QUALIPORT
Why Radio Is Great For Buy And Hold

By Maynard Paton (TMFMayn)
October 14, 2002

Commercial radio is a great sector for long-term shareholders. A licensing procedure restricts the impact of industry newcomers, so giving the major players a definite 'franchise' feel to their businesses. Radio is also a visible industry for the ordinary investor, with market shares and operational performances easy to keep track of. With Qualiport company Emap (LSE: EMA) and watch list member Scottish Radio (LSE: SRH) both having substantial radio interests, this article outlines the background and investor attractions of the industry.

Background noise

Commercial radio began life thirty years ago when the 1972 Broadcasting Act sanctioned the creation of five independent local radio stations. The first of these stations, LBC, went on air during October 1973 and Capital Radio (LSE: CAP), Radio Clyde, BRMB and Piccadilly Radio all commenced broadcasting soon after. By 1980, 19 stations were up and running and the 1981 Broadcasting Act allowed the network to increase to 69 stations. However, the 1990 Broadcasting Act provided the major catalyst for the industry's growth. A new, independent and self-regulatory system was implemented, all overseen by the Radio Authority (RA).

Importantly, the RA was given a free hand in deciding when and where new licenses could be issued. As well as relaxing station ownership rules, the 1990 Act also introduced the concept of tradable radio licences and prompted a rash of takeovers during the early 1990s. The requirement for stations to simulcast on AM and FM frequencies was done away with, while the nine-minutes-per-hour advertising limit and the pre-vetting of programming schedules also disappeared. The launch of a unified industry marketing strategy and a new audience research system (RAJAR) also contributed to a quantum leap in commercial radio's fortunes.

Since 1992, the number of analogue AM and FM stations has doubled from 130 to over 260. However, commercial radio's share of all UK advertising has also doubled (to about 6%) over the same time. Recent figures from RAJAR showed commercial radio having a 45% share of listening hours, with the BBC having a 53% share.

License to play

Why is commercial radio so good for long-term investors? In short, rivalry between competitors is restricted because a licence is required to broadcast.

As the RA state: "The radio spectrum (the frequencies on which services are broadcast) is a scarce resource; therefore, the Government has empowered the Radio Authority to plan and manage its use for the commercial radio sector"

"There are more people who want to broadcast on a 'permanent' basis than there are frequencies available. Successive governments, therefore, have concluded that the fairest way is to hold a competition that is open to anyone who wants to apply for the license. Although new digital technology will make more efficient use of the spectrum available, demand will still outstrip supply for the foreseeable future for most regions of the UK"

When awarding a local analogue licence, the RA is required to consider:

* Whether the proposed service will broaden listener choice, and;
* Whether the applicant has the appropriate financial resources to sustain the service for the eight-year licence period. Indeed, the RA "will always attach much importance to evidence of an applicant's ability to maintain the service -- without which, excellence in other areas will be of little avail".

Both of these criteria are good news for incumbent (and usually mainstream) radio players:

* 'Broadening listener choice' often means new entrants are niche or specialist stations, who won't steal a rival's advertisers by simply replicating their broadcasting formats, and;
* 'Appropriate financial resources' restricts small start-ups entering the fray and limits desperate advertising rates from cash-strapped newcomers.

Radio saga

A good example of 'broadening listener choice' and the benefits of being an existing broadcaster comes from the local license award for the East Midlands, announced in June. Fifteen applications were received, with the RA's Members declaring:

"The licence award decision was closely fought between applications of impressive quality proposing to serve the youth audience in the East Midlands and those targeting an older listenership, both of which would widen choice. After lengthy consideration, Members concluded that Saga Radio's proposals would do the most to broaden choice."

"Members considered that the audience research undertaken by Saga Radio provided thorough and compelling evidence of the need for a commercial radio station for the over-50s...Members noted that the proximity of [Saga's] West Midlands service provided numerous operational synergies which would benefit the station and listeners in both areas"

In addition, the 1990 Broadcasting Act specifically emphasised diversity and financial resources when it sanctioned three national commercial stations. Two of the stations had to be non-pop music-based, with one of them to be predominantly speech-based. Furthermore, all had to be chosen on a highest cash bid basis.

Although analogue licenses run for eight years, renewal appears to be a formality. Over the past four years, no local incumbent broadcaster has failed to have their license renewed, even though rival operators often put in competing applications. Indeed, 42 local analogue stations had their licenses automatically renewed during 2001 under the 1996 Broadcasting Act, which allows renewal if the station provides (or makes a commitment to provide) a digital service.

Who's who

The table below highlights the major listed players within the radio industry:

Company           Year    UK Radio/     UK Radio   UK Radio
                  End    Group Sales     Sales    Op. Margin*
                             (%)         (£m)        (%)   

Capital Radio     Sep 01     99          122.2       29.9
Emap              Mar 02     10           90.0       36.7
GWR               Mar 02     87          111.2       21.5
Chrysalis         Aug 01     23           44.0       16.4
SMG               Dec 01     10           27.9       37.6
Wireless Group    Dec 01    100           31.1        n/a
Scottish Radio    Sep 01     43           34.2       31.0

(*Excludes exceptional items and digital expenditure)

Apart from The Wireless Group (LSE: TWG), which owns the loss-making national talkSPORT station, the high margins evidenced elsewhere confirms the 'franchise' nature of a commercial radio broadcaster. Although the advertising market has deteriorated throughout 2002, robust operating margins are still exhibited. Capital Radio, for instance, reported operating margins of 23% in its latest interim results, where "difficult trading conditions" saw like-for-like revenues fall 7%.

Digital

The future of commercial radio revolves around the gradual switch from analogue to digital. It's a major change -- which could upset the industry applecart. However, the take-up of digital radio licences should reassure current shareholders. Every digital 'multiplex' awarded so far has gone to one of (or a consortium dominated by) the leading analogue players, with few (if any) 'outsiders' even putting in an application. No doubt the existing programmes, services and experience of the major players has discouraged newcomers, especially as the RA assesses applicants on the proposed timeliness of providing the new digital stations.

By snapping up the local digital multiplex licences, the existing players will almost certainly retain their sector leadership. Multiplex owners will effectively be the gatekeepers of digital radio, with new stations having no option but to broadcast through a multiplex in the years to come. What's more, the multiplex licenses have come cheap: annual fees of between £100 and £8,500 are currently being paid over the first twelve-year licence period.

Digital radio remains a fledging operation at the moment and just how profitable it becomes is anybody's guess. The BBC has forecast 45% of all radio audiences to be using digital by 2009, while the RA expects digital to bring up to 24 different stations to listeners in major areas. The ability of digital radio to also send data to listeners may also have additional revenue implications.

Summary

Overall, UK commercial radio is a great industry for long-term investors. Even with extra stations, the proliferation of television channels and the growth of alternative media, the past decade or two has seen the sector continue to improve its share of advertising spend. In addition, commercial radio is dominated by a handful of players, which given the licensing and renewal procedures and digital multiplex take-up, looks set to continue well into the future.

The major risk for radio shareholders is an aggressive acquisition strategy. The forthcoming Communications Bill will allow another round of consolidation to take place and some of the smaller players will surely lose their independence. However, as SMG (LSE: SMG) and GWR (LSE: GWG) have discovered, buying rivals at too high a price will cause problems if trading conditions deteriorate and assets have to be sold to reduce debts. Notably, Qualiport member Emap did not partake in the top-of-the-market scramble for radio companies a few years ago.

More: The Radio Authority website