Viacom: Too Addicted To Ads?

They're highly volatile as an income source, and that makes investors nervous

Viacom Inc. has a lot to prove these days. For 18 months, the media giant's stock has languished, dragged down in part by its tepid showing in Hollywood and in radio. But if investors are looking for a big move from Viacom (VIA ), President Mel Karmazin doesn't hold out much hope. Ever the contrarian, Karmazin insists he's sticking to what earned him his stripes with Wall Street: selling ad time as fast as he can, even if that unpredictable business makes shareholders nervous. "Our dependency on advertising shows that we are focused," says the 60-year-old exec.

But the world of Big Media is a volatile place -- just four years after then-CBS Corp. Chief Karmazin and Viacom Chairman Sumner M. Redstone merged their companies. The collapse after September 11, the worst ad recession since World War II, revealed a new level of uncertainty in the business. And now, Rupert Murdoch's acquisition of DirecTV and Comcast's (CMCSK ) hostile bid for Walt Disney Co. (DIS ) are forcing execs to reconsider the power of content-and-distribution combos. Yet Viacom, which could end up being the last big pure-content company, continues to swim boldly against the tide. The strategy: Offer a broad cross-section of outlets for ads, from network TV to billboards, so that they are hedged against each other. Says the 80-year-old Redstone: "Advertising is the fastest-growing area of media, and we can offer what no other company can: many platforms and programming."

In fact, if the company successfully spins off or sells its Blockbuster Inc. unit this summer, Viacom will go from being 45% dependent on advertising for revenues to about 60%, the largest reliance among the media giants, including News Corp. (NWS ), Time Warner (TWX ), and Disney. Certainly, it shouldn't be tough to sell ads in 2004, with political spots and Olympics-related promos lifting total ad spending in the U.S. as much as 7%, estimates J.P. Morgan Chase & Co. (JPM ). But in the long term, with such exposure to advertising's cyclicality, Viacom could find itself increasingly vulnerable. "They're a bit of a one-trick pony," says media consultant Christopher Dixon, a Viacom shareholder. "Longer-term, this company really has to look for ways to diversify."

That single dominant stream of revenue could be a big reason why investors have been wary of the stock. Since October, 2002, Viacom's common shares are down 2%, to about $40, compared with a 30% rise in a Bloomberg index of 33 media stocks and a 42% hike in the Standard & Poor's 500-stock index. Making matters worse, big-time media investor Gordon Crawford of Capital Research & Management Co., whose moves are closely watched, has slashed his position in Viacom, dumping at least 30 million shares in the past six months. Crawford declined to comment. Karmazin says he plans to make a presentation to Crawford and his team in May to pitch Viacom's prospects.

Karmazin will argue that the Street is unfairly punishing Viacom for its success. Because the company has hit its own aggressive financial targets for so long, he says, missing a number draws outsize investor reaction. "There is an extraordinary discrepancy between our performance and our stock price," insists Karmazin. "Simply, we've done a poor job of managing expectations." Indeed, Viacom's revenues grew 8% in 2003, to $26.6 billion, and free cash flow rose 15%, to $3 billion, largely because of ad revenue growth at its hot cable networks, including MTV Networks and Nickelodeon. Overall, Viacom's ad revenue was up 8% in 2003, as an economic recovery started to revive ad spending. Karmazin says advertising will become even more necessary as companies dependent on outlets such as Wal-Mart Stores Inc. (WMT ) to sell their goods will need to advertise more to distinguish their brands amid the clutter.

Maybe so. But to see how much an advertising drop-off can hurt when those revenues are all you've got, look at Viacom's Infinity Broadcasting. The No. 2 radio group in the U.S., with 185 stations, has been stung by the slumping ad market in the radio industry. As a result, Infinity's operating profits dropped 3% last year, to $975 million. John Sykes, the longtime head of Viacom's VH1 channel, was brought in by Karmazin in 2002 to run the radio empire. Two years later, Infinity is looking to unwind some of the early initiatives by Sykes and then-Chief Operating Officer John Fullam, who was fired last year and replaced by radio veteran Joel Hollander. One of Hollander's first moves has been to add 200 more salespeople to drum up extra ad revenue. The efforts may be paying off. Some analysts think Infinity's ills may have peaked. In an Apr. 2 report, Merrill Lynch & Co. (MER ) analyst Jessica Reif Cohen projects Infinity's earnings could grow 8% this year.

BOX-OFFICE DUDS. At the same time, the minority of Viacom businesses that aren't ad-dependent have problems, too. Paramount Studios is at the top of management's fix-it list. Investors were encouraged recently to hear Chairman Redstone vow to pump more money into the struggling studio and to be less risk-averse in greenlighting movies. That can only help. Of Hollywood's 53 blockbusters (at least $100 million at the box office) in two years, Paramount produced only three. The list of duds is longer -- from the recent Meg Ryan boxing tale Against the Ropes to the second Lara Croft flick. It's no wonder Viacom Entertainment Group saw its operating earnings fall 24% last year, to $271 million. Says Chairman Jonathan L. Dolgen: "While we had some great success, a number of our films did not work. I'm not going to run from that. Sumner and Mel have told us that we'll have all the money we need."

Still, shouldn't Viacom be thinking about getting into more businesses that are less ad-sensitive, perhaps more subscriber-based? Distribution, such as cable and satellite, would give it breadth as well as leverage against competitors to negotiate prices for all of Viacom's programming. Karmazin insists that's not necessary. He cites the case of satellite distributor EchoStar Communications Corp. (DISH ), which, after pulling Viacom's channels off the air recently in a pricing dispute, put them back just 48 hours later. "I think that affirms that [ad-supported] content is a pretty good business," he says. Spoken like a man who's happy with his company just the way it is.

By Tom Lowry in New York and Ronald Grover in Los Angeles

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