Fitch US Media Industry Outlook: Credit Stability in a Changing Landscape.

NEW YORK -- Fitch Ratings expects that favorable economic conditions, moderate growth in advertising spending, the improved financial condition of many media companies, and the allocation of the media companies free cash flow to share repurchase or acquisitions will be the primary drivers of the operating performance and credit quality for the media companies in 2005.

Following the weak advertising environment from 2001-2003, media companies benefited from both a solid pick-up in advertising in 2004, driven by the continuation of the economic expansion in the U.S., and from special factors, including political advertising and the Olympics. The expectation of continued moderate economic growth in the U.S., with current GDP projections in the low 3% range for 2005 (as compared with over 4% in 2004), should provide a stable operating environment for most major media companies.

The credit profile of the media industry has improved over the past 18 months as compared with the 2001-2003 period, when the trough in advertising spending combined, in many cases, with overly aggressive acquisitions or share repurchases produced numerous ratings downgrades. Many companies in the industry responded by curtailing their share repurchases, slowing acquisition activity, and utilizing free cash flow to strengthen their balance sheets. As the economic and advertising environment improved, this change in financial priorities yielded gradually improving credit metrics for the major media companies. In 2004, Fitch upgraded three companies in its rating portfolio while revising the Outlooks on three companies to Positive. Although two companies, Cox Enterprises and Dow Jones, were placed on Negative Rating Watch, these actions resulted from announced acquisitions that will have a material effect on their respective credit profiles rather than from any deterioration in their operating performance.

Given the general improvement in their balance sheets over the past 12-18 months, the better operating environment and the limited availability of attractive acquisitions, many media companies are now redirecting their free cash flow to increased dividends and share repurchases, with major stock repurchase programs being initiated or expanded at Tribune, Clear Channel, Viacom, and Omnicom. Fitch's view of credit stability in the media industry in 2005, in part, reflects an expectation that these share repurchase programs will be financed predominantly with free cash flow and from modest increases in debt so as to allow these companies to maintain target credit metrics within current rating categories. Nevertheless, trends in share repurchases and acquisitions could affect ratings if the major media companies do not maintain appropriate leverage targets, recognizing the cyclical character of advertising base of much of the industry.

In the current modestly expanding economic environment, given the typically high margin character of advertising-based media businesses, most media companies should see stable to improving levels of EBITDA in 2005. Modest growth in advertising sales can have a significant effect on EBITDA as a marginal dollar of advertising typically generates $0.75-$0.80 in additional EBITDA for print media and $0.90-$0.95 in additional EBITDA for broadcast media. Also, the typically modest level of capital reinvestment for the traditional media businesses, including newspapers, television, radio, and magazines, allows their parent companies to generate significant excess free cash flow.

Advertising aggregates, which typically follow the general trends in the economy, should be slowed somewhat in 2005 by the absence of the Olympics and political advertising. This dynamic primarily affects the broadcast industries, with the former most prominently affecting the major broadcast networks and the latter primarily affecting ad rates in local media, particularly local television. The remaining advertising categories should move in concert with general economic trends.

The upfront advertising market for the television broadcasters was down about 2% for the 2004-2005 season. The decline, in part, reflected a decision by advertisers to reduce their commitments to the major network's prime-time schedules, given the long-term decline in audience ratings. This reluctance appears to have been borne out by early season ratings, which again showed an aggregate decline for the broadcast networks. The cable networks saw about a 13% increase in total upfront sales. Of significance is that the ratings of the cable networks exceeded those of the broadcast networks for the first time in the 2003-2004 season. (See Fitch's report 'Will 2004-2005 Be the High Water Mark for the Network Upfront Market?' dated Sept. 7, 2004, available on the Fitch Ratings web site at 'www.fitchratings.com'.)

Revenue growth in broadcast radio has been modest in 2004, reflecting the maturing of the industry after the long consolidation phase, following deregulation from the 1996 Telecommunications Act and from developing competition from subscription-based satellite services and personal entertainment systems like iPods. At best, broadcast radio ad growth is expected to track GDP over the next several years, even as pockets of growth, most prominently Spanish-language radio, continue to stand out in 2005.

Advertising growth for newspapers is likely to be in the low-single-digit range. Assuming a healthy job market, classified recruitment advertising should continue to grow, following its recovery in 2004 from the multiyear trough that began in 2001. Retail advertising, classified automotive, and classified real estate should all reflect more general themes in the economy.

Regulatory issues, which have historically had a shaping influence on the media landscape, are not likely to be significant in 2005 and should have minimal if any impact on credit quality. The FCC and Congress have now settled on a 39.5% cap on the national coverage of television station groups (up from the previous 35% limit but modified downward from the FCC's increase in 2003 to a 45% cap). The new cap allows the existing groups of Viacom and Fox television stations to remain intact, both of which exceeded the old 35% cap. However, cross-ownership rules (ownership of both a newspaper and television station in the same market) have grown murkier following a midyear court decision that overturned FCC deregulation. These rules most prominently affect the Tribune Company, which presently owns television stations and newspapers in five markets, with station license renewals beginning in 2006.

Acquisition activity is not likely to be a general theme for the media industry in 2005, although, as in 2004, with the announced acquisition of Marketwatch by Dow Jones and the privatization of Cox Communications by Cox Enterprises, acquisitions may occur in selected circumstances, regardless of their negative credit implications. Time Warner's management has expressed interest in acquiring Adelphia's cable assets to enhance its existing cable footprint and/or to swap subscribers with Comcast in exchange for Comcast's remaining ownership in Time Warner Cable. While Fitch does not anticipate major mergers between distribution and content providers, as with Comcast's unsuccessful attempt to acquire Disney in 2004, additional vertical integration within the industry remains possible.

Among the long-term trends shaping the media landscape is the ongoing shift away from traditional media, including newspapers, television, broadcast radio, and magazines, which is reflected in the long-term decline in their audience base. In the newspaper industry, declining circulation has led major newspaper companies to develop specialized web services to protect some of the key advertising categories while expanding their online delivery of news services. The audience ratings declines of the major television networks continued unabated in 2004, reflecting the ongoing fragmentation of the audience base. This fragmentation has resulted first, from the growth of cable networks and, second, from growth in non-advertising-based entertainment alternatives, including videotaped entertainment, DVDs, pay-per-view, and video gaming. In broadcast radio, growth has slowed and the full effect of the emergence of subscription-based satellite radio services and other audio entertainment alternatives has yet to be felt. Advertising on the internet, which presently only represents about 4%-5% of national advertising, continues to grow at high double-digit rates, gradually appropriating advertising dollars normally spent on traditional media.

As the audience base of traditional media continues to erode, pricing pressures for their advertising services will intensify, limiting revenue growth and pressuring margins. Nevertheless, the effect of the shift away from traditional media will be felt most prominently in the long term.

Full special report 'Media Outlook 2005: Credit Stability in a Changing Landscape.' will be published in January 2005.