Proof that cost cuts add up for media firms

Is the Mouse lousing up movies? Wall Streeters are split

NEW YORK -- Nobody likes talking about cost cuts, whether you are a media and entertainment giant or among the thousands pink-slipped by one during the current recession.

But in reviews of the latest quarterly earnings season, analysts repeatedly mentioned the key role expense controls have played. Al¬though a single quarter provides just a snapshot, there are lessons to be gleaned from the latest financials given that entertainment biggies have shared only the occasional detail about their moves to rein in expenses.

Some takeaways from the just-ended earnings parade:

Expense reductions weren't enough to offset revenue declines. Quarterly revenue took a major hit at all sector biggies in the quarter as the economy and advertising market seemingly reached rock bottom. Even big boxoffice gains weren't enough to save the top line at film-studio owners as advertising and DVD sales fell.

But a look at the expenses -- operating, selling, general and administrative, along with depreciation and amortization and possible restructuring costs -- shows that, taken together, they generally also trended lower, even though networks had to spend more this quarter compared with the WGA strike in the year-ago period.

The hook: Even the biggest reductions couldn't offset weaker revenue, leading to operating-profit declines.

Says Barrington Research analyst James Goss about CBS Corp., "Management made substantial cost-containment efforts, but they proved inadequate to offset a revenue decline of this magnitude."

News Corp. and Time Warner were the quarter's expense-cutting champions. News Corp. reduced quarterly expenses by nearly 10% compared with the year-ago period, more so than any of its peers amid an above-average revenue decline. Time Warner came in second with a 6.7% expense reduction, which came closest to the percentage of lost revenue.

But don't overlook Disney, whose core expenses basically were unchanged in the quarter but still managed to squeeze more profit from its operations than anyone else.

Some film divisions provided upside surprises thanks to lower expenses. Many analysts had forecast a down quarter for film units, but lower expenses helped TW and News Corp. exceed expectations and boost film operating profit, partly because of smaller slates but also thanks to cost cuts.

News Corp. overcame a 9% film-revenue drop as the unit's profit rose more than 7%. TW, meanwhile, offset a 7% revenue decrease to boost film-unit profit by 17%.

TW touted reductions in print and advertising expenses, restructuring charges and overhead costs. In its earnings call, management mentioned a key contributor by name: last year's folding of the New Line label into Warner Bros.

Overall, expense reductions pleased Wall Street. This won't be popular with people in the industry, but the Street cheered the expense trends.

"Many of these companies proved to be better cost managers than expected," Sanford Bernstein analyst Michael Nathanson says. "This is truly a positive that led to positive earnings revisions at (ad-agency conglomerates), Disney, Discovery and News Corp."

Cable network owners benefit from reductions quickly, he argues. These assets have "relatively stable revenue pools due to the contractual nature of their business, and both have grown nicely over the past cycle and have probably built up a higher degree of discretionary costs than the newspaper, TV station and radio owners."

Expense cuts should help media giants in the coming quarters and as the economy recovers. Collins Stewart analyst Thomas Eagan says TW's cuts bode well and "should help improve film margins throughout 2009."

Once the economy begins growing again, other units also could see outsized benefits.

"The power of positive operating leverage for ad-based businesses that have permanently cut costs will become more transparent," Barclays Capital analyst Anthony DiClemente says.

Wunderlich Securities analyst Martin Pyykkonen points to CBS as a benefactor. "CBS' cost-reduction efforts for the TV segment should have a positive (bottom line) impact in the second half of 2009" and beyond, he says.

One key question that didn't come up much is whether companies might be shooting themselves in the foot with expense cuts, hurting their product or competitiveness. Some CEOs, including Disney's Robert Iger, emphasized that they remain committed to producing high-quality content.

Analysts mostly ignored the issue, though Pyykkonen warns that CBS' decision to reduce 2009 capital expenditures -- which, unlike expenses, are one-time capital outlays -- from a planned $350 million to $275 million-$325 million could hurt longer term by cutting back on things like high-margin digital billboards.
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