Ratings factor: Weighing correlation to ad growth

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NEW YORK -- TV ratings momentum -- usually not a major focus in Wall Street reports -- featured prominently in two analysts' notes last week.

Oppenheimer & Co. analyst Thomas Eagan initiated coverage of Crown Media Holdings Inc. with a "buy" rating on its shares and a price target of $9.25, citing positive ratings trends at the company's Hallmark Channel.

And Bear Stearns analyst Spencer Wang provided an update on the second-quarter ratings trends at Viacom Inc.'s cable networks and looked to a ratings recovery at Discovery Communications for guidance on the likely financial trajectory at Viacom.

The big entertainment company's ratings in the second quarter have remained "soft," according to Wang, but he added that "revenue growth has less downside than ratings due to subscriber and (advertising rate) growth."

In Discovery's case, the correlation between ratings and ad growth is only 40% at best, the analyst estimated. "In addition, qualitative factors such as long-standing relationships between ad buyers and sellers and the mix of advertisers can mitigate ratings weakness," he argued.

Overall, he concluded that thanks to "a strong scatter market and robust growth in digital," and despite the continued ratings challenges, Viacom is "on track to meet or exceed" his 5% U.S. ad growth estimate for the second quarter.

But what about the expense side of the ratings equation?

"As Discovery Communications reinvested in programming to restore ratings, costs grew 9% year-over-year, which is consistent with our 8%-9% expense growth estimate for Viacom," Wang said.

Recent staff cuts provide a cushion for the company's margins, he added.

Meanwhile, Eagan had fairly bullish comments on another TV player.

"With gains in ratings driving ad revenue, Crown Media is in the midst of a turnaround that we expect will be further driven by contract renewals ... for more than half its sub base," he wrote in a report.

He predicted the firm will reach operating and free cash flow break-even in the fourth quarter, allowing it to pay down its "considerable" debt.

"The stock's doubling in 2007 reflects the start but not all of the turnaround," Eagan suggested. "The Crown shares do not seem to reflect the potential for affiliate fee increases at the next round of carriage renewals."

These could provide "significant upside to our forecasts and therefore our valuation," he said.
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