[eccr] Media Mergers: The wave rolls on

Title: Media Mergers: The wave rolls on

      Media Mergers: The wave rolls on
    
In the absence of practical organic growth prospects, media industry executives still have the urge to merge. 


Michael J. Wolf 
The McKinsey Quarterly, 2002 Number 2 Web exclusive 

Even without February 19th¹s US federal court decision, which removes the block on media companies owning both cable systems and local broadcasters in the same market, the era of media mergers was far from over. Now, it will surely accelerate.

The recent spate of mergers represents the last throes of a consolidation that started a dozen years ago and has been marked by such deals as Time merging with Warner, buying Turner Broadcasting, and then selling itself to America Online; Disney buying ABC; Viacom buying CBS; and Vivendi buying Universal. Recent months have seen such combinations as Comcast and AT&T Broadband, EchoStar and DirecTV, Vivendi Universal and USA Networks. Critics of media concentration will now wonder how much more wheeling and dealing can go on before there are but one or two juggernauts controlling every image, syllable, and sound of information and entertainment.

Actually, the industry has a long way to go yet before it reaches that point. There are more than 100 media companies worldwide, with more than $1 billion in revenues; and entertainment and media are still fragmented compared with other industries such as pharmaceuticals or aerospace. As part of the next merger wave, even the biggest and most acquisitive players are simultaneously looking to sell businesses that no longer fit the strategic bill. Recent examples are Sony¹s and Liberty Media¹s sale of Spanish broadcaster Telemundo to NBC and News Corporation¹s sale of Fox Family to Disney. While the media mogul archetype may be Charles Foster Kane, the better analogy is Jack Welch in his early GE days, in pursuit of strategic fit and maximum returns.

Driving the media¹s recombinant ways are two imperatives, financial and strategic. Financially, the cooling of equity markets has left most major media companies trading at elevated stock market prices based on multiples of cash flow that cannot be justified by growth alone. What investors are counting on, and executives are pursuing, is a burst of revenues through new digital services.

An array of new technologies, combining elements of broadband technology, wireless devices, personal video recorders, telephony, and other interactive services, is now coming to market. Consolidation should create media platforms with the leverage and scale to introduce services widely and economically. While all the bugs and kinks‹not to mention intellectual-property issues‹have been agonizingly slow to resolve, a whole new set of service offerings can now be realized.

Video on demand, for example, is a tremendous application. If you look at the $17 billion that consumers already spend renting and buying videos and at the meteoric growth of the DVD market, it isn¹t difficult to imagine what convenience and accessibility will do for the film business. The same approach can be applied to TV, music, and gaming. In all, typical consumers should be willing to increase their monthly expenditures on media and entertainment services dramatically. That is what really drives all these deals.

There are challenges to overcome first. One is the distributors¹ ability to deliver new services reliably; another is how to price and sell them. Most immediate is getting content providers and distributors to sit down, sort out their rights issues, and agree on how they are going to share profits.

The strongest companies seek to overcome these issues by owning more pieces of the puzzle, increasing leverage. Distribution-centric companies such as Comcast and EchoStar hold a powerful hand by controlling direct access to consumers‹an especially important relationship when two-way interactivity is in the mix. But content companies such as Viacom, Disney, Vivendi Universal, and News Corporation also have leverage because the talent in their studios is expensive and scarce, and without their wares, new technology loses its appeal.

Beyond technology, there are other factors, including the court decision, driving the coming wave of mergers. Some media companies may be seeking deals for succession reasons, and some smaller companies are realizing that they lack the scale to compete amid the leviathans. For others, it is simply a matter of finding new markets. European media groups such as Bertelsmann, Reed Elsevier, VNU, Pearson, and Wolters Kluwer have driven their growth by expanding into the United States.

Meanwhile, the industry¹s $36 billion question is whether Microsoft will spend some of its cash hoard by acquiring media businesses outright and moving to lock up consumer access. That would pit it even more directly against AOL Time Warner, which is still the 800-pound gorilla of the distribution-content business.

How to pay for all these acquisitions? That is where February¹s US appeals court ruling comes in. It allows new value to be extracted from local TV station operations that will pay the premiums for the acquisitions. For example, local broadcast news can be leveraged into profitable local all-news channels. In addition, broadcast-cable consolidations could ensure the distribution of local high-definition TV signals through cable. Access to broadcast spectrum offers operators and networks the ability to pursue new wireless services. Last, in an environment of squeezed margins, the consolidation of local operations (through broadcast hubs or local duopolies) will greatly reduce the operating costs of stations.

The challenging conditions facing the media industry today‹a brutal advertising environment, a radical change in existing channels of distribution, and the unlikelihood that organic market growth will create value‹will test a new generation of executives. But one thing is common to old guard and new: the urge to merge.

Notes:

Michael Wolf is a director in McKinsey¹s New York office. This article was originally published in the Wall Street Journal on February 21, 2002. 

Source: http://www.mckinseyquarterly.com/