Fitch: Reduced Costs & Potential Advertisement Improvement Could Stabilize Rtgs; Economy Remains Wildcard.

Business Editors

NEW YORK--(BUSINESS WIRE)--Dec. 12, 2001

While the rating agency Fitch believes that the softness in advertising will continue into 2002, there are some factors that suggest a more favorable outlook. The Winter Olympics in February will provide an early-year increment to advertising in 2002, as will U.S. congressional elections in the fall. The World Cup Finals in June will have minimal effects on the domestic media companies, but will benefit the global advertising agencies, which have a sizable representation of international business. It is also important to note that brand building and brand maintenance must be maintained even in a weak economy, least a company yield market share to its competitor. Further, new technologies and new product introductions have to be supported, regardless, and the levels of such introductions can represent incremental shifts in advertising, both upward and downward, that are independent of the economy. The performance of the U.S. economy remains the wildcard in the outlook and a prolonged recessionary environment will hinder a recovery in advertising. For the media sector, newspaper advertising remains the most sensitive to the direct performance of the economy, with the major components in retail and classified categories.

Apart from the effect of revenues on EBITDA, expense and capital savings programs implemented in 2001 to adapt to the weak environment should have a significant impact on results in 2002. Restructuring programs became commonplace in the media and advertising industries in 2001 as many companies focused on balance sheet improvement. This should yield material reductions in operating costs for many companies. The newspaper companies should also benefit from year-over-year declines in newsprint prices. Share repurchase programs have also been trimmed back or, in some cases, eliminated and capital expenditures have been reduced, as many of the companies in the industry focus on stemming any further deterioration in credit quality. Indicators that Fitch will be watching closely are economic trends, particularly employment and consumer spending, the trends in newsprint prices for the newspaper companies and the success in the upfront selling season that begins in June for the broadcasters. Other factors that may affect the credit outlook next year include the impact of new FCC ownership policies for cable operators, the potential lifting of television station ownership caps, and possible changes in newspaper and television station cross-ownership restrictions, which may affect the potential for consolidation in the cable, broadcasting and newspaper sectors. However, at this early stage it would appear that some stabilizing of credit profiles could occur for many companies in the industry. Conversely, for companies currently on negative outlook or negative watch, a prolonged recession and an inability to achieve some balance sheet improvement could lead to additional rating actions.

2001: A look back ? A stage being set

The year 2001 can be generally characterized as a period of credit erosion for the media sector, as evidenced by numerous negative rating actions during the year. The main cause of this erosion has been the significantly reduced advertising spending, resulting in a negative impact on corporate financial measures. The "bursting" of the dot-com bubble, the decline in the telecom sector, soft technology demand, the absence of political and Olympic-year advertising, and the overall slowing of the domestic economy were the main drivers of the advertising slow-down. Compounding these factors were the events of September 11, which further reduced advertising spending as companies re-evaluated the appropriateness of certain program themes, even as the news organizations of many media companies simultaneously incurred additional costs to broaden their print and broadcast coverage. These factors produced sizable reductions in EBITDA and free cash flow for many media companies. However, media companies with more stable revenue and cash flow streams, such as AOL Time Warner and cable companies, were only modestly affected by the advertising contraction.

The effect on credit quality of the earnings deterioration on the media companies was compounded in many cases by aggressive share repurchase programs early in the year and selectively by debt financed acquisitions. Riding the crest of the advertising surge in 2000, many companies had large and active share repurchase programs going into 2001, even as the weakening fundamentals for advertising were emerging in late 2000. This was particularly true for those companies with large newspaper operations: Knight-Ridder, Tribune, Dow Jones, Belo Corporation. Newspaper operations typically generate high levels of free cash flow after capital expenditures and dividends, and with modest growth prospects, share repurchases are viewed by these companies as a preferred use of cash. With debt levels elevated by share repurchases, declining cash flow produced weakened credit fundamentals for all of these companies and each was downgraded or placed on negative outlook during the year. A critical factor to the stability of these ratings in 2002 will be the amount of cost savings resulting from the significant cost reduction programs implemented in 2001.

For other companies, large debt or cash financed acquisitions, exacerbated by the fall-off in operating cash flow, were the starting point for a weakening credit profile. Cox Enterprises acquisition of ADT Automotive for $750 million toward the end of 2000 and Disney's recently completed acquisition of Fox Family Worldwide for $5.2 billion produced ratings downgrades and subsequent negative outlooks or rating watches as business fundamentals declined. For Disney, the effects of September 11 were particularly onerous. While the effect of lost advertising and higher costs on the ABC Network was short-lived, the subsequent fall-off in vacation travel has had a severe effect on Disney's theme parks and resorts business, a business that has become the company's largest source of corporate cash flow.

Neither could advertising agencies elude the effect of the general pull-back in advertising, although their ability to weather the down-turn differed significantly. In the case of Omnicom, client wins and strong operating management have more than offset the macro decline in advertising markets allowing the company to maintain a stable credit profile during the year. WPP's acquisition of Young & Rubicam strengthened the company's credit profile and lead to an upgrade. For the Interpublic Group of Companies, large acquisitions, weaker advertising markets and selective client losses produced weaker credit profile and precipitated a downward rating action and outlook change to negative.

Compared to more advertising-reliant peers, AOL Time Warner and Viacom benefited from more predictable streams of cashflows such as subscription based services like AOL and Showtime and sizable affiliate fees associated with cable networks. Broad diversification within the media and entertainment sector, unique brand franchises, leading market positions in core businesses as well as cross-medium and promotional platforms have enabled the large media companies to better weather the current environment and enabled them to maintain stable ratings.

Similarly, the large, recurring subscription-based revenue streams of the cable operators provided a stable financial base for these companies in spite of more difficult economic times. New service growth remained strong, which contributed along with annual rate increases to solid operating cash flow growth. Acquisition activity was reduced compared to 2000 as companies integrated transactions and focused on advancing toward the completion of modernization programs and new service expansion. Basic subscriber growth rates fell materially in 2001 as a result of aggressive satellite competition and general increased penetration levels. Nevertheless, average revenue per subscriber still continued on a solid upward trend and from an operational perspective, cable companies should continue to produce solid growth levels in 2002 as penetration levels for new services increase, aided by a wide deployment of video on demand. Acquisition activity could increase in 2002 with new FCC ownership rules, increasing the event risk as Fitch believes the new rules are likely to be less restrictive and could lead to further industry consolidation and asset rationalization. The recent acquisition interest involving AT&T Broadband is evidence of this. The size and complexity of any deal for AT&T Broadband coupled with the expected transfer of a large amount of debt or issuance of debt if cash is used as part of the financing will impact the credit quality of any potential acquirer.