Old and new media part ways

Viacom

Jun 16th 2005
From The Economist print edition

To revive its growth in a digital world, Viacom is confounding many of its media rivals by splitting into two

VIACOM, the world's third-largest media company, is extraordinarily good at what it does: feeling the pulse of popular culture and making programmes that get people hooked. Viacom's profits depend on this ability, whether these are earned by CBS, its broadcast-television network; its radio stations; its cable channels such as MTV; or by Paramount, its movie studio. Last year Viacom had sales of $22.5 billion, and its market capitalisation is $51 billion. There is no sign that the firm has lost its creative edge.

Nevertheless, Viacom is about to break itself up and start all over again. This week it formally announced its split into two publicly traded firms. Sumner Redstone, its 82-year-old controlling shareholder, will divide the group into a slow-growing company, to be called CBS Corporation, and a fast-growing one which will keep the Viacom name. The idea is to hive off Viacom's traditional “old” media assets and create a smaller, nimbler version of the company to manoeuvre more easily in a world of “new” digital media, such as the internet, mobile phones and video games. “Sometimes divorce is better than marriage,” reasons Mr Redstone.

“Lunacy”, says an executive with a rival American media firm. “They'll lose a lot of their scale and their market power.” Viacom and the other three big media giants—Time Warner, the Walt Disney Company and News Corporation—have been built on a principle that size matters in media businesses. But times are changing.

The main reason why Mr Redstone has taken such a bold step is that Viacom's overall rate of growth has slowed and its shares have fallen by 23% since the beginning of 2004 (see chart). America's market for advertising on TV and radio is still valuable, but it is mature. Advertising contributed 60% of Viacom's revenues last year, but the market grew at a compound annual rate of just 3% during 1998-2003, according to Veronis Suhler Stevenson, a New York investment bank.

Other parts of the media industry are growing more quickly. Revenue at Viacom's cable networks rose 16.5% last year, though this is likely to slow. Advertising on the internet, video games, satellite radio and selling content to people on their mobile phones are growing the fastest. But Viacom has comparatively little presence in these fields. And even if it did, their relative size would be overshadowed by its traditional media interests.

By making the fast-growing businesses more visible Mr Redstone hopes that the stockmarket will value the two different parts of his empire at more than the whole. The high-growth company's main assets will be the cable networks; Paramount Pictures, a movie studio; and Paramount Home Entertainment. Its boss will be Tom Freston, currently co-chief operating officer of Viacom and who already oversees cable and Paramount. The new Viacom will have a balance sheet designed to allow it to acquire other high-growth assets.

CBS Corporation, on the other hand, will be made up of CBS; UPN (a smaller broadcast-television network); TV stations; radio and outdoor-advertising businesses; Showtime, a cable channel; the CBS, Paramount and King World television-production operations; Paramount's theme parks; and Viacom's publishing firm, Simon & Schuster. Its boss will be Leslie Moonves, currently co-chief operating officer and responsible for CBS, radio and some other operations. CBS Corporation is expected to take on most of Viacom's current debt and will return cash to shareholders through dividends and share buybacks.

Underlying the split is the change in traditional television and radio advertising as consumers spend more time with new media such as the internet.
Companies are having to think of new ways to reach consumers. Procter & Gamble and General Motors, America's biggest advertisers, are both shifting more of their marketing budgets this year away from TV in favour of new-media channels and other forms of promotion. At the same time, Americans are becoming accustomed to avoiding advertisements, whether by skipping through them with a personal video recorder, watching video-on-demand or subscribing to advert-free satellite radio.

Sibling rivalry

To some extent, the split simply reverses the $43 billion merger in 1999 that created Viacom. Back then, Mr Redstone merged his group of companies—including MTV and other cable networks, the Paramount movie studio and Blockbuster, a video-rental chain—with CBS, a broadcast-television company which also owned radio and outdoor-advertising businesses.

Yet many media executives outside Viacom reckon it is a mistake to undo that merger. Mr Redstone could boost growth without breaking up the firm, they say. And because Viacom owns mostly content and little distribution, it relies on the quality of its programming to get access to the airwaves. A break-up deepens the risk that a powerful distribution firm, such as Comcast, might either dump its least popular content or, more likely, beat its prices down. Viacom's main defence against this happening—a powerful one—is to keep producing must-see programmes.

Another fundamental reason not to break up a media conglomerate is the supposed synergy between the different bits. This notion has been partly discredited, but there remain some real examples. Owning CBS, for instance, means that cable and satellite-TV firms have to give something valuable in return for the right to broadcast the network's content. In the past, Viacom used this clout to help get distribution for new cable channels. Now, it says, it has extracted most of the value from these synergies.

A theory among some media insiders is that the split is simply Mr Redstone's way of dealing with succession. His plan until now was to pick Mr Freston or Mr Moonves to replace him as chief executive of the group, but now he can avoid choosing. This week he appointed his daughter, Shari Redstone, aged 50, to occupy a new position as non-executive vice-chairman. Messrs Freston and Moonves are expected to be named as chief executives of their respective companies in the coming months, and Mr Redstone will be chairman of both companies.

Of Viacom's offspring, Mr Freston's company has the hardest task. It has to produce the dizzying growth to justify Mr Redstone's decision. It plans to buy more cable networks, one or more video-gaming businesses and other digital-media businesses to help it grow.

It will be able to count on loyal staff. “The people who work for Tom Freston admire him so much, it's like they're part of a cult,” says an executive at a broadcast-TV network in New York. As chairman of MTV Networks, a position which Mr Freston held until Viacom's former chief operating officer, Mel Karmazin, resigned last year, he managed to achieve the hardest thing in the media business: giving creative freedom to his employees and making consistently large profits at the same time. It is crucial, he says, to keep things vibrant in an enormous factory of a company. “Consolidation can lead to mediocrity,” he says. Running a smaller Viacom should suit him well.

Getting into digital media and video games will not be easy or cheap, however, since every other big media company wants to do the same. The strategy is a risky one, says a report by Richard Bilotti, media analyst at Morgan Stanley, an investment bank, especially given the fact that in the past Viacom made massive acquisitions that earned it less than its cost of capital. Late last year, the company wrote $10.9 billion off the balance-sheet value of its radio business and $7.1 billion off its outdoor-advertising business.

Some of the new Viacom's aim of growing on the internet can be realised organically. As a whole, Viacom earned $100m of income from the web last year, and expects to double that in 2005. This month MTV Networks announced the launch in Japan of “Flux”, an internet and mobile-phone subscription service selling clips of Japanese content as well as MTV Networks material, such as “Dirty Sanchez”, a show about a group of Welsh skateboarders. In April, MTV Networks launched MTV Overdrive, an internet-based entertainment and news service.

For the immediate future, the fortunes of Mr Freston's company will rest largely on the health of its long-established cable networks. Cable television has already seen its best growth from advertising and fees from cable and satellite-television firms. Few in the media industry, however, doubt that MTV Networks will continue to thrive. Despite being almost 24 years old, the original music channel, MTV, has managed to maintain its appeal to fickle teenagers and young adults in America, as well as in over 160 countries around the world.

One guiding creative principle at MTV Networks is that good ideas are allowed to rise from the bottom up. Also vital, says Mr Freston, is frequent consumer research and changing the channels' content before the popularity of a particular type of programming passes its peak. MTV started the reality-television genre back in 1992 with a programme called “The Real World” when it saw that back-to-back music videos were losing their novelty. But now the reality genre “has a sameness”, says Mr Freston, “and we're trying to move away from it”.

Right now, MTV Networks' consumer research also suggests that the generation gap between young people and their parents has mostly disappeared. The mood of “I want my MTV”, and friction between generations has passed, says Betsy Frank, executive vice-president of research and planning at Viacom. Today young people even see their parents as heroes, she says. Moreover in America and elsewhere most young people are extremely tolerant of sexuality, and indifferent to ethnic origin, says Mr Freston.

A priority for MTV Networks is to increase its profits overseas. At the moment, Viacom earns 16.5% of its revenue from outside America. Along with America's other big media firms (apart from News Corporation, which earns about two-fifths of its sales overseas), it relies heavily on its domestic market. Of its overseas revenue (most of it from MTV Networks), 83% comes from Europe and Canada. MTV Networks wants to earn more from farther afield, especially in Asia.

Whether or not the new Viacom will be able to meet Mr Redstone's high expectations will also depend on Mr Freston's ability to turn around Paramount Pictures, which has had few hit movies in recent years compared with other studios. This year Viacom daringly hired as Paramount's new boss Brad Grey, a talent agent who previously ran his own management business but who has no experience of running a studio. Under Mr Grey, Paramount is trying to shed its reputation for creative conservatism, and is more welcoming to actors, directors and producers. It is also developing films for a younger audience and is working with MTV Films, whose successful movies include “Jackass: The Movie”. An easier way to generate cash will be to release more of its collection of films and TV shows on DVD. Up to now, Paramount has exploited its library far less than other studios.

“I am happy to be the underdog,” says Mr Moonves. Though responsible for the sort of traditional media that bloggers love to mock—including the business that has done more to drag down Viacom's growth than any other, radio—Mr Moonves is unlikely to sit back and remain content with slow growth. Indeed, one media executive predicts that the two companies are unlikely to stick to the growth characteristics that Mr Redstone seems to expect, and that CBS Corporation may do better than the market expects.

Here to infinity

Infinity Broadcasting, the radio division of Viacom, performed brilliantly when the government allowed the industry to consolidate during the late 1990s, which coincided with sharp increases in advertising revenue from the pharmaceutical industry and dotcom firms. But Mr Karmazin is said to have extracted all the growth he could while neglecting content. “What I found in the radio division was that they were starved and burning the furniture,” Mr Moonves told investors recently.

To stop listeners switching to satellite radio and their iPods, Infinity is replenishing its schedules. It is also rolling out a popular new format called “Jack” which it first launched at some stations more than two years ago. Designed to sound like an iPod on shuffle, “Jack FM” plays randomly from 1,200 familiar songs from the past three decades with less interruption from DJs. Another new initiative is the first podcasting radio station, with content taken entirely from listeners' submissions.

The other big chunk of the slower-growth business is CBS. For years, network TV's audience has been declining as viewers shift to cable. But CBS now has the biggest audience, and has trounced the long-established leader, General Electric's NBC. That is a huge achievement, even compared with the success of Viacom's niche cable-channels, says Michael Wolf, head of McKinsey's global media and entertainment practice, because CBS has had to win over a massive audience in middle America. CBS is also positioned well to grow in digital media. It has been particularly aggressive among the broadcast networks in using content from its shows to build a popular presence on the internet.
Viewers of its “Big Brother” reality show, for instance, flock online to watch live webcasts.

Mr Redstone's rivals will be watching events closely to see which of the two companies does best, because they face very similar challenges. If the new two-part Viacom performs as expected, even the bloggers may have to admit that a stodgy old media firm can duck and weave like a digital upstart.

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