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For whom the gloom

By Steve McClellan -- Broadcasting & Cable, 10/22/2000 8:00:00 PM

If Wall Street's view of the TV-station business and its prospects were accurate, you'd think that all the local signals were about to go dark, that business is so bad that local operators are just going to fold their tents and find another industry to toil in.

That won't happen, the fantasies of spectrum-hungry would-be wireless service providers notwithstanding.

But there are signs that, in the short term, growth will be marginal. Many are betting that industrywide revenues are sure to be down next year, coming off record levels of political and Olympics spending in 2000.

There are signs of softness in the current advertising market at both the national and local levels. Increasingly, talk of a slowing economy has advertisers jittery and very anxious about their upfront commitments.

Anecdotal evidence suggests that advertisers are preparing to exercise options in record numbers to cancel some of their upfront buys for the first, second and third quarters. Some are already predicting that next year's TV upfront advertising market will be down significantly from this year's record $8 billion.

And the national spot market, already shaky after a down year in 1999, is looking less stable this year, exclusive of political and Olympics money. Analysts suggest that advertisers will probably cancel some fourth-quarter buys as a prelude to cuts they will make in January when options to pare upfront commitments kick in.

Prices for network scatter inventory are said to be substantially lower than last year's 20% to 30% gains and, in many cases, lower than the 11% average price increase for this year's upfront.

And conflicting pronouncements last week from several media moguls only made the picture less clear. Gerald Levin and Steve Case, the men who would be merged at Time Warner and AOL, vigorously denied any softness in the advertising economy.

"There's been a lot of swirl in the market," Case said. "AOL's advertising growth is right on target."

Levin went further, saying that the whole question of a slowdown is "spurious." Yes, spending by dotcom companies has dropped, but some big spender is always fading and being replaced, just as dotcoms replaced free-spending pharmaceutical companies, which had replaced long-distance companies, which had replaced videogame makers.

"There is no advertising issue," he said, adding, "We have the most resilient economy in the world." Like most stocks in the media sector, both Time Warner and AOL have been hammered lately on concerns of a slowing advertising economy. But both stocks got a nice upward push (more than $3 each) last Wednesday when Case and Levin presented their happy scenario to reporters.

But half a world away at his company's annual shareholders meeting in Adelaide, Australia, News Corp. Chairman Rupert Murdoch braced investors for a downturn.

He warned of "weakness" in the U.S. TV advertising economy. "I have to say the immediate future for us and our competitors looks a little uncertain," he told shareholders. "There are signs of weakness in the next couple of months." News Corp. stock dropped almost $3, to a little more than $40.50 on the news.

Then there's the digital-TV conversion, which few deny has ground to a halt. Some believe it has evolved into a $70 billion white elephant that has viewers yawning, networks punting on digital programming commitments, and station executives scratching their heads wondering how they're going to make a $2 million to $3 million (per-station) DTV-conversion investment pay off.

Station values are plummeting, particularly outside the big markets. Although FOX is paying top dollar for Chris-Craft, station prices outside the top 20 markets have fallen in the past four months from an average 15 times cash flow to about 10 to 12 times cash flow, analysts say. At least one mid-size-market station sold for only nine times cash flow.

That trend also highlights the struggles of small- and mid-size-market operators, for which the situation is a lot worse than for big-market stations. Network compensation is being phased out, and that comes directly off the bottom line. For big-market affiliates, compensation is a relatively small percentage of profits. In smaller markets, it's a much bigger percentage.

National spot dollars are also a lot less available in markets No. 50 and below.

"I don't think there is upside short term," said David Woods, who owns and operates WCOV-TV Montgomery, Ala., in the No. 117 market. Not all markets are participating equally in the political and Olympics windfalls. In Montgomery, national spot in the third quarter was down 10%, while total TV ad revenue was down about 5%, he says. On average, that means stations' operating income in the market will drop nearly 10%.

"The next year or two could be soft," Woods continued. "But it's almost two different industries. You have larger and smaller markets, and the dynamics are a lot different in markets 50 and below."

For one thing, according to Woods, inventory is much tighter in the bigger markets and advertising rates are a lot higher. That has forced some of the bigger advertisers to put more of their national spot budgets in the bigger markets. "If you can't deliver the rating points you're planning in New York City," he observes, "you start pulling money out of the smaller markets."

But it's not just smaller stations that are feeling softer ad sales. Analysts say the entire sector is under pressure. Drew Marcus, media analyst at Deutsche Bank Alex Brown, wrote recently, "We continue to underweight TV station stocks due to audience fragmentation, slow ad growth, deteriorating [network compensation] and deteriorating program exclusivity."

PaineWebber broadcasting analyst Lee Westerfield maintained that there will be no growth at all next year for TV stations on average, with national spot decreasing by 2% and local sales rising perhaps 2%. And that, he stressed, is the best-case scenario. Westerfield says local station operators are "hamstrung" by the ownership caps. Remove the caps, he said, and operators can more efficiently scale costs, particularly for better programming, across larger distribution systems.

One of the scarier questions confronting the industry is whether the signs of ad softness and a slowing economy are signals of a recession on the horizon. For Sanford Bernstein media analyst Tom Wolzien, the jury is still out on that. "The market is almost acting like it is, but there isn't enough negative information to make a 'we're-headed-for-recession call,'" he said. "But we certainly have all the signs of a correction or softening." Station executives privately admit, he added, that "ad cancellations are running at record rates."

Francis L'Esperance, managing director and head of broadcasting and communications at Veronis Suhler & Associates, said forecasts of an advertising downturn are just the latest negative implications for the TV business.

Such concern has taken its toll on station values in smaller markets, L'Esperance continued. "The secondary markets have seen lower than expected valuations." That has led some would-be sellers to pull their stations off the sales block to wait for more-favorable conditions. So far, though, major-market valuations are holding up well and in the mid-teens, he noted.

Over the past 18 months or more, he added, there have been underlying concerns about the impact of increasing competition to local TV from cable, radio and satellite services, coupled with the confusion over the migration to digital "and the outcome of spectrum negotiations with Congress." Adding concerns about a slowing economy amounts to a sort of "double whammy" for the station business, he said.

And the confusion over digital will cause many stations to miss the 2002 FCC deadline for converting. The National Association of Broadcasters is working behind the scenes to get the deadline moved back. Wcov-tv's Woods hopes the NAB is successful but said he may miss the deadline regardless. "With receiver penetration at less than 1%, those DTV costs are more frightening than ever," he added. And the cost of converting a station in Montgomery is the same as the cost of converting a station in New York.

It's not just the smaller guys that are worried about the 2002 deadline. Some of the bigger groups aren't sure they'll make it either. At Hearst-Argyle, for example, a source said, "We're in a holding pattern on DTV. The whole thing is being debated, so its hard to say" whether the group will meet the 2002 deadline or not. "Where that debate ends up is anybody's guess."

The debate centers on the 8VSB transmission standard. Some question the standard's ability to cover entire markets with a quality picture. Others are concerned about being shut out of new business opportunities because 8VSB transmits poorly to mobile receivers such as Palm Pilots.

But despite all the doom and gloom, broadcasters remain optimistic about the long-term prospects for their business. Even Woods said the industry will "weather this storm," as it has previous downturns.

Most of the broadcasters contacted for this article say they have to make themselves indispensable to local viewers. If they do that, they say, they will thrive, regardless of DTV and no matter how big or powerful the gatekeeper (such as a merged AOL Time Warner) passing along their signal.

For LIN Television Executive Vice President Paul Karpowicz, localism is key. "Those stations that have positioned themselves well as leaders in local news, public affairs, local community service and local sales will be well positioned for the future. Those who have not will be in trouble."

Emmis Communications Chairman and CEO Jeff Smulyan is still very bullish about local TV because it's still the most efficient mass-audience medium, and he doesn't see that changing. And he put his money where is mouth is this year, buying 10 local stations for almost $700 million.

Smulyan sees three areas of upside for local TV. "It's got to be run more like radio," he explained. "You've got to find local dollars. If you depend on national spot, you will not grow your business. National spot is going to get fragmented over cable channels, the Internet, radio and every other form of advertising." Within a few years, Smulyan said, Emmis' 30-plus TV-station group will derive 80% of its revenues from local sales and just 20% from national spot.

He also said broadcasters have to get cash for retransmission rights to their signals. "Americans are paying billions for TV, and they're paying for what they don't watch [cable], and they're not paying for what they do watch [broadcast stations]. What's wrong with this picture?"

He also said the digital spectrum would pay off-eventually-when the industry figures out what new services can generate income. For now, he and others acknowledged, such services remain elusive.

At NBC, Jay Ireland, president, the NBC Stations, sees a rough patch for station operators ahead and believes it's difficult to say how long it will last. "We're starting to see a little bit of a slowdown now. It's not going to be as robust as it's been."

But he stressed that there is "still a base of business there that we will be able to tap into. We've just got to knuckle down and keep churning out profitability and trying to grow the revenue base." There's no way NBC Stations will match 2000 revenues next year, because of this year's huge political and Olympics windfall. But the group can come close on profitability, he said.

Longer term, the upside for broadcasters will depend largely on the ability to "have as strong a Web presence as we do a broadcast presence in each of one of our markets," said Ireland. "We've got to be the local news, information, entertainment and commerce portal for whatever city we're in."

Broadcasters have to use technology and the Web in ways that streamline their operations, he said. Case in point: using the Web to eliminate the paper trail of advertising sales transactions. That way, he explained, greater focus can be put on "having a value discussion" with clients instead of a "reconciliation discussion."

Stations also have to pinpoint other "leverage points for changing the way we do business," Ireland said. "We can't operate 13 stations all doing the same thing 13 times over. We have to take the power of what we can do as a group and leverage that where possible." Technology can help eliminate duplicative backroom administrative functions. At some point, he said, it may be possible to have one master-control room for the entire group. "We're exploring all those ideas."

Not everybody is feeling the pinch. The CBS Stations group is budgeting strong double-digital sales and profit growth for 2001, according to President John Severino. That's on top of what will be double-digit revenue and profit growth for 2000.

Of course, the CBS stations are riding the wave of some huge ratings gains for the CBS prime time schedule so far this season. And in the first quarter of next year, the network has the Super Bowl, Survivor II and the NCAA basketball tournament.

But Severino acknowledged that, as strong as business is, "it's not as strong as we thought it would be. But we're outperforming everybody else."

And if the economy does take a downward turn, said Severino, CBS sales people will be out in force trying to convince advertisers that "that's the time when they've got to advertise more, not less."

Will it work? The CBS Stations sales staff will die trying. "You've got to push the sales people," he claimed. "If you give them enough push, drive and determination," they will sell.

Forecast 2001/TV industry analysts offer a fairly broad range of projections for ad sales in 2001. The following chart compares percentage growth or loss projections from the Television Bureau of Advertising with estimates from a cross-section of financial analysts.

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