AS CHANNEL 4 chairman Luke Johnson settled at his desk and flicked through the afternoon's headlines on the internet last Wednesday lunchtime, he could barely believe his eyes.
Staff across Channel 4 and rival firm Five were left choking on their post-lunch lattes as headlines about a merger with ITV, proposed by its colourful chairman Michael Grade, stared up at them.
In an instant, Johnson's inbox bulged with worried e
-mails about whether he or Channel 4 chief executive Andy Duncan knew anything about the proposed merger.
It was a similar story across London at Five's headquarters in Covent Garden where chief executive Dawn Airey was midway through a busy day of meetings.
Looks of bewilderment crossed the faces of the two broadcasters' most senior executives as they made several hasty phone calls to ascertain the source of the story.
Their inquiries drew a blank. It appeared Grade had bowled them a googly by proposing to the communications minister Lord Carter of Barnes that ITV, Channel 4 and Five be allowed to form a "super commercial broadcaster" without first discussing the proposal with his counterparts.
A Channel 4 spokesman quickly dismissed the idea, saying it had held no talks with ITV about a merger. Privately staff at both broadcasters expressed their fury and it wasn't long before allegations were flying off the record, alleging ITV was trying to use the story as a smokescreen for its forthcoming annual results, due out on Wednesday.
Speaking the following day at a media summit in London, Johnson said he would rather see embattled Channel 4 fully privatised than be forced to merge with a rival. He called a merger with Five or ITV "part privatisation by stealth", adding: "I fear that part privatisation by stealth of Channel 4 would mean there could only ever be one buyer for the rest – at a discount – and the taxpayer value would therefore be destroyed."
The City was similarly unimpressed. Leading media analyst Paul Richards of Numis Securities dismissed Grade's idea as "pie in the sky", and it was quickly pointed out that the creation of a "super broadcaster" was impossible for competition reasons.
Analysts argued that a merged entity created out of ITV, Channel 4 and Five would monopolise 70% of the television advertising market and 40% of TV viewing.
"It was very much just a brainstorming exercise," said Charles Stanley analyst Sam Hart. "The main impediment would be the competition issue. You just have to think what controversy was created when BSkyB acquired a 17.9% stake in ITV. They have been told to downgrade that to below 7.5%. It would then be incredibly strange to encourage ITV to merge with Channel 4 or Five or both."
Amid the furore, ITV stressed that the proposal, which was submitted to Carter as he mulls how to support cash-strapped Channel 4, was an attempt at "blue-sky thinking" as the television industry faces unprecedented challenges during the recession.
But the fact that Grade, who returned to the broadcaster as chairman in January 2007, would even countenance such a radical idea quickly set City tongues wagging. And as shareholders look ahead to the company's 2008 results on Wednesday, serious questions are being asked about what awaits them.
Investors are aware the broadcast industry has been plagued by difficulties for months but even so, analysts are warning shareholders to expect a "savage" session when Grade faces his inquisitors.
Last September ITV cut 1,000 jobs as it adjusted to the new advertising climate under the recession. Grade cautioned that advertising, which accounts for 70% of ITV's total annual revenues, would fall by 9% in 2008, but all eyes will fall on figures for the first few months of ITV's current financial year. Analysts suggest advertising revenues may have collapsed by as much as 20% in recent months, and Grade will be forced into some pretty desperate and substantial cost-cutting measures to balance the books.
First to go will be the dividend pay-out to shareholders. Last year ITV halved its interim dividend but Jeffries International analyst Nick Bell says this will now have to be reduced "pretty much to zero".
STV, which is part of the Channel three network, has not paid a dividend since 2006 and is still contemplating whether to reinstate it this year. But Numis analyst Paul Richards expects the ITV dividend to be just the tip of the iceberg. He suggests Grade will announce a major cost-cutting strategy on Wednesday which will leave few areas untouched – including his treasured £1bn programming budget which he hoped would lead to a "content-led recovery" when he took back the reigns at ITV two years ago. There are already reports that some of ITV's best known talent, in particular Ant and Dec, hosts of the hit show Saturday Night Takeaway, are negotiating with other broadcasters in anticipation of budget reductions.
At the end of last year, ITV management hired the Boston Consulting Group to suggest where it could slash costs further, and the devastating fruits of that exercise are expected to be laid bare this week. "The advertising environment has deteriorated sharply since last autumn," Richards of Numis says. "We expect ITV to unveil a strategy of how to cut costs to compensate, with possible courses of action including its programme budget, online investment and general overheads. Although ITV has a solid liquid position, its debt and pension obligations are sizeable and we believe the group will consider non-core disposals, passing the dividend and a capital raising."
He added: "We expect another round of staff and general cuts; the last round saved £35m."
Rumours are leaking from ITV's headquarters in Gray's Inn Road in central London that a further 500 jobs are on the line, further reducing the broadcaster's workforce to 4,000 from 5,500 at the start of last year.
Some analysts suggest Grade will also hang the 'for sale' sign on several of the company's subsidiary businesses including the social networking website Friends Reunited and its Freeview arm SDN.
It is believed SDN, which rents Freeview slots to other broadcasters such as Five and QVC, would be the more profitable option as it has been valued at as much as £200m.
The disposal of Friends Reunited is also thought to have been brought to the table by Boston Consulting Group, but Sam Hart of Charles Stanley questions how much its sale would actually help the broadcaster's finances. Friends Reunited was bought in 2006 at the height of the frenzy over social networking sites such as My Space and Facebook for £175m. But now the site, which was once described by Grade as "one of the great unsung jewels in the crown", is thought to be worth £80m in the best case, and £20m in the worst.
"I don't think the sale proceeds would be particularly significant in the group context," says Hart.
He also suggests Grade will turn to a rights issue as a last resort. There have been rumours that management could seek to raise as much as £300m from shareholders but Hart warns there is little appetite for rights issues in the current climate.
Nevertheless, it's clear Grade will have to make some tough decisions this weekend as he finalises his strategy going into Wednesday's shareholder meetings.
In addition to the collapse in the advertising market, there are concerns over ITV's swelling pensions deficit.
The deficit currently stands at £221m. However, it is believed this is likely to rise to £300m at the next valuation while net debt is valued at around £750m. Analysts say the chairman will have no choice but to urgently address the widening chasm between debt and earnings as pre-tax profits for 2008 are tipped to come in at around the £140m mark, down from £188m last year.
As one analyst put it: "It's going to be grisly."
The full article contains 1328 words and appears in Scotland On Sunday newspaper.
