an actors' strike after June 30. Although contract negotiations appear to be going well, film producers are reluctant to commit funds to rent facilities and sign talent without a ratified new pact. A strike would have a negative impact on film studio profits within 12 months, adding to media conglomerates' financial woes, said JP Morgan analyst Imran Khan.

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