• by Diane Mermigas , October 9, 2008

CBS is breathlessly striving for digital gains while scoring victories in prime-time television's game of diminishing returns, and bracing for a recessionary hit to its nearly 70% dependence on advertising revenues.

Although revenues from its interactive initiatives (anchored by its recent $1.8 billion acquisition of CNET) would only partially offset a fraction of the advertiser pullback that could come in traditional media, its digital efforts constitute a future bright spot. Why, then, did CBS cancel an Oct. 7 investors conference to review and report its interactive business as a separate segment for the first time in the third quarter?

A note fleetingly posted to its investor relations Web site stated that the conference will be rescheduled for November. A CBS spokesperson explained that it was in deference to analyst requests in light of market volatility. Timing is everything. Good news would surely be welcome amid the latest round of slashed ad spending forecasts and earnings warnings from leading retailer advertisers.

Unfortunately, it appears that the pullback in advertiser and consumer spending will also have an adverse impact on Internet companies and sites, including branded online operations maintained by CBS and its rivals. Despite the continued slower growth of Internet advertising, the interactive initiatives that help to amortize content costs may be under as much ad revenue pressure as CBS' traditional businesses.

Although the CBS TV Network generated the top revenues with the largest group of commercial-owned stations in 2007, its television studio, syndication business and TV library (representing 12% of estimated 2009 revenues and 16% of estimated 2009 operating income) will rise and fall on its future TV network fortunes. Deteriorating economics could hit CBS on both ends of its media spectrum, leaving it nowhere to run for shelter, according to analysts.

As the only traditional media pure-play among its peers, CBS would have no buffer. Nearly one-third of its overall earnings are tied to television advertising, which will be under economic and audience erosion pressure through 2009.

In lowering its overall broadcast television estimates for 2008 (down 2.5% in an election and Olympics year) and in 2009 (down 8%), Barclays Capital offered comparative data showing nearly all of CBS Corp.'s financial fundamentals in a declining state to its peers. Barclays estimates that CBS earnings will decline -4.8% in 2008 and decline 6.7% in 2009, when its free cash flow could fall 15%.

Even before the market collapse of recent weeks, analysts were warning about CBS' inordinate advertising exposure to nearly 70% of overall revenues: 41% from television (30% national, 11% local), 17% outdoor and 11% local radio. Rival broadcast networks are part of padded conglomerates with less advertising dependency for overall revenues (39% for News Corp., 20% for Walt Disney and 19% for Time Warner), according to Bernstein Research.

A month ago, Bernstein estimated that CBS' dominant television earnings will decline -7.8% to $1.8 billion on a decline of -4% in television revenues to $9 billion in 2009, from 2008. CBS Interactive earnings will increase 131% to $113 million on a doubling of revenues--to nearly $500 million in 2009 from 2008. CBS says its interactive businesses are generating $600 million in annualized revenues, on the way to a goal of $1 billion within three years.

Much of CBS' Interactive strategy rides on mining CNET and other operations across its local TV, radio, outdoor and Internet outlets at a time when individual ad markets are among the most vulnerable in the turbulent economy. CBS CEO Les Moonves talks about taking money away from failing newspapers. One area of particularly underestimated negative reporting leverage will be at CBS' owned-and-operated local TV stations, for which financial numbers are buried in CBS' overall reporting.

Bernstein analyst Michael Nathanson points to the collective -6% decline in revenues and collective -27% decline in collective station earnings reported in 2005 by near-pure play TV station owners Tribune, Hearst Argyle and Sinclair off of the highs in the 2004 presidential elections. He estimates that organic TV station advertising growth decelerated from -8% in the first quarter to -13% in the second quarter, driven by the deterioration of the automotive, retail and financial sectors that comprise half of its TV station advertising base. CBS' only bright side will be selling an estimated $175 million in political advertising this year, most of it in the second half of 2008.

Further revisions by Wall Street analysts could come before--or as a result of--CBS' Oct. 30 third-quarter earnings report. Given the high incremental operating margins in advertising, a small miss in ads can have a dramatic impact on earnings. The -2% advertising miss would result in a downward revision of a -6% decline in earnings; a -4% miss in ad revenues would drive earnings down -12%, Nathanson points out.

The bigger issue is how CBS rides out the financial storm for the next 12 to 18 months.

What CBS can do to help itself, in addition to steadying its prime-time ratings, might include working with Google analytics to create demographic targeting tools to better value cross-platform exposure and account for advertiser ROI. CBS could create more innovative, valuable models for video advertising and content beyond its rudimentary CBS Audience Network. Or it could create a solution for delivering more Internet video, such as CNET and interactive content, to living room TVs.

Despite the company's denials, CBS' $7 billion market cap in a free-falling market (trading near its record low of $11.37 per share) makes it a possible merger or acquisition candidate. In a better market, CBS Interactive (like News Corp.'s Fox Interactive Media or like Facebook) could be the subject of a public offering to generate cash. For now, CBS is selling non-core assets like its 50 mid-sized radio stations--when it's not writing its own "Survivor" episode.