Proceedings of the Standing Senate Committee on
Transport and Communications
Issue 11 - Evidence - June 12, 2003
OTTAWA, Thursday, June 12, 2003
The Standing Senate Committee on Transport and Communications met this day at 9:30 a.m. to examine the current state of Canadian media industries; emerging trends and developments in these industries; the media's role, rights, and responsibilities in Canadian society; and current and appropriate future policies relating thereto.
Senator Joan Fraser (Chairman) in the Chair.
[English]
The Chairman: Welcome to this meeting of the Standing Senate Committee on Transport and Communications, which is examining the state of the Canadian news media.
[Translation]
The committee is authorized to study the appropriate role of public policy in helping to ensure that Canadian news media remains healthy, independent and diverse, given changes in the media in recent years, notably globalization, technological change, convergence and concentration of ownership.
[English]
Today we have the pleasure of welcoming Tim Casey and Andrea Horan. Mr. Casey is Media Analyst with BMO Nesbitt Burns and Ms. Horan is Managing Director of Westwind Partners. They are both financial analysts covering the media in Canada, and therefore they will give us an overview of the financial situation of Canada's media industries.
Ms. Andrea Horan, Communications and Media Analyst, Westwind Partners: We were asked to give an overview of some of the financial metrics for the industry. We have split it up. I will be speaking on some of the revenue metrics for the industry, some of the pressures the industry faces and I have some comments on capital requirements. Tim Casey will cover profitability of the industry, convergence and the impact of debt. Advertising is really the key driver for the media industry. We have provided a chart of how major dollars are split up among the various media and, flipping forward to the next page, how the revenues are broken out between advertising and subscriptions. As a group, television attracts about a third of all major media advertising dollars. Of this total, conventional television represents just over three quarters. Conventional television generates almost all of its revenue from advertising, whereas specialty television generates 60 per cent of revenues from subscriber fees, actually 68 per cent if you include pay television.
The relationship between advertising and subscriber fees for specialty television has been reasonably stable over the past five years, but this reflects the introduction of new specialty television channels whose revenues are much more subscriber driven. As the channels become mature, they will get an increasing proportion of revenues from advertising. If you look at channels that have been around for the past four or five years, the proportion of advertising dollars contributing to revenues has increased 500 basis points.
About 40 per cent of all major media advertising dollars are directed at newspapers, and that combines daily with weekly newspapers. Depending on the newspaper, anywhere from 70 per cent to 100 per cent of the revenues are generated from advertising. The average for the group is just under 80 per cent, with subscription revenue and job printing making up the balance.
You can further segment advertising revenues into local, national and other. In the case of newspapers, that would be classifieds, and we have included a summary on the next slide of how that breaks out. What you will see is that specialty television generates almost all of its advertising from national sources. That is a function of the licensing requirements. Because they have national signals, they do not tap into local advertising dollars. Conventional television has a greater ability to tap into the local advertising dollars and gets about 20 per cent of its revenue from local sources.
Newspapers generate about 44 per cent of revenue from local advertising and only 23 per cent from national and the balance from classified. Radio is split almost three-quarters local and one-quarter national.
There was some hope that when the rules with regard to radio ownership were relaxed that the consolidation of radio properties might lead to them attracting a greater amount of national advertising. That has not been the case. The relationship has remained stable and radio's share of national advertising has been constant at about 4 per cent.
Trends have been reasonably stable over a long period of time, such that you are not seeing dramatic growth rates. Overall, advertising growth over the past 10 years in major media has increased at a compound annual rate of 3.4 per cent and the major media are plus or minus about 100 basis points off that average, with the breakaway being the specialty channels. We have seen specialty channel advertising growth at 20 per cent, and at the same time, subscription growth for specialty channels has been 18 per cent. Conventional television has grown at about 2.4 per cent. Newspapers have grown at about 2.5 per cent and have faced declining circulation revenues. They face dual pressures there.
Radio has grown quickly, at 3.9 per cent. That is over the last 10 years. If you look at the last five years, the growth rate has been about 5.5 per cent since the relaxation of ownership rules, but local revenues have largely driven that.
Probably the greatest impact on the industry has been the fragmentation of media choices. There are those that fragment audience attention, but not necessarily advertising dollars, and those that fragment both audience attention and advertising dollars.
In terms of audience attention, gaming has been successful in attracting a youth market. The Internet, although it has attracted a huge amount of audience attention, has not been successful in attracting advertising dollars. That relates to the fragmentation within the Internet itself. The proliferation of U.S. channels does draw away audience attention.
The Chairman: What do you mean by "gaming"?
Ms. Horan: Consoles like Sony Playstation.
Senator LaPierre: Golf, hunting?
The Chairman: You mean leisure activities focused on screen gaming?
Ms. Horan: Yes.
Senator Merchant: You said golf; there is a golf channel?
Ms. Horan: I am not talking about television so much as alternative forms of entertainment.
The fragmentation of advertising dollars takes several forms. There has been a proliferation of Canadian specialty channels. We have seen the number of specialty channels grow from 35 to 98 over the past five years, and over the last two years, 50 digital channels were added. New newspapers have been launched. That is primarily in the major markets like Toronto and Montreal, where we have seen the launch of free daily newspapers that have further fragmented those markets. New conventional television and radio stations have been licensed. We have seen new licences in Toronto and Vancouver. Hearings will start next week in Edmonton and Calgary. New radio stations are being licensed all the time as well.
The result is that advertisers have found it increasingly difficult to reach mass audiences. Given the industry's dependence on advertising, there has been a need to respond to that difficulty and the reaction has been twofold. On the one hand you have consolidation, which helps to re-aggregate audiences, and on the other hand there have been price increases in any medium that successfully manages to aggregate audiences. Over the last week, we have read press articles on the increased prices on popular prime-time programming.
The impact of the consolidation has been different for each of the industries. Within conventional television, while you have seen the WIC Network acquired and the consolidation of the CTV network, at the same time, you have seen the emergence of new national players like Chum, with licences in British Columbia, and now, potentially, Craig starting up a licence in Toronto, and new digital channels. You can make an argument that you could not get the launch of new digital channels without a strong base of media companies to support money-losing operations.
We have seen consolidation of newspaper ownership, but it is not as dramatic as you may think. Ten years ago, the top five controlled 88 of 108 newspapers, or just over 74 per cent of circulation. In 2003, the top five newspaper owners controlled 62 of 102 newspapers, or about 79 per cent of total circulation — not a huge difference. We have seen significant consolidation in radio since the relaxation of ownership rules.
There has been a question of the industry's need for access to foreign capital. Some have argued that the discounted multiples at which Canadian companies trade is a reflection of our restrictive foreign ownership rules. That implies that the gap between multiples would get arbitraged away as capital south of the border sought out less expensive investments. That argument ignores the reality that there is a different regulatory and tax environment in Canada versus the U.S. and there may be real reasons for that discount to exist, causing it to persist regardless of any changes in ownership rules. There is a perception that there is this wave of capital at the border, waiting to pour into Canada the minute that ownership rules are relaxed.
My own experience suggests that is not the case. When I look at media companies that are not subject to foreign ownership rules, such as printing and information publishing, it has been a challenge for those companies to attract foreign capital. These are companies that have great management track records and lots of U.S. revenues, leading market share and well-known franchises. That is not to say that the industry does not need capital. Maybe foreign capital is not necessarily a solution. The reason an industry needs capital could be twofold. They need it to maintain their current operations. That is not the case with media. Media generate cash. However, with any publicly traded company there is always pressure to grow. This is a relatively mature industry. The way they will grow is through acquisition, either domestically or internationally. Acquisition opportunities do not occur at regular intervals. You need access to capital because your current cash flow may not always be sufficient to handle your next acquisition opportunity.
While growth may not seem like an important public policy priority, the thing to remember at the end of the day is that capital is mobile. If we want public capital to support our media, we need to create an environment where media companies are allowed to grow and earn a good return on investment. If capital markets perceive media companies as risky because of an unpredictable or unfriendly regulatory environment, it will make those companies less attractive and increase their cost of capital.
Mr. Tim Casey, Managing Director, Media and Entertainment, BMO Nesbitt Burns: I will address the cost side of the business and talk about debt and investor expectation. We will touch on convergence.
On page 4 I will go over some of the costs and the trends. The main point I would like to leave with you is that media are fixed-cost businesses. That implies that there is significant operating leverage. We know that advertising is a barometer of general economic activity. As the economic cycle ebbs and flows and the economy grows and contracts, advertising activity follows those trends. These businesses have fixed costs. That means that as the economy improves, their profitability increases, and the reverse happens when the economy contracts.
The other truism about the business is that it does not require a lot of capital. Unlike the cable business or the printing business, you do not have to replenish your plant and equipment. You may have to do that in the newspaper business every 30 years, but it is not an ongoing cost of doing business. The capital requirements would be under five per cent of revenues.
What is an ongoing cost to the business is fragmentation. That means that there are only so many hours in the day, but we have more media options competing for our time. The companies are faced with a challenge. If they do not fragment their own audience, their competitors will do it for them. They have to re-deploy a certain amount of their profitability into growth businesses, which implies they will incur some operating losses in those businesses as they ramp them up from the start-up phase. We see that across any business sector. These businesses are mature and are being eaten away at the margin by some of the new competitors. They have to get into that game and take capital out of their existing business, a significant operating leverage in these companies and a high fixed cost.
Pages 5 and 6 provide some long-term operating market trends. In our business, we use EBITDA, earnings before interest, taxes, depreciation and amortization. That means the operating cash flow that you are producing from your business to pay taxes, service debt and provide a return to your owner. Page 5 illustrates the long-term profitability in the television business in Canada. This is public information generated by the CRTC. You can see that the conventional television business has suffered systemic margin erosion. There are cyclical variations. We see the trough in 1990-91 during a recession and a little dip in 1997-98. It is going in a southward direction.
The specialty television line — think of that as cable channels — generally shows a decline in average reported margins. That reflects all the new channels coming on, because new channels generate a loss, whereas older channels have a more stable level of probability. There are few of these companies that are pure plays. Most of the media companies in Canada — all the big ones — have a variety of businesses within their asset mix, so they are insulated from the "air pockets" that one might experience in an individual business.
Page 6 shows the radio business. There is a trough in the early 1990s because of the recession, but also a nice margin recovery. That reflects deregulation in the business in 1996. The CRTC introduced some rules that allowed operators to own twice as many stations in an individual market and the big operators in Canada doubled up. That permitted them to buy all the revenues of an in-market competitor with only half the costs. We have seen a decent recovery in the margins. It levelled off in the last couple of years. This is not to imply that radio is attracting market share away from some of the other media out there. They have got their own house in order because of some CRTC rules.
Page 7, 8, 9 and 10 outline the cost breakdowns of individual businesses. The most important thing is to recognize this fixed-cost aspect, except one note on page 9, which is the newspaper business; there is a more cyclical influence on the cost side because of the cost of newsprint. Newsprint and ink represent about a quarter of the cost of the business. It is much more volatile than any cost input on the broadcasting side. Newspaper profitability is generally more volatile than some of the other media. Interestingly, the newspaper business benefits from the decline of the U.S. dollar because newsprint is priced in U.S. dollars. Canadian operators are benefiting from the decline in the U.S. dollar.
I want to take a moment to talk about convergence. Fragmentation is the number one trend that we struggle with when we try to assess these companies. Three things bring it on: Digitalization, deregulation and globalization. I mean by that, as the content businesses went digital, as television companies are allowed to transmit their signals off satellites, as newspaper companies can transport their content across a variety of individual newspapers, it has allowed an explosion of content. At the same time, business has been deregulated around the world. The European television industry was deregulated in the 1990s, which allowed private entrepreneurs to come into what was a state-regulated business. That has provided a globalization trend. We have seen the big U.S. companies — the studio system, particularly, from a content perspective — really globalize their business. In Canada we have kept those forces at bay with our content regulations, but we are not immune to them. Our broadcasters buy product that is priced on a global basis. They are competing with these other media choices. That has caused a fragmenting effect and led the industry to consolidate. This has resulted in convergence. It means that operators are either consolidating horizontally — buying more media properties — or consolidating vertically, which implies they are buying distribution. AOL Time Warner was the marriage of content and distribution. It is my opinion that this trend will accelerate.
I was in Chicago at the National Cable Show, which is the cable industry convention. There are cable channels, operators and equipment suppliers. The cable industry is developing interactive models at an unprecedented pace. Television viewers will be able to interact with their TVs more in the future than they have in the past. That will provide a greater incidence of fragmentation. This trend will continue and the industry continues to evolve in trying to react.
Page 12 shows some share price charts of six companies that pursued a convergence strategy in the late 1990s and early 2000. It has been a difficult venture. This is not to say that convergence does not work; this reflects that the industry and the investment community oversold the idea to shareholders, and essentially, people paid premium prices at the top of a cycle. Capital is mobile. We had a recession in the last couple of years. The impact of September 11, 2001 impacted the media business. It has been a difficult time for these companies, but that is not to suggest that anyone has slowed down their consolidation or convergence strategies. They just no longer talk about it as a way to accelerate profitability.
Pages 13 and 14 are six simple pie charts that illustrate the revenue mix of six publicly traded Canadian media companies. These companies represent almost $7 billion in revenues. They are the backbone of the business. There is not one that does not have an integrated-media platform as central to its strategy. Even Torstar, which many of you may think of as The Toronto Star, has several media properties through which it distributes its content and attracts advertising. Convergence is here to stay.
On the debt side, we have just had a massive consolidation cycle. Many of these companies used debt to finance their acquisitions. There has been an overall increase in leverage.
Page 16 illustrates one metric that the investment community uses that compares debt to EBITDA. It measures debt versus operating cash flow as a measure of financial risk. I have highlighted the cable companies, which have a ratio of about 5:1. They have a stable revenue stream. The media companies — except for CanWest Global — are below that. None of these companies are bankruptcy candidates. They generate inherent cash flow from their traditional businesses. Nobody is facing any significant financial restrictions. The risk is economic. If there were a significant macroeconomic event that pushed the economy into recession, most of the companies on this list — particularly the media companies — would suffer top-line erosion and that would impair their ability to service debt.
We have seen some anecdotal evidence from some advertising markets, and it looks favourable.
We were asked to provide some assessment of what investors are looking for. The simple answer is performance. Capital is mobile. If shareholders perceive that they are not getting a return on their investment in the media business, they will pursue other opportunities. They do not have to have media in their portfolio. People who own shares in a mutual fund want the fund to go up. If they perceive that a regulation has been introduced that impairs the ability of media companies to generate a return that is competitive with other industries, that capital will flee. If you ask what is the number, I would say that the industry has a long track record of outpacing GDP growth and inflation in the context of cyclical variations. The industry produces free cash flow, which should mean an ability to pay down debt or increase dividends. Right now the stock market is probably discounting growth at about five per cent across the TSE as a whole. Investors are expecting a growth in excess of that.
Ms. Horan: One other thing I might add on the debt front is that often, people will look at leveraged companies and think they are taking action because they have this debt load that they have to service. It is important to remember that debt is the least expensive form of capital. It is less expensive than equity. The pressure to perform or generate cash is not greater when you finance with debt; it is arguably greater when you finance with equity. You have diluted yourself and the pressure is to grow faster.
The Chairman: Could you explain the meaning of "national advertising"?
Ms. Horan: National advertising is handled by a national sales force. If I use the automotive industry as an example, General Motors introducing a new vehicle would be a national ad, but a local dealership would be a retail or local ad.
The Chairman: The ads you can see all across the country?
Ms. Horan: Yes.
Senator Gustafson: My questions come from page 7, "fragmentation of audience only." My observation, watching my grandchildren and other young people, is they are on the Internet. I seldom see them read the newspaper or even watch the news. What will this trend do to the industry? Has it always been like that?
Ms. Horan: You are right that the youth market is difficult to reach. That is a key concern for media directors of advertising companies. The youth audience is not reading newspapers and the audience levels for television are not as great as they used to be; that has been a significant trend. That is why I mentioned gaming as something that has attracted youth attention.
Senator Gustafson: That trend is also at the university level. You do not see students reading newspapers, even in fourth-year university; can you comment on that?
Mr. Casey: We can look at the experience of the music industry. When Napster was introduced and altered the profit model, it left media operators quaking in their boots, particularly on the content side. The media companies are feeling their way through this. They know that fragmentation is unstoppable. There are a number of media assets geared to kids and university-aged people. There is no simple solution to it.
Senator Gustafson: It appears to me that when the Canadian public gets fed up with CNN, they turn to the BBC. How big an impact is globalization having on our media — or is it?
Mr. Casey: The television that most Canadians watch is regulated by the CRTC through the eligible list. The CRTC decides what channels can and cannot be on that list. As more people acquire a satellite dish or digital cable box their options will increase, but there will still be a gatekeeper. They are free to go on the Internet and read anything they choose.
Senator Gustafson: The dish is being used more in rural areas than in urban areas?
Ms. Horan: Satellite has increasing penetration in urban markets and digital cable is a primarily urban distribution means. Most Canadians still get their news from Canadian sources and look for a Canadian viewpoint, although there are those alternatives.
Senator Ringuette: In your table on page 3, composition of major media advertising dollars, you do not include Internet advertising dollars in your pie chart. Would you know what it is?
Ms. Horan: It is small, less than five per cent. I think it is $50 million.
Senator Ringuette: Of the total advertising in Canada?
Ms. Horan: It is about $50 million or $60 million, in that range. For example, television is about two and a half billion.
Mr. Casey: One of the things that we struggle with is that integrated media companies own many of the major Internet sites. You may go to The Globe and Mail Web site and see an ad. It is difficult for us to figure out when that ad is sold, whether it was packaged in with The Globe and Mail or CTV or someone was trying to buy over the Internet. That is a grey area.
Senator Ringuette: I would think that would be part of the revenue strategy for convergence, to add another medium to the advertising community.
Ms. Horan: I will mention that the Internet is such a fragmented market. Even though there are viewers on the Internet, it is so fragmented that it is not that attractive to an advertiser wanting to build a campaign. That is a problem.
Senator Ringuette: That $50 million to $60 million has moved from one advertising source or medium to the Internet. Would you know who is losing out on that dollar?
Ms. Horan: It is hard to track when it is that small. There has been some move of classified advertising to the Internet and the long-term trend for classified advertising is down significantly. It is hard to track where the cash is exactly.
Mr. Casey: On a long-term basis, daily newspapers are growing more slowly than other media, which implies they are losing market share. They may not be losing an ad to somebody else, but they are not getting the next ad.
Senator Ringuette: I would suspect that for the marketing industry, the consumer is identified as readership for both newspapers and the Internet, so I would tend to agree with your comments.
Senator LaPierre: We were told that convergence is the answer to the decreasing revenues and to the difficulties of traditional media. If you consolidate ownership of various means of communication — radio, television and newspapers — paradise will be yours forever?
Ms. Horan: At least it will not be certain demise.
Mr. Casey: It has been less than utopian for shareholders.
Senator LaPierre: It has not happened? We were sold a basket of nothing?
Ms. Horan: You can look at it as more of a defensive strategy than an offensive strategy. If they did nothing, things could have been worse.
Mr. Casey: I think it was oversold. If the hype had not been there, I do not think that "convergence" would be such a dirty word. It is a natural reaction in an industry that is facing these trends.
Senator LaPierre: Is convergence an argument for consolidation of ownership of media or is it a result?
Mr. Casey: I think it is a result.
Senator LaPierre: It is a result. In other words, companies did not go out to buy a whole lot of properties in order to converge. They bought a whole lot of properties because they wanted to, and it gave them a great sense of being the males of the planet. I just got back from Banff, where there was a big discussion about which came first, the great desire to consolidate and make money, or convergence.
Mr. Casey: I think Canadian companies have seen massive consolidation on the U.S. side. Their suppliers of content get bigger. They have seen buyers of their airtime get bigger. They had to consolidate just to keep pace.
Ms. Horan: There is a pressure to grow in what is ultimately a reasonably mature market. There is always pressure to find the next dollar, and it is easier and you are more likely to be successful buying in a market where you are familiar with the dynamics than trying to grow internationally.
Senator LaPierre: However, could it not be argued that the consolidation has created an immense amount of debt? This has been financed by accumulated debt. Look at the debts of CanWest Global and Quebecor. This debt has been accumulated to facilitate ownership, with the hope that the Canadian government will change its foreign ownership rules so that they can be easily sold to the Americans. The end result is that the companies with this immense debt are not fulfilling the Canadian content requirements of the CRTC. Yet they buy billions of dollars worth of American programming from Los Angeles that they play in prime time, and the Canadian people are paying for this nonsense that continues merrily on and for which there seems to be no rational economic reason.
Mr. Casey: I respectfully reject that.
Senator LaPierre: Why?
Ms. Horan: Rather than the Canadian people paying for the broadcasters going to Los Angeles, in fact it is the profitability of that American programming that pays for Canadians to see Canadian content.
There has been accumulation of debt in order to acquire companies. There was a lot of consolidation at the peak of the market. That created two problems: One, it made it difficult for these companies to substitute debt for equity because suddenly they did not have the equity currency and the capital markets were not there to replace debt with equity.
In the case of Quebecor, the plans were to sell set assets to finance some of the acquisition activity, and those markets collapsed. They could not sell Abitibi at the price they wanted. They could not sell their telecom assets at the price they wanted and Microcell went bankrupt. At the same time, we had a downturn in the economic environment. You have a high fixed cost, so a tiny downturn on the top line has a dramatic impact on the bottom line and reduces the ability to address debt through free cash flow, which was also impacted. The assumption of debt was more a result of bad markets, and they are still living under that.
Even though there is a lot of debt, it is still cheaper than equity. I am not sure that the companies' actions have been significantly different from what they might have been had they financed with equity.
Mr. Casey: The senator's comment that people are loading on debt for no economic reason and giving money to Hollywood is wrong. CanWest Global pursues a programming strategy that they have had for 25 years. They have not altered their strategy because they own newspapers. The only change since they acquired the newspapers has been a much better news product. Viewership of their nightly news has increased.
I do not see how it can be argued that Canadians have been ill served because they used debt to finance this acquisition and continue to pursue programming that produces profits and Canadians watch. The viewing habits of Canadians continue to be oriented towards U.S. programming. That is a fact. Quebecor buys an infinitesimal amount of U.S. programming relative to what they buy from anyone else.
Ms. Horan: It is interesting that through convergence, Quebecor has used all its properties to drive a key Canadian- based program called Star Académie, which was the top-rated program and had a 72 per cent market share when it aired. It was driven by promotion in their newspapers and video stores. It was a very compelling example of how convergence can work.
Senator Eyton: It is interesting to listen to this conversation, because our committee is focused on content and how can it be made better, and you are representing an industry focused on increasing profits and share price. There is a bit of a conundrum there.
I want you to comment on the current regulatory regime for media and broadcasting in Canada. Would you regard that regime as helpful or harmful?
What can that regime do to help our media? To my mind, you can only require greater investment and better news, including balance and public affairs, if you have the cash to sustain it. It seems to be coming together. The EBITDA numbers here reassured me. The share price has been a little less fortunate, but EBITDA seems reliable and capable of servicing the existing debt levels. Can you comment on the current regime — is it helpful or harmful and how may it be improved?
Mr. Casey: These guys are in show business and if there is no business there is no show, and if there is no show there is no business. They are profit-oriented businesses that need to attract readers and viewers. That will always be the case. We could say kindly that they are pragmatic business people. The less kind way to put it would be to say that talk out of both sides of their mouth, in that they like the CRTC rules that protect their businesses but they do not like the ones that restrict their ability to grow. I am not a public policy expert. I do not know how deregulating the CRTC will help these businesses, but from an investment perspective, less regulation will cause value to surface. That is not to say there will not be some roadkill along the way. Some businesses benefit more from regulation than others, but as a rule, stepping back from the regulatory perspective will create economic value. The public policy implications of that are for somebody else to answer.
Ms. Horan: To a large extent — I am going to talk more on the television side because that is where we see more regulation — the Canadian content is the cost of doing business. You see that in the margins, which are smaller in Canada than in the U.S. There is regulatory protection to help offset that and it is difficult to say what the right balance is. I think the capital market perspective is important because individuals' money is supporting these companies and if it dries up it will not be helpful to the industry. What is important for investors is predictability in the regulatory environment and not switchbacks. If there is a stable environment that can be counted on, then the people managing the business can make decisions around that and work out the best way to run a business in that environment, and investors can figure out what it is worth.
A shifting regulatory environment increases the risk profile, discourages investment and makes capital more expensive.
Senator Eyton: Broadly speaking, what are your current recommendations in terms of buy, sell and hold relative to the companies we are talking about here?
Mr. Casey: We think the sector has benefited in the latest rally. Given what looks like a half-speed recovery, we think there are some stocks that will go higher.
Ms. Horan: Are you asking to see if there is any bias to our comments or for personal investment?
Senator Eyton: No. I wanted to know how you felt about the industry from a financial point of view. What I hear is a hold or a buy in some situations; is that correct?
Ms. Horan: It is a question of where the industry is and the investor's view of the industry, which can create investor opportunity. The industry as a whole seems to be on a steady road to recovery. We are seeing reasonably good advertising growth and management continuing to focus on costs. In some cases, that is accurately reflected in the share prices, and in other cases I think there are opportunities. There are a couple that are overvalued and we have a sell on them, but it is not so much a comment on a failing industry as a valuation comment.
Senator Day: You made the comment that equity is more expensive than debt. Could you explain what you mean by that?
Ms. Horan: You can look at it in different ways, but let's look at required return. When money is lent to a company it is usually at prime plus a certain amount. Let us say these companies are financing at around seven to nine per cent. The required return from an equity standpoint is higher than that. You can look at the impact on earnings. Financing with debt will often have less of a negative impact on earnings per share than if you finance with equity, so that you have more shares outstanding.
Senator Day: You also said if you finance with equity there is greater pressure for higher performance because that dilutes the shareholdings?
Mr. Casey: Debt provides some shield against taxes because interest is tax deductible. The risk of debt is that it is a fixed cost and these are cyclical businesses; when there is a slowdown, your ability to service that debt shrinks because there is a direct impact on the top line that affects your ability to produce excess cash flow.
Senator Day: You also said that investors' dollars could move quite easily. It is fleeting. I think you said that regulations could cause investors to be skittish if they think that will impact on the enterprise's ability to make the profit that they are expecting. Having in mind Senator Eyton's comments with respect to the CRTC and their decision not to get involved in the Internet, we are trying to decide whether that is the right decision, whether there should be regulatory intervention, and if so in what regard. Are you suggesting to us we had better be very careful because the investor dollars could move as a result of any regulation?
Ms. Horan: It is not that all regulation is viewed as bad. It is just that to the extent that a regulatory decision is made without any care for profit, if that is the environment that investors perceive, they will not want to be involved because their interests are not being protected.
Senator Day: Going back to Senator Gustafson's comment about audience fragmentation, I understood you to say that is, to some degree, pushing or driving convergence of various media?
Ms. Horan: In order to re-aggregate.
Senator Day: Re-aggregate in order to reach the audience and get the advertising dollars that drive the profit?
Ms. Horan: Yes.
Senator Day: You mentioned gaming as one aspect of the fragmentation. I agree with my colleague that gaming is hugely popular with the younger generation. Are you seeing media moving into the gaming side or do you see that happening in the future?
Mr. Casey: Canadian companies do not have the capital to get into that business. We are talking about Sony versus Microsoft. That is a league in which Canadians cannot play.
Senator Day: What happens to the Canadian media as a result?
Ms. Horan: Right now, the advertiser has not been able to effectively spend in that area. It will be difficult for Canadian advertising dollars to get into gaming because it is much more of a global product.
The good news is that advertisers in Canada still need to reach people and those dollars are not gone. They have to live with reaching fewer people.
Senator Day: There are lot of business dollars trying to gain access. You mentioned Napster, and that worked because they were not paying copyright fees. That model is evolving on the Internet and, presumably, there will be models in gaming to gather revenues from various sources. Do you agree with that? In this digitized world, a lot will happen in the next while in terms of business models to obtain revenues that we may not perceive at this stage.
Mr. Casey: Absolutely, but once again, that business has significant capital requirements to build platforms, develop games and leverage off content plays that are well above the capital resources of the domestic media business. That is not to say that somebody might not make a hit sometime.
Senator Merchant: I am expressing my own frustration here. I come from Saskatchewan, which is a very small market, and this profit-driven model that we have been talking about this morning is not serving the public very well. I think large media corporations are focused on short-term profit and not long-term value. They kill local programming because it is expensive, and they push national programming because it is cheap, even if it runs counter to local interests and community values. They kill the small businesses. I think that small owners have good ideas sometimes and are not looking at the profit. They do not have to make big profits or satisfy their shareholders. The large corporations are doing a disservice to small communities and small broadcasters, who are serving their own communities and are a reflection of their values. What are your views on that?
Ms. Horan: It is a bit of a conundrum. To some extent, there is a requirement for minimum local programming such as local news, for example, and in some cases — and this is more in larger markets — some of the magazine-type talk shows get produced.
You mentioned that the profit model is not serving the community that well. First of all, as a free market, that is the model we are left with; that is, individuals have put their own money into creating something and they want some money back as opposed to having it go down the drain. That is part of the purpose of the CBC, to be less focused on the bottom line. The government subsidizes it. If you cannot live with the profit model, you have to create a non-profit model, and that has been the one that services the communities that cannot justify creating that programming from a profit perspective.
Senator Merchant: The CBC, because the funds are restricted, is no longer able to service certain markets. You get people who are not familiar with certain areas. It is impersonal even at that level.
Mr. Casey: I would suggest that it is the right or the domain of local media entrepreneurs to fill that niche. Local radio operators should be able to serve those areas. One of the areas into which we see capital going is community publishing, where a paper is produced three or four times a week. It is advertisement driven. Those businesses are growing much faster than daily newspapers, but you cannot regulate a solution to a market that is underserved because of structural inefficiencies. There is just not the interest from advertisers to fund a local television station in certain markets. Canadian local media will survive and prosper by telling Canadian stories that Canadians want to hear, be that in a newspaper or on radio or TV. I do not see how you can regulate that.
Ms. Horan: To some extent you can create subsidies or encourage investment in local programming by giving tax credits to the advertiser to throw more support into local community programming or create incentives for broadcasters, but at the end of the day, you are left with a profit model. You cannot effectively regulate that, but a government can potentially offer incentives.
Senator Merchant: We have a local newspaper in Regina, but it has about two pages in it. People say they buy it to see who has died.
Senator Day: You made the point that the community newspaper is a fast-growing segment. Have you done any analysis, or you aware of any analysis, as to whether the larger media companies are moving into that niche, or is it the small entrepreneurs?
Ms. Horan: Yes, they are. That is partly fuelling the growth. When it is small entrepreneurs it is very difficult for advertisers as a group to pour in a lot of support. The big players are Torstar, Transcontinental and Osprey. There are some other players like Black Press in BC. There is consolidation of that ownership, so if someone wants to blanket- cover Southern Ontario they call Torstar. If you want blanket coverage of the Atlantic provinces or Quebec you call Transcontinental. Osprey is increasingly a part of Ontario advertising. It makes it more efficient to transfer dollars into community newspapers.
Senator LaPierre: I find it disconcerting that we are told that private broadcasters do not receive subsidies. The Canadian people provide a large proportion of the funds that are expended on content in Canada by private broadcasters. Millions of dollars are provided for that. The broadcasters pay the lowest licence fees in the Western developed world for programs that they make. They do not spend the money for the sole reason that the CRTC tells them that they have to have so many hours. The CRTC should say to them that a margin of their profit should go into that and then we will resolve the problem.
The Chairman: Those are great theories, but they are not the field of expertise of our witnesses today.
Mr. Casey: What we do know is that other than news and sports, Canadian broadcasters lose money on Canadian programming because nobody watches it.
The Chairman: I wanted to go to Miss Horan's slide on page 6. That is advertising revenues. With the exception of specialty television, which is growing from a base of almost zero so the numbers would look high, it is not that great. To the best of your knowledge, is that revenue growth based on volume or rate?
Ms. Horan: It is a combination of both, and these are nominal dollars, not real. You will get rate increases. The rate increases on prime time television have been much higher than this, but rate pressures on daytime television have offset it. It is a little of both. On television it would almost be rate because the amount of advertising is limited. With newspapers, you do get a growth in volume over time.
Mr. Casey: These businesses have been around for a number of years. They are mature and they still outpace average economic growth with a model that is not capital intensive. They are still attractive businesses.
The Chairman: We have heard conflicting testimony. We had the former publisher of the Ottawa Citizen tell us that local newspapers are profitable — and he was talking about newspapers like the Ottawa Citizen or The Winnipeg Free Press as distinct from the national papers.
We heard testimony from a professor that the newspaper business is not profitable, and I would like to know which it is. I have an abiding concern in connection with newspapers with the notion of circulation; that newspaper readership has declined over recent years and advertisers are trying to buy readers. At what point does this strategy not work any more — or is there a point at which it does not work any more — and the advertisers say, "Wait a minute, you are charging me too much for diminishing readership and I would do better to buy more advertising on the specialty channels"? Is this a problem you foresee in the future?
Mr. Casey: I agree with the businessperson rather than the academic. The evidence is clear. An urban broadsheet, which is what you are talking about, has one market competitor — usually an urban tabloid — and they attract different readers and different advertisers. Those businesses are extremely profitable if run correctly.
The Chairman: What is "extremely profitable," is it working numbers?
Ms. Horan: A big city paper will have margins in excess of 20 per cent in a decent year.
Mr. Casey: That is 20 per cent on maybe tens or hundreds of millions of dollars worth of revenue, and again, with little capital required to go back into it for printing press.
The Chairman: Upwards of 20 per cent EBITDA?
Ms. Horan: Yes, The Toronto Star has a lot of infrastructure; they are creating content. As you spend less on content and get more from news feeds, your profit can go up and 30 per cent margins are reasonable for smaller local papers.
Mr. Casey: You do run the risk of disenfranchising your core readers if you pursue that strategy too aggressively.
Ms. Horan: There is a balance. Given how competitive the Toronto market is, a lot of investment goes into The Toronto Star and it would be tough to get those margins up to those in other markets, where a newspaper is operating with much less competition. Community newspapers — not all of them — can get margins in excess of 40 per cent. I find it hard to believe that someone would say that newspapers in general are not a profitable business.
Mr. Casey: I am sure there are specific ones that are losing money, like in any sector, but the evidence is clear that this is a profitable business.
Ms. Horan: Certain newspapers got themselves into difficulties by allowing their costs to run up significantly. PacPress in Vancouver, which owns The Vancouver Sun and The Province, is a clear example of that. They did not recognize the competition that they were facing and allowed their costs to run up. You wonder how they could lose money with a monopoly of two papers in a city. Their costs got away from them, and so did their readership.
With regard to mass audiences, definitely advertisers are paying more for less. It is not just in newspapers, but also television. The point has been made repeatedly that conventional television, which used to be 80 per cent-plus of viewing, is now below 50 per cent, yet they still attract a significant portion of ad dollars. You make the point, will not advertisers at some point go to the less expensive media, and to some extent that is happening. There is a corrective force. There are good reasons why you pay a premium to reach a mass audience. If you are launching a campaign and you want to do it with a bang, you need a mass audience. I will use television as an example. You can reach a million people with one ad or 100,000 people each with ten ads, but there are a few things you have to keep in mind. First, your 10 ads may not be reaching a unique audience of 100,000 each time. You may reach one person 10 times. You may have annoyed that person by the end of the campaign because you have not controlled the frequency. In addition, it takes a lot longer for those 10 ads to come out. In any promotion that is time sensitive, like a launch, a political campaign or a sale, it is not efficient to do it that way.
The Chairman: Even though the mass audience is diminishing, it is still the biggest thing out there so that is what you end up buying?
Mr. Casey: When you are you trying to analyze how sustainable the newspaper business is, my view would be that you presume it will be around for a long time.
The Chairman: Thank you. It is has been fascinating.
The committee adjourned.