Come Gather ’Round: Straight Talk For Confronting Challenging Times From Veteran Wall Streeter Victor Miller (04/07/08)
By Editor-In-Chief Joe Howard
From radio’s booming days of the late 1990s through the disappointing times that have defined the current decade, Victor Miller has been one of the industry’s closest and most respected observers. After a successful stint with what was then Chase Manhattan, in May 1996 he joined the investment firm Bear Stearns — a move that timed perfectly with the start of radio’s consolidation boom and the industry’s meteoric rise as a Wall Street darling. The Street’s courtship of radio has soured as revenue growth has slowed, and one by one analysts have cast radio aside. Through these times, Miller remained stalwart in his coverage of the industry.
Now, it’s the financial industry that’s on the ropes. The sub-prime mortgage crisis hit Bear Stearns hardest, forcing it into negotiations with former rival JPMorgan Chase. The proposed buyout has left many Bear Stearns investors with the same sinking feeling that radio shareholders have been treating with antacids and aspirin.
While the banking industry is in the early stages of what may be a long, dark road ahead, many industry observers — including Miller — wonder if radio has finally hit bottom. “One of the signs that people think points to radio hitting bottom is the fact the analyst community has thinned out dramatically,” he says, “It’s a sign that people have given up. If you look back five years at the owners of these shares, a lot of the people have abandoned the radio space. The shareholders that were committed to the industry leaving and the analyst community thinning out is a sign that it’s kind of washing out.”
Miller adds, “The third and fourth quarters of last year weren’t particularly pretty, but the industry continues to make strides with podcasting, webcasting, and all other platforms. Put those together, and the second half could be better. Hopefully that will come to pass.”
RADIO INK: Talk of the economy heading into a recession is constant. How is radio’s position heading into this uncertain environment?
VICTOR MILLER: When you consider the fact that retail, auto, finance, and travel comprise about 44 percent of the industry’s revenue, it has to be prepared for a tough economic time. Roughly 15 percent of radio advertising comes from retail; 14 percent each from package goods, autos, and telecom; 9 percent from entertainment; and about 8 percent from finances. The retail and auto environments have been poor, and entertainment was badly disrupted by the TV writers’ strike because a lot of TV tune-in dollars weren’t placed in November and February. That category was down double digits for almost all radio operators both of those months. Package goods tend to be a little bit more predictable, because it’s not as economically sensitive. And the telecom business is still fairly good given the competition in wireless and the video segment. Finance has been very mixed.
One thing that intimidated us is the mix of this with the potential overall leverage in the business. With the last ad recession in 2001, I think radio revenue dropped 6.5 percent. At that point total industry leverage for the public companies I followed was about $15 billion worth of debt on $2.6 billion dollars of cash flow. So, overall the public companies were levered about 5.8 times. Now, four of those companies actually had leverage in excess of 9 times cash flow, so it was a very precarious debt situation. And, by the way, I have postulated that part of the reason the industry really didn’t grow much in the last eight years is because of some very irrational behavior on the rate cards because the focus was really on reducing debt as opposed to protecting rate integrity.
Fast forward to 2007 — pro forma at year end I guessed we’d have about $27.25 billion of debt on about $3.3 billion in cash flow. So, overall industry leverage goes up to 8.2 times. That’s assuming that the Clear Channel deal gets done and also that some form of the Cumulus deal gets done. The bottom line is that if those two deals get done, there’s about 2.5 times more leverage. So, you’re going into a potential recessionary environment with even more pressure on the leverage situation than you had in 2001. It’s something I worry about — the mixture of a recessionary environment and increased leverage in an industry that has 45 percent of its revenue associated with economically very sensitive advertisers.
RI: How can radio address this?
VM: You can’t offset a recession. You just have to be very diligent. The blessing for most radio operators — even back in 2001 — is that the industry generates plenty of free cash flow. It’s not an industry that relies heavily on capital expenditures; most of these companies are in net operating loss positions or have significant tax shields from the assets they’ve purchased, so they really don’t pay too much in terms of current taxes. With the interest rates falling because of the fed cuts, a lot of the interest bills that people thought they would be paying at the beginning of the year have fallen fairly significantly. They’ll just have to be very prudent and use their free cash flow to reduce leverage. They also have to be very smart in how they attract new advertisers. They have to maintain the integrity of the programming and drive the audience, and also be very diligent about growing streaming and podcasting.
Also, they’ve got to be very supportive in building the ultimate, appropriate, accurate ratings solution rather than a diary-based solution. There has to be a rebuilding of trust between the advertiser and the radio operator. And they need to start exploring the future with more mobile services, and getting tuners into different platforms where they can leverage the content they provide. It’s about being clever in a market that is pretty stressed.
RI: Are radio operators generating significant new revenue from digital initiatives?
VM: For most companies, we’ve looked at how much revenue is coming from the Internet in non-on-air based advertising. I think Emmis had the highest percentage at around 5 percent. Cumulus was the lowest, but as of January 1 it has basically rolled out all of its websites, and they’re starting to see some nice return.
The general consensus for most companies is around 2 percent, and most are hoping to get in the 5-6 percent range, so there is some growth ahead. Some companies are seeing astronomical growth; last year Cox was up 20 percent. Other operators think they will be up very strong, double digits; the range is between 15 percent to doubling the revenue. And that really reflects the maturity of the effort — those that launched a while ago are probably seeing slower growth than those just launching.
RI: What do you think of the revenue-generation possibilities for HD Radio?
VM: The stations have to start going their own way. The HD Digital Radio Alliance was formed so that there wouldn’t be 50 Rock stations on HD, but the trade-off is that there is no advertising. I think this was done with the Department of Justice in mind, because you can’t organize an industry. The minute people decide they want to make it into an advertising business, the Alliance by its own nature will have to fall apart. Then people will be able to do whatever they want with their HD signals. Perhaps this is where some really interesting things can start to happen in terms of new programming. The HD Alliance has helped the industry be much more deliberate in the way it rolled out so that people could find different types programming on these second channels. But at some point — once it becomes an ad revenue-generation model — I don’t believe the Alliance can remain a coordinated effort by the industry. At that point it will become everyone for themselves.
RI: What effect do you expect the influx of major private equity investors will have on the radio industry?
VM: The experiment is relatively new. There’s not a lot of evidence yet on how they’re going to operate these stations, and whether it will be universally different from what the operators do now. They can be much more deliberate in how they change the franchises because they’re not trying to meet Street expectations. So, we’ll have to see. My sense is that private equity guys tend to be very supportive. They put in the proper management team and allow a lot of autonomy in how it’s run. In certain cases they really have to stand back, because when they own pieces of different companies they have to remove themselves from the board.
RI: What about the widely held belief that these investors expect a short-term return on their investments?
VM: Most exit strategies are in the three- to five-year range, but if you look on the TV side, you’ve got Linn Television — Hicks Muse has been in there for ten years — and ABRY Partners has been in Nexstar for eight or nine years. It all depends what the ultimate feeling is — if the ultimate feeling is that the upside still exists, there can be some flexibility beyond a three- to five-year time period. I’m not saying they would ever reach the types of levels at Linn, where it’s double that, but private equity is still committed to Linn and Nexstar nine to ten years into their investments.
RI: You mention that equity investors tend to install a management team and step back. Despite the eventual expectation of a return on investment, are these deals ultimately good for public radio groups since they remove Wall Street from the equation?
VM: I think it takes a little pressure off. You have an industry that’s been flat for eight years in terms of total revenue, so it does feel like it would be more comfortable for these to be private, out of the limelight, and able to be more deliberate about the changes that need to be made to grow the business.
RI: Especially at a time when Wall Street is losing interest in radio…
VM: I think I’ve had 15 competitors leave this space in the last three or four years — about five of them in the last few months. Wall Street tends to binge and purge; when there’s a lot of interest and investor activity in a category, it needs to be and will be actively followed. And when the market cap of the group falls to a certain level and there are fewer shares to trade, it narrows the pool of interest. When that occurs, directors of research shift analysts into another space where there’s more market cap, and where investors could use research help. Or, they simply eliminate entire teams of coverage of different categories. Clearly it’s not a great sign for the industry; the fact that analysts are leaving is probably another sign that radio is hitting bottom.
RI: What needs to happen to improve radio’s Wall Street image?
VM: Sustainable growth, for two, three, four quarters in a row, of two-and-a-half to three percent top-line growth for the industry. I think that would reverse the evidence that the industry can’t grow. The real question you have to ask is what radio initiative during the last five years has actually worked out? Name a m new format that’s been particularly successful. Name a new technology that’s taking the industry by storm. I also cover TV, and the TV industry’s got re-transmission consent — they’re actually getting paid by cable, DBS, and phone companies for their local signal. Radio has not seen that. Broadband penetration will reach 60 percent-plus by the end of ’08, and if you think about who’s well positioned for taking advantage of video on the Internet when broadband capability becomes more ubiquitous, it’s local TV.
Investors two years ago started migrating some of their holdings out of radio and into local television, because there’s more readily identifiable benefits. People ask, “Where is that new revenue stream? Where is that new technology?” For TV, re-transmission is the new revenue stream, broadband is the new technology.
RI: And how is this affecting advertisers’ perception of radio?
VM: I don’t speak for the advertisers, but I would say that when you only represent single-digit amounts of industry-wide spending, it’s hard to get a seat at the table. Radio, because it doesn’t involve huge amounts of production money, is one of the most readily cancelable media — there is no real implication for the advertiser that cancels. Also, radio creative just doesn’t get the attention that video creative does. Ad agencies are filled with younger people who may not see radio in the right light — it’s just not something they use as much. To a certain extent, it almost seems like the radio industry has to re-introduce itself to the younger demo. The RAB came out with RAEL studies, and while you could say they were helpful tools, where’s the actual change around the edge in terms of advertisers?
Also, the fighting that’s going on over PPM and audience measurement issues — and other issues as well — collectively is a disappointment, and for national advertisers in particular. Less Is More probably created more inventory, so we need more advertisers in the medium. We need to actually grow the number of advertisers in the radio business, and I don’t think the industry has been able to grow the advertisers it needs. That’s the central challenge.
Miller believes the radio industry needs an infusion of leadership; here he outlines the characteristics this leader – or leaders – must possess:
• Be an instrumental part of leadership and coalescing within the industry, providing some consistency. They must be leaders within the radio community and its associations — NAB, RAB, HD Digital Radio Alliance, or whatever.
• Help to stabilize advertising, especially on the national side. It feels like there is a break in trust between advertisers and the radio companies. For example, the PPM was obviously adapted as good technology, and was fully backed by many of the agencies and advertisers in radio. Then the industry, for the most part, attacked it. Now it’s been pushed back. The agencies could be saying, “This is very important to us but you guys keep fighting it, so we’re gonna lay back until you guys figure it out.”
• Figure out from the operational side how to reinvest in and generate more from the sales side. Come up with more people on the street selling radio time, and telling radio’s story.
• Air a really great product. Radio needs leaders who actually know programming. It would be interesting to see more innovation on the station level, and to see more ad and promotional dollars promoting this space on a local level. Rely more on local content rather than laying back on syndicated product.
• Keep your eye on the wireless and mobile applications, the HD applications, Internet streaming and podcasting, and all those things that are part of radio’s future. Get it on more and more platforms.
• Radio needs leaders who know how to rationalize assets. They must know which assets are the core to your business, and which assets aren’t. The leader must be able to figure out what they need and what they don’t; somebody who is definitely de-leveraging the company so that they can create as much flexibility in that capital structure as possible.
• For public companies, radio needs a leader who is prepared to go private, to take the company out of the public marketplace and do the work that needs to be done on the company before they come back into the public marketplace — if they even care to.
• The leader must have an understanding of the issues surrounding PPM, and be willing to help Arbitron and the industry come to consensus on sample sizes, ethnic composition, and gender composition. The leader must determine if the pager model will work, or if the industry needs to call in somebody like Media Audit with cell phone technology, or if radio — however unfortunately — might need to push back time even more for a better technology.
• Radio’s leaders must stop the in-public fighting. Take Google, for example: Some people say Google is commoditizing the radio product, others say it’s great because it adds capacity for ad spending. Some people say consolidation is the only way to go, and some people say de-consolidation is the only way to go. On PPM, some people think there should be an alternative, others think it’s a huge, huge improvement. With HD Radio, some people call it a huge disaster — they’ll say that’s what HD stands for — and others believe it’s a great opportunity, particularly for localism. On Less Is More, some say it actually exacerbated the sales problem — that radio has too many units in the marketplace it can’t digest, and doesn’t have enough new advertisers to digest all this new inventory. Some people say it gives advertisers a lot more choices. The frustration is spilling out into the streets.
• The bottom line: Radio needs some calmer heads. We need leaders with enough of these collective skills to help take the industry to another place.
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