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Cable holds its breath

Can ratings growth overcome uncertainty, shrinking ad budgets? 4/29/2001 08:00:00 PM Eastern

If a rising tide lifts all ships, who gets grounded in low tide? That's the question cable networks and ad buyers are asking as they jockey for position in this year's advertising upfront. Just about everyone accepts that networks will not enjoy the surge that pushed upfront commitments to $12.5 billion, and some analysts expect significant reductions. The question is, which side will feel the pain?

Cable networks go up against broadcasters—and each other. Will they be buoyed by cable's overall ratings growth? And can they press ad agencies into paying a higher cost per thousand viewers?

Or will advertisers seeking mass reach spend their shrunken budgets on sudden bargains at hungry broadcast networks? And how will networks with middling ratings—Court TV, Fox Family, CNN—fare as advertisers trim their budgets?

A lot depends on buyers' and sellers' view of the severity of the economic downturn. Network sales executives generally contend that ad spending will rebound in the second half of the year. If they're right, buyers will want to lock in prices now. If they're not, buyers have nothing to lose by waiting to buy time in the scatter market next fall and winter.

The wild card is the looming writers and/ or actors strike. A shutdown of Hollywood's production operation will quickly crunch broadcast net's fall lineup—and accompanying viewership. But USA Network, for example, already gets better ratings for repeated runs of theatrical release A Clear and Present Danger than for any of its original series.

Only June will tell. "Right now, it's like high-school football," said MTV Networks Chairman Tom Freston in early April. "One side's screaming, 'We're gonna kill you, man.' And the other side's saying, 'No, we're going to kill you!' "

It's not looking pretty. Morgan Stanley media analyst Richard Bilotti believes that upfront spending on both cable and broadcast could drop 15% this year. He expects second-quarter ad spending to be as bad as the sagging first quarter. "This signals trouble for the upfront market across broadcast and cable television," he said. "If upfront results are markedly better than the current scatter market, it would imply that advertisers believe that economic conditions will greatly improve in late 2001 and the first half of 2002. We believe that this is irrational."

He estimates that ESPN's ad revenues dropped 15% during the first quarter, Nickelodeon's fell 10%, as did TNN: The National Network's, despite its huge ratings surge from its acquisition of World Wrestling Federation programming.

That shakiness will carry into the upfront. After growing 14% last year, 2001 TV ad spending will be flat compared with last year, according to the most optimistic forecasts.

The upfront market is no different from the futures markets for corn or wheat. Buyers want to lock in a steady supply of product at a known price, protecting themselves against a shortage of spots in, say, MTV's Jackass at Christmastime. Sellers can bank on ad buyers' commitments and hedge against a sudden slowdown in the economy.

Is a network salesman feeling confident? Hold inventory out of the upfront to sell—hopefully, at a higher price—in the scatter market. Nervous about the holiday rush? Lock in a commitment months in advance. And always posture that demand is strong, regardless of the economic weather. Established networks generally sell anywhere from 50% to 85% of their ad inventory in the upfront market.

Buyers say that the good news this year for cable is that it remains cheaper per eyeball than broadcast and makes it easier for advertisers to target specific demographic groups.

The bad news is that agencies will not be able to use cable as a threat to keep broadcast-network pricing in check. "In years past, we needed them for leverage," said Howard Nass, executive director for broadcasting at TN Media. "This year, we don't need that. The economy is giving us all the leverage over broadcast networks that we need."

Said Chris Geraci, senior vice president of national broadcast for Omnicom Group's BBDO Worldwide: "Cable networks are going to play into the fear of the strike that will probably cause some shift in spending. Broadcasters say they'll have reality stuff to go on in the fall. But some advertisers aren't comfortable with reality."

Freston's boss, Mel Karmazin, is talking the game better than anyone. During a conference call with securities analysts last Tuesday, the Viacom president insisted that, if buyers balk at strong pricing, Viacom's cable and broadcast networks will hold inventory back. In recent years, the MTVN channels have sold about 75% of their annual inventory in the upfront market.

"You're going to read and going to hear a lot of misinformation," Karmazin said. "We're not going to sell that content at prices below what we need to give shareholders. If they want to wait for scatter, we are willing to wait for scatter with them."

But, as much as Karmazin brays that CBS and MTVN are "not going to participate" in a recession, this is not a great ad market for cable networks. Just watch how frequently "house ads" for America Online appear on the online service's newly acquired TNT, TBS Superstation and CNN.

Merrill Lynch & Co. media analyst Jessica Reif Cohen sees a lot of anti-advertising feeling. "Our view is, there's an advertising recession."

She sorts the winners and losers according to their momentum. Networks with recent ratings gains will fare well. That includes Viacom's TNN: The National Network, which sold practically nothing in last year's upfront; FX; and MTV. The likely losers: CNN, the wrestling-free USA and ESPN. "Sports has been incredibly weak," Cohen said. "I don't know what changes that."

The first question is how big will the pie be? Bill McGowan, executive vice president of ad sales for Discovery Networks, contends that overall spending in the upfront market will be flat, at $12.5 billion. But he argues that broadcast networks will feel most of the pain and predicts a "major correction" in broadcast network pricing, with spending falling 5%, from $7.8 billion last year to $7.3 billion this year.

But he also believes the $500 million shortfall will shift to cable nets, whose sales should rise 11%, to $5.2 billion. He maintains that, with basic cable's ratings going up and broadcasters' falling, a recession will break the network's leverage over ad buyers.

The ratings trend continues to favor cable, he says. The Big Four now average a 48% share of prime time viewing, while cable gets 45%. Each side will get 47% by 2003, he believes, and cable will move ahead of broadcast the following year.

"The worst point of the marketplace was fourth quarter 2000," said McGowan. First quarter 2001 "showed more strength."

Not even McGowan's peers buy into his forecast of a 5% gain for cable. "I want to know who his math tutor is," said Joe Uva, president of entertainment sales and marketing for Turner Broadcasting Sales, "It's conceivable that it could be flat."

Uva does not accept the harshest outlook, Bilotti's 15% drop. "It's a market everybody wishes were better, but we're seeing a glimmer of hope," Uva said. "The second quarter has picked up a little vs. the second quarter last year." He added that he's not seeing as many advertisers opting to renege on commitments made in last year's upfront. "We expected it to be worse than it was."

Harvey Ganot, president of MTV Network advertising sales, agrees. "I think cable is going to be healthier than other media. We're niche-oriented. The audience increases for cable in general have been well documented. I'm pleased with the cards I hold."

Advertisers' Growth: As a group, cable networks big customers are in worse financial shape than the biggest spenders on broadcast network advertising, according to Morgan Stanley
1999 2000 2001E 2002E
Top 50 broadcast network advertisers
Sales 7.6% 8.1% 4.1% 6.0%
Operating income 10.9 6.7 4.6 10.0
Net income 14.2 4.7 6.4 12.0
Top 50 cable network advertisers
Sales 6.6% 6.7% 2.8% 4.7%
Operating income 12.1 5.7 3.2 9.8
Net income 7.3 2.8 2.0 11.4

E = estimated

Source: Morgan Stanley

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