Risks in Buying NBC Universal Include Broken Peacock Network

The escalating risks associated with buying NBC Universal or any traditional media conglomerate -- which includes declining TV stations and broadcast networks -- is why Comcast will likely settle for a 51 percent stake in the company, for now.

Corporate parent General Electric is in talks to spin off NBCU into a private company to which Comcast would contribute an estimated $6 billion in content assets and about $7 billion in cash. Although GE's 80 percent ownership would be reduced to 49 percent, it would accrue NBCU cash flow on its balance sheet and could transfer an estimated $12 billion in debt to the stand-alone entity, sources said. A report on NBCU-owned CNBC confirmed some of the details being discussed with Comcast, the nation's largest cable operator.

The talks are the result of Vivendi SA's anticipated sale of its 20 percent stake in the media giant in a November options window created when NBC acquired Universal from the French company in 2004. GE also has talked to other interested suitors including Time Warner, whose ownership of Warner Bros. and Universal studios could prompt anti-trust concerns.

Vivendi's stake is worth an estimated $4 billion, or half of its previous value, according to Bernstein Research analyst Steven Winoker. Both Vivendi (which can retain its stake until 2016) and GE (which is resetting its GE Capital, jet engine, medical equipment and other technological businesses) are interested in non-media consolidation and expansion.

In a recovering market, most analysts expect GE to buy back the 20 percent stake or flip it to another third-party equity investor (Providence Equity Partners and John Malone's Liberty Media also have been mentioned) in preparation to spin-off or even sell all or part of NBCU, as I reported last week. Falling media valuations and the digital destruction of old business models makes this a tenuous time to publicly spin off NBCU, whose estimated $35 billion market cap is less than one-third of what it was in better times. GE acquired NBC for $6.3 billion in 1985.

What Comcast, Time Warner and other well-heeled suitors are really after is NBCU's cable networks (including USA, MSNBC, CNBC and Bravo), valued at about $22 billion. Although its popular cable networks generate only one-third of overall revenues, they account for more than 60% of NBCU's total earnings.

The suitors would prefer to avoid the NBC TV network and stations, once considered the company's crown jewels. Broadband, interactive content, social networks and all things digital have changed that.

Under another scenario considered earlier, GE could sell Universal Studios, possibly to cash-rich Time Warner for between $8 billion and $10 billion, which would yield the funds to buyback Vivendi's stake. Time Warner (owner of Warner Bros. studio and cable networks led by TNT, TBS and CNN) has repositioned itself as purely a content company by spinning off its cable systems and AOL.

The plan being explored with Comcast must avoid jeopardizing the cable company's credit rating and cross-ownership challenges to NBC TV stations in cities such s Philadelphia, Chicago and San Francisco where Comcast has cable systems. It would likely draw the ire of Comcast shareholders, who have objected to management's desire for major content acquisitions. Comcast shares fell seven percent on the news Thursday.

The challenged existence of traditional media conglomerates makes the potential sale of NBC Universal very different than when Comcast made its failed $49 billion bid for Walt Disney in 2004. Comcast has continued making smaller content acquisitions and owns E! Entertainment, Sprout, Golf Channel and Comcast Sports.

Even as GE ponders whether to retain NBCU, it know it must modify the media giant's structure and focus to make it more financially viable. It has considered converting NBC TV into one or more cable networks supported by subscriptions and advertising.

It is imperative to get NBC away from the deteriorating broadcast model no matter who owns it. "NBC has been a share loser in a segment of the TV market that itself is losing share," Winoker observes. Any prospective buyer of NBCU must consider that as well as other risks which will adversely impact its value and could ultimately cause its break up. They include:

• The NBC TV network and stations are in a free fall: The NBC TV network, which is fourth in prime time ratings, wrote an estimated $1.5 billion upfront advertising sales - a 21 decline from the prior year on 11 percent less inventory. NBC-owned local stations generate 11% and its broadcast network generates 25% of NBCU's overall revenues, but only a combined 14% of earnings. Contributions from the NBC TV network and stations in 2009 will shrink to $893 million of NBCU's overall $2.56 billion in operating income.
• The broadcast TV business continues to deteriorate: The big four broadcast TV networks sold about $2 billion less in upfront advertising this summer, or one-fourth less than 2008. Only a portion of those losses will be recouped in the scatter market (when ads are sold closer to air time) or even in Olympics and election-bolstered years. A mere five percent increase in Big 4 network unit prices and a continuing five percent in audience erosion could result in another six percent decline in their overall 2010 advertising revenues, according to Credit Suisse analyst Spencer Wang.
• Cable can only do so much to offset declining TV and film revenues: Cable networks, NBCU's only real growth business, will outperform an average three percent growth in cable network advertising in 2010 and six percent annual growth long-term. But that will barely offset double-digit declines in broadcast TV and films.
• This is NBCU's worst year ever: NBCU's overall revenue growth will decline a record ten percent in 2009 and will not gain more than 4% annually over the next five years even with exclusive Olympics telecasts and election-year advertising, analysts say. The lion's share, or $2.34 billion in operating income, will be generated by its cable networks. The film studio and theme parks combined will generate $795 million in of operating income, according to JP Morgan analyst Stephen Tusa. In the second quarter, NBC Universal posted a 41 percent drop in second-quarter profit to $539 million from a year earlier on dramatically lower earnings from broadcast television and its cyclically waning film studio. Broadcast posted a loss on a nine percent decline on revenues of $1.4 billion, while the cable unit's profit climbed seven percent on a three percent increase in revenue.
• Media values continue to bottom: The strained economics of NBCU's non-cable businesses are reflected in their declining values. NBC TV network and owned stations are valued at about $6.3 billion, films and parks $5.4 billion and its digital operations about $250 million, Tusa estimates. That presents a major obstacle to publicly spinning off NBCU even as the IPO market revives. Bernstein estimates that media conglomerates generally trade at an average low seven-times multiple of ebitda (earnings before interest, taxes, depreciation and amortization).