• by Diane Mermigas , October 21, 2008

The loan covenant issues threatening Viacom and CBS underscore the unexpected, devastating impact the credit crisis and the recession will have on even the biggest media concerns, some of whose repayment and cash flow issues have not yet come to light. The resulting realignment of media players could alter the competitive landscape on the upside of the economic recovery 18 months from now.

Speculation that controlling chairman Sumner Redstone may be forced to sell CBS or Viacom to satisfy the requirements of a $1.6 billion loan demonstrates how broad and deep the adverse effects of the credit crunch can be.

The loan was made to National Amusements, the private Boston-based holding company through which Redstone owns his Viacom and CBS shares, which were used as collateral. NA owns a string of national movie theaters and an 87% stake in Midway Games. NA is also managed by daughter Shari Redstone, who is feuding with her father. They are working with banks to renegotiate terms of the loan, about half of which is due in by mid-December.

The precipitous drop in CBS and Viacom shares made it impossible for National Amusements to meet a covenant requiring that it maintain a certain debt-to-asset ratio. This year, CBS stock has declined 53%, and Viacom stock has declined 57%, with half that value lost just in October. Redstone last week sold $233 million of non-voting stock in the companies, and will have to sell more non-voting and even voting stock if he cannot access debt markets to refinance the bank debt.

Pali Research analyst Richard Greenfield said the most surprising element of the forced sale was "the speed and seriousness" of the situation. "...nobody was aware that Mr. Redstone had put substantial leverage on National Amusements backed by Viacom and CBS shares." The analyst initiated coverage of CBS with a "sell" rating and $5-per-share price target Monday--citing declining margins due to a prolonged advertising downturn, inevitable dividend cut, lack of management credibility, and the inability to sell its assets or the company as a whole, whose market cap has fallen by half to about $6 billion.

Due to its 70% exposure to advertising, Greenfield estimates that CBS earnings will decline -14% to $2.64 billion on a -1% decline in revenues to $13.9 billion in 2008, an election year. Earnings will fall nearly -18% on an -8% decline in revenues in 2009, barely helped by the $100 million in operating profits generated by CNET, which it acquired for $1.8 billion this year. Viacom has its own debt issues, and both companies continue to lower earnings and revenue guidance.

Regardless of assets that he might be prepared to liquidate, Redstone does not appear to have the financial wherewithal to reintegrate CBS and Viacom in a reverse play from the split two years ago, which he insisted would yield better returns for investors. Redstone will resist selling all or part of Viacom, the core of his holdings and the culmination of his life's empire-building.

News Corp. chairman Rupert Murdoch, whose empire was threatened by debt and repayment issues more than a decade ago, is so far steering clear of the current malaise. Although Murdoch told shareholders last week that the company has manageable debt and $5 billion in deal reserves, it has a huge economic risk in its newspaper and television advertising exposure.

Clearly, the entire media landscape stands to be changed by the adverse impact of advertising revenues, economically demanded changes in operating structure, ownership change, falling stock prices and company values, loan covenants and other financial requirements.

General Electric, the quintessential global conglomerate and owner of NBC Universal, has been under siege for a month dealing with the negative credit crunch hit on GE Capital. It has prompted a scramble to raise $15 billion in cash, sell assets and cut costs everywhere, including at least $500 million in NBCU's 2009 budget. GE also leveraged against bull markets by lending to customers of its subsidiaries which are hard-pressed to make payments in a recession.

Like Redstone, other corporate chiefs are being forced to sell their holdings to avoid breaching loan covenants or to meet margin calls in response to plummeting stock sales. Liberty Media controlling chairman John Malone recently sold $49.5 million of stock back to the company at a deep discount. However, Liberty Media executives working closely with Malone recently indicated that he may opportunistically acquire the debt of some media companies and possibly make a run at others trading at record low levels. If so, that could present an interesting dilemma for companies like Viacom and CBS.

Halting rigorous stock buyback programs--a good idea while prices were falling and cash was flowing--now seems the least of media company concerns. The continuing decline of stock prices has even Time Warner concerned that its core assets could be sold separately for a greater premium than the company is worth in total. But S&P and Moody's contend that it is the small-to-medium broadcast and newspaper companies that are most at risk.

Tribune Co., taken private by real estate investor Sam Zell, has drawn $350 million from a $750 million revolving credit line-- slashing jobs and selling assets to service $12.5 billion in debt while stemming the loss of advertising and readers. Gannett Co., the largest U.S. newspaper publisher, is also drawing on a $3.9 billion revolving credit line to repay its more than $2 billion in commercial paper. Banks for McClatchy Co. extended the terms of a $1.18 billion loan by nearly tripling its lending rate, creating even more of a squeeze.

Overall, the places to go for money are narrowing as global financial institutions have racked up $585 billion in writedowns and losses since the start of 2007, and as private equity companies increasingly assume the corporate debt of the portfolio companies they purchased in leveraged buyouts. The lack of affordable liquidity and options (including IPOs) will result in increased corporate defaults and bankruptcies.

Still, a recent Fitch Ratings report deemed that liquidity for the media and entertainment sector is generally healthy, with 12 months or $18.1 billion of free cash flow and $21 billion in balance-sheet cash. If free cash flow remains stable, internal liquidity will exceed debt maturities of $6.2 billion this year to $12.4 billion in 2010. Ideally, major media conglomerates such as Viacom and News Corp. are best-positioned for turbulent financial markets with their strong, stable operating liquidity, diverse revenues, meaningful cash and revolving credit and longer-dated maturities. However, recent events underscore what can go horribly wrong with that picture.

The high cost and scarcity of liquidity and the tightening of ad revenues has all media companies in a vice through 2009. That distressing situation is worse for companies that leveraged their fortunes against good times they thought would never end.