What's not there yet key to media future

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CHICAGO -- Media deals are taking on new importance because they not only are reflecting but reshaping the nature of an industry that is in the throes of major transformation, one that eventually will render new formulas for valuations and new business models.

The fact that media deals are being proposed on the basis of new expectations in an evolving digital broadband marketplace, using more traditional, older metrics, could cause some problems in the interim. Add to that such new change agents as the intensifying grip of private equity, accelerated consolidation and dramatic new competition and consumer choice, and wheeling-and-dealing across the complete media spectrum -- from newspapers to the Internet -- is taking on new complications.

To be sure, price and terms always will be at the heart of all mergers and acquisitions. But determining price and terms isn't what it used to be in a media world in which the business of entertaining, informing and communicating is being redefined. Media deals today have the potential to set new operating and investment precedent as billions of dollars in shifting valuations, revenue and profit are on the table in a high-stakes game involving founding old-media executives, high-tech industry newcomers and an intriguing array of investors.

This certainly is true of the proposed $5 billion XM and Sirius Satellite Radio merger of so-called equals, which is challenging government regulators, shareholders and the media marketplace with the notion that changing competition, technology and economics justify the creation of a single, dominant media category provider.

Supporters of the deal argue that hardly seems a threat when one considers the alternative ways for securing free-flowing music of choice, including streaming music on the Internet and music downloads to numerous devices. Despite widespread anticipation of high hurdles to regulatory approval, the pertinent question might be whether the FCC, wrapped in a self-proclaimed campaign against media indecency, will be sufficiently enticed by the notion that a merger of XM and Sirius would provide a strong enough economic base to make Howard Stern an a la carte (rather than mandatory) offering for millions of satellite radio subscribers who would be allowed to select specific satellite radio options on the basis of their personal music and talk preferences. That could lead to a similar business model for subscription television programming, something cable and satellite operators have been fighting for years.

The prospect that a transforming marketplace might actually create some lucrative new business models is now a backdrop to all media deals, even if they can't be quantified or even identified. Bernstein Research analysts expect routine "merger politics" to prevail in the case of the proposed XM/Sirius merger in what "promises to be a political circus in Washington, replete with self-interested posturing, fatuous windbaggery, gratuitous grandstanding and ... (yes even) Howard Stern," Bernstein analysts wrote.

But in the new-media environment, it could be that less might be more. While Bernstein analyst Craig Moffett does not prescribe to the "merger or die" sentiment that is bolstering the satellite radio stocks and currently gives the proposed union 50-50 odds, he concedes that "there is no question that a merged satellite radio entity would be stronger and more profitable than the two companies in question."

Washington regulators didn't see things that way just a few years ago, when they rejected the proposed merger of equals between DirecTV and

its only rival, EchoStar Communications. However, the media marketplace has begun changing just enough since then that an FCC and Justice Department review of XM-Sirius will have to be different. That has some in Washington scared, suggesting that an XM-Sirius review will open the floodgates on marriages of so-called equals on the notion that the digital marketplace will provide the necessary checks and balances against monopolies by relying on Internet bypass.

Even though the digital marketplace might or might not be up to the task just yet, the perception is there, and sometimes perception is everything. But just as emerging digital broadband technology giveth, it also taketh away.

For instance, the growing fuss over Google's YouTube and other Web video content funneling directly to consumers without flowing through cable and satellite operators smacks of the Internet's bypass of traditional media players that can challenge the value and earnings projections of companies that can suddenly become entrenched in dealmaking. While media companies in all sectors are struggling to work out such fundamental logistics, private-equity players are flooding the market with deal money.

Bernstein analyst Michael Nathanson calls the infusion of private equity the "great equalizer for purchasing assets at multiple in excess of public value due to their willingness to embrace non-investment grade debt leverage of eight to nine times." To be sure, private equity is basing its moves on existing business models, projections and economics that could be rendered obsolete as it moves into media companies minimizing costs with the intent of maximizing quick returns on their investment.

Whether that plays havoc with some media companies' ability to embrace the new rules of play, private equity will leave a formidable footprint on media and other industries based on the more than $700 billion in capital these firms have available, according to the Private Equity Council, a trade group recently created by the likes of Carlyle Group, Kohlberg Kravis Roberts, Apollo Management, Bain Capital and Blackstone Group. (Carlyle and KKR are members of a consortium of private-equity firms that own Nielsen Co., parent company of The Hollywood Reporter.)

About nine buyout firms have raised at least $100 billion, available for future media deals. And private equity already reaches deep into Hollywood, where more than $4.5 billion has been invested in movies the past two years, according to Wall Street sources.

Shareholders of such public media companies as Tribune Co. and Clear Channel Communications should be wondering aloud about the disparity in value that might be paid not by private-equity buyers and the value creation yet to come since the usual modus operandi is to cut costs and increase profit for a reasonable return on investment.

The other relatively new force to be reckoned with in media deals is well-heeled new-media players who can change the course of competition and industry financials based on their acquisitions and investments. These new-media buyers usually operate under an entirely different set of intentions and expectations.

Google's $1.65 billion acquisition of YouTube was meant to get ahead of the Web TV video curve and has since become tangled in network television copyright infringement issues.

Lest we forget that the Internet's relatively brief history is dotted with pricey deals that failed to deliver much if any actual long-term value to the buyers: eBay's $2.6 billion buyout of Internet telephone services provider Skype; Terra Networks' $4.6 billion acquisition of Lycos; Yahoo!'s $3.6 billion acquisition of GeoCities and $5 billion acquisition of Broadcast.com; and Time Warner's priceless 2000 merger with AOL. They all failed to deliver any reasonable return on investment that News Corp.'s cost-effective $525 million acquisition of MySpace delivered in less than one year by embracing a new user-generated content business model.

Although financing is plentiful, and media's future is promising, many companies might rely more on strategic partnerships and limited investments rather than outright mergers and acquisitions until some of the new business models and metrics shake out. No matter which end of the deal you're on, in the nascent new-media world, there are few sure things.
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