ITV no longer has a monopoly on TV advertising but it may yet reverse its long-term decline.
In Mario Puzo's classic novel The Godfather, a businessman's desire for a monopoly was described thus "…like many businessmen of genius he learned that free competition was wasteful, monopoly efficient. And so he simply set about achieving that efficient monopoly."
What Don Corleone knew is that a business which owns a monopoly has a licence to print money because a monopoly enables its owner to sell its products at a price well above that it could charge in a more competitive market.
The television company ITV (LSE: ITV) used to have a monopoly of the UK television advertising market. That's ITV's big problem; its monopoly lies in the past having been underdone by multi-channel television. This is reflected in the share price with ITV's shares having fallen by almost 90% since early 2000. ITV's 2008 results were especially bad, showing a massive loss of 65.9p per share (much more than ITV's current share price of about 36p).
The big question is can ITV turn itself around? Consider the key figure in ITV's 2008's accounts, an impairment charge of almost £2.7 billion in respect of written off goodwill. If we treat this as a "kitchen sink write-off" and assume that it will not be repeated, we can remove it from the accounts so as to consider the remaining business. Doing so makes ITV's pre-tax profits 2.7p per share, putting the shares on a P/E ratio of around 13. This tells us that there is a profitable business underneath but can ITV adapt to the current business climate?
The death of a monopoly
ITV's business consists of selling television advertising and broadcasting programmes in order to attract people to watch its customers' advertisements. Thus ITV has to compete in the markets for both TV advertising and TV audiences.
When the regional ITV companies were established in the 1950s each one held a local monopoly so anyone wanting to advertise on TV had to use a regional ITV company. With only the BBC for competition and few alternatives for home entertainment this meant that lots of people watched ITV, so the combination of local monopoly and large audiences made the ITV companies a stack of money. However, in recent years ITV's monopoly has been obliterated by technological change and deregulation which have combined to flood the market with numerous competitors. The heydays when audiences of 20 million plus watched Coronation Street and Inspector Morse are long gone.
The regional ITV companies' monopoly first came under attack in 1982 when Channel 4 was established, providing advertisers with an alternative commercial broadcaster. Nowadays ITV faces significant additional competition for advertisers (and viewers) from Five, the satellite broadcaster BSkyB (LSE: BSY) and numerous other stations which broadcast via Sky's platform and the Freeview service. The spread of alternative media such as the internet and DVDs has also cut into ITV's potential audience over the last decade and the recession has led many firms to reduce their advertising spending which further hurts ITV's bottom line.
Unfair competition
If that wasn't bad enough ITV also has to compete for viewers with the BBC on a playing field that is about as level as the famous sloping pitch where Yeovil Town beat Sunderland in the fourth round of the FA Cup in 1949! The BBC directly competes with ITV for viewers by producing similar programmes whilst being funded by its recession-proof annual licence fee income of £3.3 billion. It's hard to cope with a massively subsidised competitor that's mostly impervious to making losses.
To sum up ITV's monopoly has been blown to smithereens and will not return. The question is can ITV bounce back?
Reality hits the TV business
The new television channels have hit ITV with a "double whammy" affecting both advertising and audience share. Other stations draw advertisers and viewers away from ITV creating a nasty positive feedback loop. As ITV loses viewers it becomes less attractive to advertisers leaving ITV with less money to produce programmes with which draw viewers to watch future adverts.
This is the main reason behind the proliferation of "reality TV", "clip shows" and makeover programmes on commercial television. It is far cheaper for ITV to make Pro-Celebrity Pet Makeover Challenge than to produce top-quality historical dramas such as Sharpe. Some people call this type of programming "dumbing down" but it reflects today's financial realities. Cheaply made TV that attracts viewers remains attractive to many advertisers and is thus quite profitable.
The Future
ITV estimates that the annual cost of its public service broadcasting obligations is about £220m which represents a massive drain upon the business. However, the recent announcement that ITV will receive some of the BBC's licence fee to meet these obligations is extremely significant and would go a long way to restoring ITV's profitability.
There are three scenarios to consider: ITV gets a chunk of the licence fee to offset its costs, ITV hands back its public service licence and stops analogue broadcasting, or the current situation continues. The first two are win-win situations for ITV, if the effect was to reduce ITV's costs by £100 million this would increase profits by 2.5p per share (i.e. doubling the underlying profitability of the business). The third is not so good for ITV.
ITV's focus on three new channels, ITV's 2 through 4, is a good response to its multi-channel competitors and enables it to make use of its massive programme library of classic shows such as The Sweeney and Rising Damp. Many of ITV's shows still attract large audiences and ITV is now run by Michael Grade who has an excellent track record in the television business.
If ITV can rid itself of its loss-making public service obligations, continues to adjust to the multi-channel market whilst producing cheaper shows that attract reasonably sized audiences, it might be able to dramatically improve from its current position.
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