Fitch: U.S. Media and Entertainment Outlook Negative in 2009

CHICAGO--(BUSINESS WIRE)--On a macro basis, Fitch Ratings believes the world economy faces a severe global recession in 2009. Fitch forecasts that the contraction in output among the major advanced economies in aggregate will represent the steepest decline since the Second World War at about -1%. Fitch expects real GDP in the U.S. to decline approximately 1.2%, while inflation is forecast to be 2.7%.

Against this backdrop, the Fitch media team is more cautious regarding the advertising environment than most major advertising forecasts, none of which currently predict advertising to be nearly as weak as 2001, the worst ad recession (on both a nominal and real basis) since 1970. According to Universal McCann and the Bureau of Labor Statistics, nominal advertising did not decline during the mid-1970s nor the early 1980s recessions (due to high inflation), declined a cumulative 2% in the early 1990s and approximately 7% in 2001. Real advertising declined cumulatively in the high 8% range in 1974 and 1975, 4% in 1980, a cumulative 7% in the early 1990s and 9% in 2001.

To put 2001's 7% nominal advertising decline in context, Fitch recognizes that it followed a very strong advertising run with increases in 1998 (up 10%), 1999 (up 8%) and 2000 (up 11%) due to the flood of venture capital into dot-com start-ups - much of which passed directly through to the ad market. By contrast, advertising growth the past few years has been more restrained with 2005 (up 3%), 2006 (up 4%), 2007 (down 1%) and 2008 (forecasted between down 1% and up 2%), so there is a much lower peak from which to fall. Regardless, Fitch believes that economic weakness could extend well into 2010 such that the cumulative affect of this downturn could approach 2001 levels (down 6%-9% in real terms).

Three key beliefs underlie Fitch's cautious view.

--Combined Effect of Local and National Weakness:

First, the 2001 ad downturn was concentrated in national advertising, while the 2008-2010 downturn will include both local and national components. In 2001, low interest rates and the availability of credit fueled consumer home and auto purchases (and advertising) that helped insulate major ad spending categories and local economies from severe economic weakness. Political and Olympic spending masked the local market weakness to some extent in 2008, but Fitch expects the absence of these revenue sources in 2009 will expose the depth of this weakness. In Fitch's view, there are more catalysts for deterioration rather than improvement for local advertising going into 2009.

Fitch expects this weakness in local markets will be compounded by national advertising pressures due to the impact of the credit market events that hit while many large national advertisers were planning their 2009 ad spending budgets. With advertising being one of the most easily scalable fixed costs, some major advertisers could plan to pull back on national campaigns considerably until there is more visibility in the market. Fitch is also concerned that they could pull back even more in 2009 than in the 2001 downturn because the credit crisis has raised the stakes and forced many companies to emphasize capital preservation and liquidity, not just earnings growth.

--Broad Weakness across Major Advertising Categories:

Fitch expects pressure across a wider spectrum of advertising categories in 2009 than in the past downturn. Fitch expects that five of the top 10 advertising categories or over 40% of the ad mix (according to Advertising Age) will be under meaningful pressure next year: No.1 Retail (12% of total), No.2 Automotive (12%), No.5 Financial Services (6%), No.6 General Services (6%) and No.9 Airlines, Hotels and Car Rentals (4%). In particular, the automotive category (which can represent over 20% of a broadcast affiliate's revenue) will present meaningful challenges. Fitch maintains that the auto industry is enduring structural changes that will permanently reduce local and national auto advertising and that the supply of available advertising units will need to contract as a result.

--Drastic Increase in Advertising Inventory:

Finally, advertising inventory has proliferated (from online and emerging mediums as well as traditional ones) since previous downturns. Owners of inventory (predominantly media companies) are likely to compete more heavily on price in this downturn to fill the vast supply of ad space available. Advertisers have many more options in the current environment than at any other time for maintaining a presence with consumers while trimming their budgets and scaling back high Cost Per Thousand (CPM) advertising campaigns. Even healthy advertisers are likely to use this increased bargaining power to command better price terms and concessions from media companies.

KEY CREDIT THEMES AND TRENDS IN 2009

Advertising vs. Non-Advertising

While advertising-based media is expected to be more negatively impacted, Fitch anticipates this downturn will also affect non-advertising based mediums as well. In particular, business-focused, non-advertising-based mediums (commercial printing, financial information, tradeshows) are more likely to be affected than consumer mediums. Excluding theme parks, consumer entertainment expenditures (movies, music, video games, books, etc.) could be modestly softer, but they typically exhibit hit-driven volatility that is generally uncorrelated with economic weakness. While theme parks were more resilient in 2008 than was expected going into the year, Fitch anticipates performance could deteriorate in 2009, especially for destination parks that represent a larger proportion of consumers' entertainment budgets.

Investment Grade: Despite Downturn, Conglomerates' Credit Profiles Still Largely at Discretion of Management Teams

Investment-grade media conglomerates benefit from geographic and product diversification which moderate the volatility of consolidated cash flow and afford them the flexibility to adapt as end-markets evolve. Because of the favorable cash flow dynamics of their businesses and strong liquidity these companies should have the flexibility to address the secular challenges facing their businesses, make smaller, financially prudent acquisitions, and endure a cyclical downturn in several units concurrently while keeping their credit profiles intact. Also, some of the media properties owned by conglomerates could benefit from a flight to quality among advertisers who could focus on proven outlets rather than experimental ones during the downturn.

However, while positioned to endure the downturn, this environment will heighten execution risk for all media companies. CBS, for example, faces several risks going into 2009: over 70% of its revenue base is exposed to the advertising downturn, its radio and TV businesses face continued secular pressures, over $2 billion in debt will need to be repaid or refinanced in 2010 and 2011, and there is heightened uncertainty regarding financial strategies its controlling shareholder may employ to address his various investments and obligations. As stated previously by Fitch, there are mitigants that can offset these risks, but emergence of new material risks that are outside of management's control, or the failure to act on elements over which management has significant control could pressure ratings. More broadly, long-term financial policies and commitments to bondholder protection are tested during economic downturns, and failure to execute in ways Fitch would expect of an investment grade media company could have negative implications for ratings and outlooks across the sector.

High Yield: Refinancing and Liquidity Focus

In contrast, non-investment-grade media companies generally have capital structures and liquidity profiles that leave them with very little margin of safety to withstand a severe economic downturn. Fitch will maintain its focus on refinancing risk, liquidity and potential covenant violations. Fitch will also continue to reflect the contraction in distressed EBITDA multiples in determining the enterprise value in recovery analysis. Also, given the depressed debt prices and limited refinancing options, distressed debt exchange (DDE) activity is likely to intensify. These transactions will be evaluated on a case by case basis, but in instances where a DDE is determined to have occurred, the Fitch rating will reflect the technical default. Given the high volume of debt that flowed into the high yield media space in the past several years, Fitch expects the media sector is likely to exceed the overall corporate default rate over the next few years.

Event Risk

Event risk has been heightened in media company ratings for several years, although the most concerning sources of this risk category have varied depending on the environment. Historically, event risk focused around low stock prices, corporate governance issues associated with controlling shareholders, and overall shareholder-friendly leveraging events. Given the tight credit markets, event risk in 2009 is expected to be less about incremental debt and more about deployment of capital decisions: continued share repurchases, dividends, potential increases in pension contributions, and acquisition risk as multiples are at historical lows. Given maturity schedules and Fitch's expectations for internally generated free cash flow, the majority of investment grade companies are not expected to have issues with future debt maturities. However, as this lead-time shrinks, Fitch believes it would be prudent for companies to build-up cash and lessen any reliance they may have on external funding resources until the operating and financing environments turn around. Fitch is concerned that media company management teams that are more optimistic about an easing of pressure in the second half of 2009 and a full rebound in 2010 may not take deep enough action on the cost or capital expenditures side to offset significant margin and free cash flow erosion and deterioration in credit metrics.

Additional event risk in 2009 could come in the form of potentially enhanced regulatory scrutiny as the composition of the FCC changes and the potential for a Screen Actors Guild (SAG) strike grows. As Fitch reported previously, a potential protracted SAG strike could be more detrimental to credit profiles of media companies in 2009 than it would be under normal circumstances, however, several mitigants exist for most companies to offset a short term strike. (See the Fitch special comment dated Oct. 2, 2008 titled 'Fitch: SAG Strike Would Have No Immediate Impact on US Media & Entertainment Sector'.)

SUB-SECTOR OUTLOOKS (listed in order of concern)

Advertising Supported:

Newspapers (Negative Outlook)

Much of the business risk for the media sector is likely to continue to be concentrated within the newspaper sub-sector. Fitch expects newspaper industry revenue growth will be negative for the foreseeable future as both ad pricing and linage will be under pressure within each of the four main components of newspaper companies' revenue streams: circulation and local, classified and national advertising. Newsprint costs could rise, and it could be difficult to offset revenue declines with cost cuts. Fitch believes more newspapers and newspaper groups will default, be shut down and be liquidated in 2009 and several cities could go without a daily print newspaper by 2010.

Yellowpages (Negative Outlook)

Incumbent publishers will likely continue to see erosion in the advertiser base and may have difficulty offsetting volume declines with price increases, particularly in local markets that are experiencing significant housing weakness. Even with the shakeout of independent players that Fitch expects, few markets will be able to support more than two directories and most markets will eventually only be able to support one book. Another year of accelerated declines in yellowpages advertising could significantly pressure the intermediate-term solvency of the two pure-play incumbent directories companies. With revenue down mid-to-high single digits and continued pressure on stock prices, the event risk environment is likely to remain heightened (covenant breaches, consolidation, etc.).

Terrestrial Radio (Negative Outlook)

Compared to newspapers, radio margins are as much as 2 times (x) higher, they have no unionized workforces, and convert a higher percentage of EBITDA to free cash flow giving them more cushion to endure the secular challenges.

Listenership is likely to continue to fall, available inventory should remain relatively stable, and pricing could be up on some advertisers but not enough to compensate for declines in unit sales. Internet streaming provides additional day parts to sell but should not make a material difference in the financial profile of the broadcasters. The continued roll-out of factory-installed high definition (HD) radio into automobiles could provide upside to listenership but the benefits could be offset by the increased inventory, which could pressure pricing unless the technology is able to attract a national advertiser base.

Magazines (Negative Outlook)

Consumer and business-to-business magazines are hyper-cyclical mediums, declining around or more than 10% in the last downturn. Year-to-date 2008 performance reveals weakness across many categories and titles. Fitch expects the larger players to rationalize available print advertising inventory through consolidation and closing down titles. Several categories that used to have multiple titles will likely have advertising bases that can support only one major title. With limited catalysts for growth in the core print product, magazine publishers have become more proactive online. However, until further evidence of successful execution and monetization is available, Fitch remains skeptical about the ability of magazines to make the digital transition profitably.

Broadcasting Affiliates (Negative Outlook)

The absence of political spending and further pressure in the auto category should pressure ad volume and pricing in 2009. Revenues could be down in the mid-teens and EBITDA could be down more than 2x as much as any decline in revenue. Fitch believes the lower-rated stations (typically CW and My Network-affiliated stations) that are unable to sufficiently aggregate the local market audiences will bear a disproportionate share of the pressure but that even No.1 and No.2 ranked stations are not immune.

Retransmission fees and continued efforts by affiliates to steal share from newspapers and radio in their local markets should provide some opportunity to offset revenue pressure; however, any successful efforts by the networks to claim reverse compensation would be a material hit to the broadcasters, especially those with the highest leverage. As networks continue to embrace video-on-demand (VOD) opportunities on their own in 2009, Fitch expects increased usage of time-shifting technologies to continue to put incremental pressure on promotions and lead-ins to the late night news and potentially on syndicated content.

Broadcast Networks (Negative Outlook)

2009 is likely to be a weak year for the networks. Viewership is expected to continue to slowly erode and, in addition, the absence of political and Olympic ad spending that tightened available inventory in 2008 could hurt pricing. While there is limited evidence to this point, Fitch believes TV networks could also face cancellations or deferrals of ad dollars committed in upfront negotiations. Fitch recognizes that scatter volume could partially offset these pressures, as prime-time TV advertising scatter inventory was scarce in 2008 because networks were forced to offer make-goods for viewership declines that resulted from the higher prevalence of re-runs during the Writers Guild of America strike. While weaker scatter pricing more appropriately reflects the supply/demand fundamentals, even if scatter prices are down, absolute network dollars could be supported by the fact the networks will be collecting revenue for ad inventory that was given away in 2008.

Outdoor (Stable Outlook)

Audience and available inventory should be relatively flat, while occupancy rates should decrease and pricing will be under some pressure. Regulation has kept traditional static billboard inventory in check, while Fitch believes the potential negative effects of increased inventory from digital roll-outs should be tempered by increasing appeal to national advertisers, as well as decreases in price per unit. Cost structures should also benefit from digital billboards, as displays can be centrally managed without physical deployment of work crews. Relatively flat audiences on static inventory, combined with low CPMs and better networked national sales pitches, position outdoor advertising companies to endure the downturn and rebound with the economy.

Cable Networks (Stable Outlook)

Cable industry ad inventory has grown significantly over the past several years, causing a deceleration of the decades-long increase in ad dollars. Cable continues to be a targeted medium, at a lower price relative to broadcast and with significant reach. Fitch expects it to continue to gain share from broadcast. While advertising could be flat or even down slightly in 2009, carriage fees should support positive revenue growth in excess of nominal GDP. Fitch expects the cable networks to continue to embrace VOD and digital strategies, which could provide some modest upside to revenue growth.

Online (Stable Outlook)

In 2009, growth will likely decelerate and could be up only single digits. Online could be negatively affected by advertisers scaling back experimental expenditures in favor of more proven, performance-based mediums. For these reasons, search is likely to be more healthy than display. Remnant advertising is likely to be hit by a shakeout in the ad network space that could rationalize the flood of players that entered the market in recent years. While CPM growth is likely to moderate and could be under pressure, online video and social networking are likely to support growth. Also, regulatory (FTC) issues associated with privacy could be a factor as firms attempt to implement more behavioral targeting. Over the longer term, online advertising is expected to rebound from economic weakness and continue to capture share from traditional outlets.

Non-Advertising Supported:

Theme Parks (Negative Outlook)

Operations can be negatively affected by several factors inherent in the theme parks business that are generally out of management's direct control; namely, weather and energy prices. Fitch expects that disruption in the housing and labor markets could negatively affect discretionary consumer spending and theme park attendance. In addition, high-profile safety problems can and have disrupted operations at important parks during peak summer operating periods. Fitch notes that theme parks exhibit very high operating leverage, meaning that EBITDA declines can exceed 2x any percentage decline in revenue.

Commercial Printing (Negative Outlook)

Industry growth is likely to be negative in 2009. Due to overcapacity, fragmentation, customer and supplier consolidation, and technology advancements, Fitch expects pricing to remain pressured. Larger, better capitalized operators should be able to at least organically keep pace with nominal GDP by capturing share from smaller printers and also through acquisition of smaller, relatively inexpensive (after synergies) targets that could experience distress and come on the market in a downturn. We remain cognizant that event risk is heightened among the slowest-growth media sub-sectors such as commercial printing.

Music (Stable Outlook)

Fitch's stable outlook reflects companies' ability to manage the risks within their current ratings. Fitch expects the music industry to continue to undergo significant changes over the intermediate term. Declines in shelf space will pressure physical volumes (and vice versa), while pricing should be relatively resilient and increases in digital sales should compensate for some of the declines. Companies should be able to continue to scale their cost structures to help preserve against severe margin contraction. Fitch will continue to monitor execution of 360-degree deals and traction with mobile offerings.

Movie Exhibitors (Stable Outlook)

Industry attendance has been solid, albeit not as healthy as Fitch would have expected given the strong film slates over the past several years. Ticket price increases have supplemented revenue growth; however, Fitch remains cautious regarding movie exhibitors' capacity to maintain this pricing power in future years, when film product may be less robust. Fitch believes revenues and profitability of movie theatres could be increasingly challenged by factors that are largely out of managements' control. Also, Fitch will continue to monitor volatile food prices (e.g. corn) that could lead to concession cost inflation and pressured EBITDA margins. Fitch notes the industry, through its Digital Cinema Implementation Partners, LLC (DCIP) and National CineMedia stakes, is making strides to take advantage of digital opportunities. As the majority of next year's releases are believed to be in the can, Fitch would expect limited impact from a SAG strike in 2009.

Ad Agencies (Stable Outlook)

Pricing should remain stable but organic growth could be pressured by a decline in national advertising activity. However, Global Advertising Holding Companies (GHCs) are well positioned to endure a decline in U.S. advertising. GHCs generally derive only around 50% from advertising and around 50% of their revenues from non-U.S. markets. GHCs also typically have fee-based contracts that are less volatile than the commission-based revenue arrangements that were in place during past downturns. GHCs also enjoy relatively flexible cost structures (predominantly labor based) that can be scaled back if necessary to preserve margins as revenue comes under pressure.

Movie Studios (Stable Outlook)

Co-financing from private equity on new deals has diminished recently; however, Fitch does not expect a material impact on the studio's blockbuster releases, as these were typically excluded from co-financing deals. Fitch expects the art-house genre to bear a disproportionate share of scalebacks in movie production. The studios are expected to focus more on titles, characters and stories that can be leveraged into other licensing and ancillary outlets. As stated, the majority of next year's releases are believed to already be in the can and therefore only limited impact from a SAG strike in 2009 would be expected.

Professional Publishing (Stable Outlook)

Several of the top information services companies, such as TRI, MHP, D&B and Experian Group Ltd, generate meaningful demand from the financial services industry, which purchases products related to credit risk, economics and financial markets. As margins at these companies come under more pressure as a result of the credit crunch, they may curtail spending. Non-financial services related professional publishing categories are expected to be relatively resilient to cyclical fluctuations.

Educational Publishing (Stable Outlook)

State and local budget constraints should continue to pressure replacement textbook and other forms of educational spending. However, even with slower economic growth, demand from the healthy phase of the adoption schedule should be solid. Pricing is expected to remain stable, as the industry is highly concentrated and there are meaningful barriers to entry. In general, industry fundamentals should continue to improve, and credit profiles of industry participants should remain intact.

Following is a list of Fitch-rated issuers and their current Issuer Default Ratings (IDRs):

Diversified Media:

--CBS Corporation ('BBB' Outlook Stable);

--Cox Enterprises ('BBB' Outlook Stable);

--Liberty Media ('BB' Rating Watch Negative);

--McGraw Hill Companies ('A+' Outlook Stable);

--News Corporation ('BBB' Outlook Stable);

--The Walt Disney Company ('A' Outlook Stable);

--Thomson Reuters ('A-' Outlook Stable);

--Time Warner Inc.('BBB' Outlook Stable);

--Viacom ('BBB' Outlook Stable).

Publishing, Printing, Radio, TV Broadcasting:

--Belo ('BB' Outlook Negative);

--Hearst Argyle Television ('BBB-' Rating Watch Evolving);

--McClatchy ('B-' Outlook Negative);

--R.H. Donnelley Corp ('B' Outlook Negative);

--R.R. Donnelley & Sons Co. ('BBB' Outlook Stable);

--Tribune ('CCC' Outlook Negative);

--Univision Communications('B' Outlook Stable).

Entertainment - Movie Exhibitors, Theme Parks, Music:

--AMC Entertainment ('B' Outlook Stable);

--Regal Entertainment ('B+' Outlook Stable);

--Six Flags ('CCC' Rating Watch Negative);

--Warner Music Group ('BB-' Outlook Stable).

Business Products and Services, Ad Agencies:

--Dun and Bradstreet ('A-' Outlook Stable);

--Interpublic Group of Companies ('BB+' Outlook Positive);

--Omnicom ('A-' Outlook Stable).

For more information, please see the Fitch reports 'Credit Encyclo-Media'; 'Pension Analysis: US Media & Entertainment'; and 'Liquidity Focus: US Media & Entertainment', available on the Fitch web site at www.fitchratings.com under the sectors:

Corporate Finance >> Corporates >> Special Reports

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.