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BIA's Mark Fratrik On What’s In The Cards For Radio’s Deal Market (01/22/07)
By Editor-In-Chief Joe Howard
BIA Financial Network is one of the radio industry’s most trusted financial research companies, and Vice President Mark Fratrik is the company’s expert for tracking, reporting, and forecasting on the radio business. Each year, BIA’s reports on merger and acquisition activity and revenue generation are among the most highly anticipated and carefully scrutinized reports in the industry. The credibility BIA data has can be attributed in no small part to Fratrik’s commitment to thorough, methodical research and the importance he places on delivering reliable information to the industry.
One of his most anticipated reports lists the top transactions of each year, and Fratrik counts Clear Channel’s privatization — and all of its radio stations — toward last year’s acquisition count. While he points out that 2006 would have outpaced 2005 even without the Clear Channel deal, Fratrik talks here about what the landmark deal could mean for the industry, and what he expects to happen with the 448 stations the company is releasing back into the marketplace.
Like executives from the many radio companies he tracks, Fratrik believes the industry can excel beyond the lagging growth it’s been experiencing during the past few years. As someone whose work isn’t dependent on the whims of the radio advertising market, Fratrik’s perspective is informed more by hard facts than hope or dogged belief in the business. But perhaps that’s just what radio needs; someone from the outside looking in to help guide the industry on its way.
RI: What kind of year was 2006 on the deal market?
MF: We actually had some pretty good growth in deals. Last year, 2,134 stations were sold for a combined $22.9 billion. That’s an incredible number, because we include the Clear Channel privatization. We account for those numbers when deals are announced, not when they close. Of the $26.7 billion price on the Clear Channel deal, we allocated $16.7 billion to the radio assets. So, even if you take out that $16.7 billion from Clear Channel, you get approximately $6.1 billion in deals for 2006. It’s still a big number. In 2005, 882 stations sold with a combined sale of $2.7 billion. In 2006, not counting the Clear Channel deal, over 1,100 stations sold. So there was definitely some increased activity. Some of that is the Citadel-ABC acquisition. Also included are all the CBS stations.
RI: What is your take on the strategies employed by ABC and CBS, both of which sold off radio assets last year?
MF: The disposition of those properties is very strategic in nature. ABC sold most of its stations to Citadel, but they’ve held on to their owned-and-operated ESPN and Radio Disney affiliates. They think they can bring value to the company through ESPN, and you can easily see why because they have all these on-air personalities in the ESPN family. With Radio Disney, some have argued that brand helps support the theme parks. For whatever reason, they thought they could continue to add value to their entire corporation by holding on to those properties.
Similarly, CBS has sold a lot of radio stations, but they are still staying in some of the larger and midsize markets they have, because they think there is still some future there. CBS decided to get out of the 10 smallest markets, but they retained all their other markets. They’re not giving up on radio completely, but there are certain situations where they think they can add value to their properties, or given their comparative advantages and resources, bring increased value and make those operations more successful.
RI: As for Clear Channel, they may be selling 448 stations, but these stations don’t contribute a lot of cash flow to the company. Are they doing the same thing as CBS, just on a larger scale?
MF: They’re not totally getting out of small markets. They are staying in 25-30 smaller, 100-plus markets, because in those markets they may have enough regional consolidation that makes it worthwhile to stay.
RI: What kind of multiples do you expect these properties to bring?
MF: I haven’t looked at the individual properties, but in some of these markets they can’t sell to one party; because of the way the market definitions rules are written, they can’t be kept together. I’ve been very surprised by some of the multiples that have been paid for CBS, so I’m going to beg off that question. I think some will go for surprisingly high multiples and others, maybe low. But, I think there are some markets where the local economy isn’t very strong, so I wouldn’t expect them to go for very high multiples.
RI: Who are the buyers? Existing groups? Former radio people jumping back in? Private equity investors?
MF: Yes and yes and yes. Nobody is going to by all 448 of them. In some situations you’ll have groups that are focused in that region. And in some, they may actually be in-market buyers, which may be difficult because of ownership caps. There may be some people who sold out to Clear Channel or somebody else and their non-compete has expired. Maybe they’ll reenter the same market they were in before. There is a significant amount of private equity that has been supportive of experienced managers.
RI: Is Clear Channel the first domino to fall? Is radio going private again?
MF: I bet some may go private. CBS is not going private; it’s part of a larger corporation, but some of the other midsize ones, maybe. There’s so much of an advantage to going private, especially the ability to think longer term. I haven’t heard of anybody who’s thinking about it, but with the dynamics of Clear Channel going private, one would think that other companies are talking about it.
RI: You mention long-term planning. Can you put a finer point on how far into the future constitutes “long-term planning”?
MF: Eighteen months to two or three years; even five years. And that doesn’t work very well in the public market. The industry changes so much from day to day; it is such a dynamic industry that it’s hard for the public investors to step back and take a longer-term view. And there are also a lot of other regulatory issues with public companies. As for HD Radio, I think return on investment is about a five- to seven-year prospect.
RI: How do you expect investors to react to the purchase price? The per share price is higher than where the stock has been recently, but lower than where it traded in the past.
MF: Maybe people who have invested will decide that there is a new reality. If you look at the buyout price on a per share basis, it is certainly much lower than it was a year ago. This was a monumental and pivotal action that may lead other investors of other public companies to decide that things aren’t the way they used to be. They may be willing to accept a price that doesn’t meet what it was two or three years ago. One thing investors look at is comparative companies; if an investor in another public company sees that Clear Channel sold for $37.60 per share, and its three- or four-year high was $70 or $80 — or more — the investor will incorporate that information in an evaluation as an owner of that company.
RI: How long do you think we’ll all be talking about this Clear Channel deal?
MF: It’s going to take a while to get through those stations — not just from a regulatory standpoint, but getting people to come up with prices. Clear Channel obviously has an idea about what they want, but it may be a while before buyers come up near those prices. Economists refer to it as the market-clearing price, and it may take a while to work out the negotiation process. Also, we may be dealing with more than these 448 stations. Other stations may come on the market. And remember what I said earlier about established managers; there are only a fixed number of those. So, it will take a while for these sales to go on through.
RI: When you mention other stations, do you mean other Clear Channel stations?
MF: Other groups. Groups deciding that they’re not doing well in a given market, and spinning it off. There is always a natural flow of stations here and there that come on the market. In a lot of markets companies have a number of stations; it isn’t just one or two. So it’s a challenge to get the prices and work their way through these deals.
RI: All of this is happening at a time when local advertising is struggling. Why have local markets dried up, while national has increased?
MF: I think Internet sites have done a much better job in selling. Outdoor is doing better. You have to be careful when you talk about national or local going up because there is a small percentage going to national. While a 1 percent drop in local may mean $200 million for the industry, that figure would be a more than 5 percent increase in national. National is such a small number that when you see the percentage increases in national, it is not a one-to-one comparison with local. It is interesting to see that national has bounced back, but last year, national went down a lot more than local did. National tends to be a little more bearable than local. But with local you have a local relationship with your local retailers.
RI: Are radio stations still worried that they can’t make money on their websites? Do they see it more as a brand extension?
MF: I bet there are some making money off of websites. With streaming, sometimes you have to insert different commercials. That’s an opportunity to sell more advertising. I’m not so sure how much additional cost is involved in streaming — obviously there is the royalty arrangement from the copyright office — but I think that is a possibility. And there are concert promotions, and lots of other things. The thing about radio broadcasting is that stations have a brand name; that is something that would be envied by so many other people in the marketplace, and I think they can extend those brand names.
RI: What are the prospects for HD to help stations expand those brands and bring more money to the stations?
MF: I think HD is very, very exciting. I’ve been dealing with HD for eight to ten years. It is remarkable what it could do for radio. Multicasting is tremendous. And people aren’t emphasizing the increase in sound quality for AM stations. I know there is a problem with nighttime coverage, but bringing music back to AM with much higher quality is really remarkable. It opens a lot of possibilities in midsized and smaller markets where you don’t have many radio stations and not all formats are being provided over the air. Also, multicasting is very exciting in terms of brand extension. Some of the more successful multicasting will be providing music formats that aren’t too far afield from your main signal. A Country station can’t put a Hip Hop station on one of its multicast signals, but maybe a traditional country station. That is exciting to me, because not only do they probably have all that music in storage, but they have the experience, they have the expertise in marketing, and they have advertisers who would be interested in advertising on those multicast signals.
I say that with a lot of excitement, but I’ll be honest with you, I’ve been disappointed in the adoption of HD radios, and I’m somewhat concerned about the lack of speed getting the car manufacturers to introduce it on OEM, though I’m well aware of all the effort that the industry is making.
RI: Do you think HD will be one of those things that builds slow, but once it catches on will grow rapidly?
MF: I don’t know if it will be that way. It’s obviously important to get the major car manufacturers to at least provide HD Radio as an option, and I’m encouraged by what is going on in terms of the aftermarket. In the industry, I hear a lot of spots about it from Tweeter and other places, and I see a lot of trade press about $99 HD radios for sale. But I think the tipping point is getting one or two major car manufacturers to offer it, and I know the industry has been trying to do that for several years. There are a lot of HD Radio stations in Detroit especially, and they talk to the car manufacturers. I’m not sure what is going to convince them. I don’t have an answer for when that will happen, and I don’t actually incorporate HD Radio in my predictions for the future.
RI: Is the industry effectively promoting HD Radio?
MF: The industry is making a valiant, committed effort. They’re putting their money where their mouth is. They are actually transmitting HD Radio signals before the radios are out there, even with the likelihood that there isn’t going to be that critical mass for some time. We are talking about millions and millions of dollars, and the industry has made the effort. What I think the industry is hoping to do is to build up enough consumer demand that people go into the showroom and say hey, why don’t you guys offer HD Radio?
RI: Will the government step in to move it along?
MF: There are federal mandates for digital television in terms of manufacture of new sets. And those sets have to be able to receive the digital signal. But this is different because radio isn’t shutting down analog. In some sense that is an advantage, but it has also sort of held it back.
RI: What are the key factors challenging radio?
MF: An incredible audio and advertising marketplace. When compounded, the many choices for consumers for audio entertainment — at a time when advertisers are being offered so many opportunities to get their message out — is having a slowing impact on radio. It has contributed to the perception that radio is a mature industry without much potential for growth, meaning that public investors have driven down the price of radio stock. But I think radio still has a place in the advertising marketplace, and believe there is potential for growth in certain areas, possibly longer term.
There are always underperforming properties, even in slow growth markets, that can be turned around with new management and new creative ideas. In some sense, the negative perception of radio provides great opportunities for great managers. I see a malaise in the perception about radio stations, which provides an opportunity for experienced operators to bring their management skills and take over underperforming assets. Will they all be successful? Of course not, but there will be enough opportunity for people who believe in their abilities, and it appears there is a decent amount of financing for experienced operators.
The cutback on ad inventory levels — particularly Clear Channel’s Less Is More — also had a depressing impact on the radio industry during the past few years, but I think that is leveling off. We can’t forget that Howard Stern leaving had a significant impact on CBS Radio and affiliates that carried him.
Even though there has been a big increase in the number of Hispanic radio stations, with many Anglo stations switching over, the full impact has yet to be felt. It takes time for a station that changes its format to build up a new advertising base and a strong programming lineup. The hundreds of stations that switched to Spanish-language programming during the past few years will, over the next one to two years, continue to grow and hit their stride. When we do valuations, we assume it takes about 3 to 3 1/2 years for a station to reach the mature level. So the positive impact of all those stations switching to Hispanic can propel the industry somewhat, especially in markets with heavy Hispanic populations.
The last force is electronic measurement. I’ve been very bullish about electronic measurement, which could really have a positive impact on radio. It adds accountability, a greater sense of professionalism, and a greater sense of accounting versus what radio is delivering. There are challenges to it, and in some dayparts results may be worse then what they now have, but I think electronic measurement in the 21st century is really necessary.
RI: How will the changes that electronic measurement is expected to have on advertising revenue affect not just comparisons to the past, but the industry’s ability to forecast for the next few years?
MF: That is a very good point. We have models that we use to predict station revenues, and we use previous years’ ratings as one of our explanatory variables. We have the luxury of not changing overnight, because Arbitron has a roll-out plan. We’ll see how Philadelphia does, then Houston, and we’ll learn from that. I’m not too worried in terms of being able to predict, because the impact of electronic measurement will obviously take some time as it is rolled out to more and more markets. I don’t see the impact occurring in 2007. It will take a while. But I do think that, over the long term, it will be beneficial to radio.
I also think radio stations’ related businesses will be paramount for the industry’s growth. The best example of that are Internet sites. For radio operations to get back to mid- to high-single-digit or possibly even double-digit growth in most markets, it’s going to have to be through these ancillary, related businesses. Radio has always had NTR, concert promotions, and so on, but in terms of growth potential for the industry, for it to get to those higher numbers, it will have to rely on these kinds of things, because I don’t think traditional radio alone is going to be able to generate those higher revenues.
RI: Public companies have the added burden of keeping Wall Street happy.
MF: You can broaden that to include all investors in radio. With more private companies entering the business, you have to think about all investors. The key is that radio needs to get into other businesses where its brand names can help. Radio people have long been creative and innovative with these types of things.
I teach a course about the economics of media markets, and in my introductory class I spend a lot of time on radio. I always bring in the famous Thanksgiving episode of WKRP in Cincinnati, where the sales manager wanted to drop turkeys out of a helicopter. Obviously the guy doesn’t know that turkeys don’t fly!
But it demonstrates the entrepreneurial spirit that has been and will continue to be in radio. There are challenges in getting into related businesses, but radio needs growth that will be attractive to investors and/or the public marketplace. I think that has to come from areas other than over-the-air broadcasting.
RI: How important is the overall economy to radio’s revenue?
MF: In 2003 and 2004 retail sales growth exceeded radio advertising growth, and it continues to be that way. What troubles me insofar as radio’s growth over the past two or three years is that the economy continues to grow but radio advertising hasn’t continued to grow. It hasn’t kept up with the overall economy; it hasn’t even kept up with inflation. Of course the overall economy is important, but over the past few years it surprisingly hasn’t kept up with the overall economy.
There were two times prior to 2003 and 2004 that retail sales growth exceeded radio growth; in 1991 and 2001. If you recall, we had quick recessions in those years, and advertisers react strongly to potential downturns. Both of those situations were the outcome of economic activity decreasing, or the anticipation of economic activity decreasing.
Plus, advertisers sometimes overreact, even if consumers wind up not really cutting back as much as they’d feared. When you have an advertising or actual recession, you have the problem of retailers thinking they’re not going to be able to sell as much because unemployment is going to go up, so why make the investment in advertising? That has long been a problem with any advertising medium. On the other hand, starting in ’03 advertisers have just been cutting back.
Now, as any good economist, I have a caveat: The strong hot growth markets continue to do well — Las Vegas, Phoenix, Ft. Myers, and some of the other big areas. Those radio markets have done better than the national average.
RI: With so many new avenues, are they just sampling new forms of advertising?
MF: It would be nice to think that it is just sampling and it will come back to radio, but I think it is just movement into other advertising mediums. And that includes outdoor, for which there is now an expanded definition and new distribution — like advertising in malls, or on kiosks. There are so many different possibilities. Maybe the parallel to that with radio is the Internet; maybe it’s streaming, podcasting or anything on the Internet side.
RI: If you could make one recommendation to the industry on how to improve local revenue growth, what would it be?
MF: If I knew that, I would be buying a radio station! My recommendation, and you hear this from a lot of people, is that emphasizing local programming, local presence, is very important in an era when you have satellite radio and Internet radio and so on. The advantage a local radio station has, whether it is in New York or Tupelo is that it is in the marketplace, and you have personnel on the ground. Whether it is sales personnel, programming or marketing personnel, or events people, they can be there interacting with the local community and keeping the brand name of the radio station out there.
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