Director’s cut has new meaning for media groups

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In an industry known for empire building and large egos, it is never easy to scale back.

This week’s decision by Les Moonves and Barry Meyer – the heads of CBS and the Warner Brothers studios – to shut down their respective television networks and jointly launch a bigger, better version will have little impact on the finances of the media operations they run.

Yet the creation of The CW, which will kick off in September as the fifth US broadcast network, is symbolic of the changes taking place in the television and movie businesses.

With growth in advertising revenues, box-office receipts and DVD sales slowing after many boom years, and media shares continuing to tread water amid concerns about the shape of business models in the digital age, similar scrutiny and hard-headed decisions can be expected across the sector.

“There is an increasing realisation by management at media conglomerates that they are running maturing businesses,” says Douglas Shapiro, analyst at Bank of America. “A natural extension is a greater focus on cutting costs.”

Time Warner, the world’s biggest media group that owns Warner Brothers, is at the forefront of the cost-cutting efforts. One reason is the pressure being put on Dick Parsons, the group’s chief executive, by Carl Icahn, the activist shareholder who controls a tiny fraction of the media group’s shares but is preparing to wage an unprecedented proxy fight for control of the group.

Although Mr Icahn’s chances of success are regarded as slim by many observers – and the Time Warner share price has not risen despite Mr Icahn’s efforts – his targeting of Mr Parsons and Time Warner is adding urgency to efforts that were already under way.

Next week Mr Icahn and Lazard, the investment bank working with him, are expected to unveil a detailed analysis of Time Warner, and the potential for cost cuts is likely to be a central theme. Already, Mr Icahn has highlighted the $250m in cost cuts made at Warner Music after it was sold by Mr Parsons to a private equity consortium.

“For management, having a proxy fight looming is a bit like having a gun to your head,” says an executive at Time Warner.

Time Warner has already cut jobs at its studios and at the Time Inc magazine business. More job cuts at the publishing group are widely anticipated, and other sources of savings will include those from the closure this year of the WB network, which analysts estimate was losing $25m to $50m per year. Total cost cuts could add up to several hundreds of millions of dollars.

The splitting of Viacom into CBS and a faster-growing “new” Viacom is also supposed to have triggered cost reductions, although analysts are waiting to find out more information.

So far, cost-cutting has not been highlighted by News Corp, the media group run by Rupert Murdoch, or at Walt Disney. But the move towards lower cost structures is the natural next step for an industry making the transition from one used to rapid growth.

A good indicator of this shift is the cash that media companies have started to pay out to shareholders, in the form of share buy-backs and dividends. Businesses with strong growth prospects rarely return cash because management can, in theory, reinvest it to produce attractive returns. Once cash is handed back, it is an admission that growth
prospects are more limited.

Bank of America estimates that the payout ratios for the sector will push past 100 per cent this year, up from 90 per cent in the first three quarters of 2005 and 60 per cent in the same period of 2004. “The shift in capital allocation started in 2005 among traditional media should be even more evident in 2006,” says Mr Shapiro.

A further consequence of the new-found enthusiasm for housekeeping is likely to be an increase in the sale of assets not regarded as core businesses.

Mergers and acquisitions bankers say they are talking to many media clients – ranging from television to radio, to print and other media – about such disposals and that in 2006 there was likely to be more such activity. “It is getting to a point where companies have to do anything they can to try and lift share prices and persuade investors that they have a sound strategy,” says one banker.

Disney’s $7.4bn acquisition of Pixar, the animinated film studio, reflects this trend. The purchase is widely regarded as important for Disney’s efforts to boost the animation business which is at the heart of the company. At the same time, the Disney board is considering the sale of the group’s radio business, worth up to $3bn.

“Over the past few years we have seen all media companies looking for ways to maximise their profits, whether by consolidating or spinning off assets,” says Rik Toulon, a partner at Katten Muchin Rosenman.

With media shares still failing to lift off, the unglamourous task of number crunching will start to become more important in the glitzy media world.

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