INSIGHTanalysis: What Next For One ITV?

With only behavioural remedies imposed by Hewitt, the two ITV heavyweights have emerged from the year-long Competition Commission investigation with one of the better outcomes proposed by the authorities earlier in the year, as far as they are concerned.

Principally, they get to hold on to both of their sales house operations. This is a huge plus for the companies, which had claimed that a double divestment of the sales divisions would have rendered the merger ineffective. Had the DTI required this double divestment, it is possible that the £4 billion merger deal may yet have been called off.

The key behavioural remedy will see Carlton and Granada tied in to certain share and discount deals with advertisers for the period of the remedy. The mechanism – termed contract rights renewal (CRR) – is designed to prevent the single ITV group, controlling 52% of all TV advertising revenues, from abusing its dominant position by hiking airtime prices or threatening to remove advertisers’ discounts.

Industry bodies like the IPA and ISBA, which represent advertisers’ and agencies’ interests, have been lobbying for an enforced divestment of the two airtime sales operations. They claim that ITV will be in an unacceptably dominant position in negotiations with advertisers and their agencies post-merger (see Advertisers Strengthen Opposition To ITV Merger).

According to media buyers, ITV has a long history of threatening to reduce price discounts if the agencies decide to reduce the share of their spend which is given to ITV. Analysts say that this threat is credible and powerful.

Whilst the detail is yet to be finalised, the DTI’s remedies should prevent this from occuring (at least for a period of time). The remedies will include a right by media buyers to reduce their spend on ITV in line with any decline in the station’s audiences and their discount would not be affected. Nor will agencies be forced to increase their share to ITV at any period during the remedy’s term.

“From now until the remedy is no longer necessary, the share of revenue committed by advertisers and media buyers on television advertising to Carlton-Granada need not increase above 2003 levels,” says the ITC. ‘As is no longer necessary’ in this case is currently assumed to be at least three years.

What does it mean for Carlton and Granada? For Carlton and Granada, today’s announcement is good news, despite these remedies. The companies estimate that cost savings from the merger will be around £55 million; Merrill Lynch predicts around £70 million.

In the short-term there is likely to be little negative effect on revenues, say analysts. In the longer-term, a coupling of media buyers’ ITV spend with the station’s audience figures could drive down ITV’s airtime premium a little.

Commenting on the deal, Sarah Simon, media analyst at Morgan Stanley said: “The conditions of the merger are significantly better than we and many others expected. The issue going forward is how draconian the contract rights renewal remedy will be. Currently the proposals will cap their share of advertising for the next three years, which gives ITV a limited power ratio. There is also the possibility that ITV’s audience share would drop, incurring penalties.”

Currently ITV trades on a premium of around 20%. In August this year, for example, it took a 51.2% of all advertising, but only delivered 43.2% of all UK commercial impacts, hence the premium (as shown in the graph below). The adjustment of media buyer spend with falling audiences could erode this premium.

If ITV’s share of advertising actually mirrored its share of audience, then it would have taken approximately £1.42 billion in 2002, rather than the £1.69 billion it actually received. In this example, a direct coupling of media spend to ITV’s audiences would have resulted in £260 million less revenue during 2002, according to Merrill Lynch.

Analysts say that ITV’s threat of reducing advertiser discounts has historically held the station’s share of spend steady at times when it may otherwise have begun to dip. The new CRR system will put an end to this kind of ‘bargaining’ and the regulators are hoping that this will be provide ITV with an additional incentive to invest in attractive programming.

However, keeping up commercial impacts is not necessarily synonymous with high quality, public service broadcasting. In fact, one possible outcome of the new demand on ITV to maintain commercial share is that it invests in a greater number of low-budget, mass audience programming. This remains to be seen.

ITV’s recent boost to programming budgets appears to have slowed the drift of audiences to multichannel stations, with adult impacts showing a turnaround this year (see INSIGHTanalysis: ITV Arrests Audience Decline, But For How Long?). Nevertheless, the long-term trend for ITV is one of audience decline, as shown below.

In multichannel TV homes, which now account for half of all UK TV homes (see INSIGHTanalysis: Multichannel TV Reaches Half Of UK Homes), ITV took a share of viewing of just 19.7% last year, dipping below BBC1 for the first time.

Given that multichannel penetration is still steadily increasing and is forecast by Merrill Lynch to pass three quarters of all TV homes by 2008, it seems unlikely that ITV’s audience share and commercial impacts will do anything but decline further.

Having said this, in a multichannel world where commercial impacts are spread thinly across many channels, the importance of key peak time ratings increases. For this reason, ITV is likely to hold on to its premium and bargaining power with advertisers for some time yet, in spite of some audience erosion.

What happens next? Carlton and Granada now have to work through the details of the implementation of the remedies with the ITC, Ofcom and the OFT. They have until 7 November to do this.

As well as the CRR structure, there are also provisions to protect the other ITV companies (Ulster TV, Scottish, Grampian and the Channel Islands broadcaster, Channel) in the structure of the ITV Network.

Patricia Hewitt is keen that the structure for the remedies is set in place as soon as possible, ideally in time for the winter round of advertising negotiations which run through November and December. Once an agreement has been made between ITV, the regulators and Hewitt, the merger of Carlton and Granada can be formally completed.

The two companies are not expecting the deal to be tied up until January next year. They cannot legally complete the merger until Ofcom formally comes into existence on 29 December. The ITC and Ofcom also intend to publish their conclusions by this date.

Implications for other broadcasters Currently the ITC’s airtime sales rules prevent any major broadcasters from combining their sales operations to sell airtime jointly. Clearly, if the ITV merger is completed under the format outlined by Hewitt this morning, Carlton and Granada will have contravened this rule by retaining both of their sales houses within one ITV business. The ITC says that it will therefore need to review its airtime sale rules.

The implications of this are that it may well be possible for other broadcasting groups to combine their sales divisions into larger units. “It may follow that, in light of the merger, other broadcasters similarly could be allowed to combine their airtime sales activities,” says the ITC. Channel 4 is already looking at the possibility of merging its sales house with that of Five and/or BSkyB.

A foreign predator? In some ways, the consolidation of ITV into a unified business makes it more attractive to an overseas (probably US) investor. Previously it was considered too dysfunctional a structure for an outside investor to become embroiled with. However, with synergies and cost savings in place it will become a more appetising prospect.

There are a number of deterrents to foreign investors though. Firstly, Carlton and Granada’s share prices are running at a fair premium to their European broadcaster peer group and stock has moved even higher today (Carlton up 12%, Granada up 9%). Whilst the broker consensus is that there is little room for further rises in market valuation, the groups are not exactly cheap prey at present.

“Current valuations for both Carlton and Granada are both too high to make a foreign take-over viable. As long as the valuations remain at this level the risk of a take-over is minimal. In the long term if valuations came down a take-over would be more likely, but still quite slim,” says Morgan Stanley’s Sarah Simon.

In addition, the remedies imposed by the DTI put a definitive cap on ITV’s commercial exploits. It cannot demand that advertisers increase their share to ITV, nor can it threaten to reduce their discounts. If audiences continue to fall, advertisers should be able to reduce their spend without penalty from ITV.

The company also has obligations to the smaller franchises, as well as the over-arching requirements of its public service remit. These kind of State-imposed obligations are not thought to be particularly attractive to outside investors.

So, for the time being, ITV looks set to consolidate itself as the UK’s largest commercial broadcaster, having escaped a structural carve-up and remaining pretty resistant to takeover advances.