R&I Rating Methodology by Sector

Transcription

1 R&I Rating Methodology by Sector Broadcasting August 10, 2016 R&I uses its broadcasting rating methodology to evaluate broadcasting companies that are involved in the entire process of broadcasting operations by creating their own program contents and owning their own transmission equipment, whose main source of earnings is advertising revenue. The main scope of this rating methodology is the key and sub-key broadcasting stations providing terrestrial television broadcasting. I. Evaluation of Business Risk 1. View of industry risk Advertising fees account for the majority of broadcasting company revenues. Advertising demand is highly susceptible to changes in corporate attitudes toward advertising and public relations spending in response to fluctuations in the economy and trend in operating results, and revenues are influenced by the external environment. Expenses, on the other hand, can be controlled to some extent but are heavily weighted toward fixed costs such as program production costs and personnel expenses. Consequently broadcasting company revenues and expenditures are characterized by the ease with which profits vary because of changes in revenues. With the spread of the Internet, changes in viewing habits such as the recording of programs to watch at viewer convenience, and the growth of paid streaming services, the environment surrounding television commercials is moving toward increasing severity. Television's value as an advertising media continues to be high, however, and the market remains nearly 2 trillion yen in size. Television's strong content production capabilities, and its value as an advertising medium capable of reaching a broad audience, are unchanged. The industry has been able to use such strengths to shield itself against other advertising media to a certain degree. Based on these considerations, R&I views the broadcasting industry to have a medium level of industry risk. (1) Market size, market growth potential and market volatility According to research by Dentsu Inc., total advertising expenditures in Japan were 6,171.0 this website or any other information included in this website belong to Rating and Investment Information, Inc. ("R&I"). None of the information, etc. may be used, in whole or in part, (including without limitation reproducing, amending, sending, distributing, transferring, lending, translating, or adapting the information), or stored for subsequent use without R&I's prior written permission. 1/9

2 billion yen in Although continuing to expand, this still remains more than 10% below the peak market size seen in Of this amount, television commercial expenditures (terrestrial television) in 2015 were 1,808.8 billion yen, accounting for about 30% of total advertising expenses. Even with the remarkable expansion of new advertising channels such as the Internet, there has been no substantial change in the breakdown by medium. The appeal of television's value as a medium capable of reaching a mass audience has not changed. It remains the preeminent medium, capable of disseminating advertising and public relations information broadly to consumers everywhere. There is little concern that television's position in the advertising market will erode rapidly. Its dominance is being affected by changes in viewing habits, however, such as the increase in recording programs to watch at a later time, and television's HUT (Households Using Television = Total household viewing rate) continues to decline gradually. This is a negative factor for television's value as an advertising medium. The probability that this trend will weaken in the future is low. Growth in the television commercial market is difficult to anticipate. (2) Industry structure (competitive environment) When selecting broadcasting companies for placing their time advertising, advertisers emphasize factors such as audience rating and program quality. The audience rating level is important for efficiently broadcasting spot advertising as well. To ensure stable revenues, television broadcasting companies engage in a fierce struggle to develop their audience ratings, and the competition to produce and form a program lineup is keen. The defining characteristic of the broadcasting industry is the fact that under the licensing system, the number of players has been restricted. Competitors within a broadcasting area are limited, and competition can be said to be comparatively mild. However, companies can be plunged into price competition easily in an effort to ensure advertising volume. This must be noted carefully. Advertisers are also taking a stricter attitude when evaluating the effectiveness of their advertising expenditures. In the competition with other advertising media, each medium possesses different strengths and characteristics, and broadcasting companies have been able to achieve compartmentalization with alternative channels such as the Internet. While large growth cannot be anticipated, such competition is unlikely to greatly weaken demand. How to boost the media value of television through tie-ups with other advertising media will be a future issue. 2/9

3 (3) Customer continuity and stability Television advertising formats can be broadly divided into time and spot. Time advertising refers to advertising by which the advertiser becomes a television program sponsor, typically by contracting for a six-month (two-quarter) block. The advertising revenue is less easily affected by changes in the short-term audience rating and is steady. Producing programs that are suitable for advertisers' objectives also enables broadcasting companies to continuously renew advertisers' contracts. Customer continuity and stability are relatively high. With spot advertising, a commercial is broadcast in the amount specified by the contract, without the advertiser deciding the program offered. Normally, Gross Rating Points (GRP) are used in the calculation of advertising volume. GRP is calculated by multiplying audience rating per minute and the number of advertisements. If the audience rating is high it leads to a higher earning capacity, and makes it easier to pursue customer acquisition as well. However, spot advertising compares unfavorably with time advertising from the aspect of stability. In recent years the percentage of spot commercials has been rising, a development that is having a negative impact from the perspective of customer continuity and stability. While the breakdown between time and spot advertising is nearly for the key broadcasting stations, it will be necessary to observe whether this trend continues in the future. (4) Capital and inventory investment cycles Normally, investment in broadcasting equipment maintenance and upgrades accounts for about half of a broadcasting company's capital investment. The amount of capital investment is kept within the range of depreciation and amortization expense, and a remarkably heavy investment burden is not incurred. In general, broadcasting equipment frequently can be used over periods much longer than its useful life for accounting purposes. A scenario in which the size of the market in the core television commercial business expands significantly is difficult to envisage. Growth in the non-advertising business centered on content production capabilities will be indispensable for maintaining and strengthening the earnings base. Companies will be compelled to finance those portions of their business they are unable to support with independent management resources by attracting outside resources or tie-ups, and mergers and acquisitions are forecast to increase. This is a sector whose investment recovery cycle differs from that of broadcasting companies' core business. When a large-scale investment has been undertaken R&I will reflect this in its rating evaluation based on considerations such as the financial burden, the contribution to earnings, and the business risk of the activity in which the 3/9

4 funds are invested. (5) Protection, regulations and public aspects Broadcasting companies are under the jurisdiction of the Ministry of Internal Affairs and Communications, and certification under the Broadcast Act is necessary to broadcast terrestrial television. Broadcast areas basically have been established at the prefectural government level (except in the broad Kanto, Chukyo and Kinki regions), with a maximum number of business entrants set for each area. Key media is required to provide all viewers in a region with various types of programs, including emergency and disaster broadcasting, and the companies assumed to be able to fulfill this role of highly public nature are terrestrial television companies that possess both hard and soft functions. This highly public nature has formed a barrier to entry through the broadcasting station approval, licensing and permit system. (6) Cost structure Broadcasting companies have a revenue and expenditure structure where a fixed cost burden is heavy for items such as program production costs, and advertising revenues are highly susceptible to the external environment, including trends in the economy and the operating results of advertisers. As a result, profits can easily come under pressure during a declining revenue phase. Since the latter half of 2008, when the advertising market suffered a downturn in the wake of the Lehman Brothers bankruptcy, broadcasting companies have ensured profits through reduction of their program production costs. Because program production-related costs are a source of broadcasting companies' competitiveness, however, there is a possibility a mere reduction of such costs can lead to a drop in program quality and lower audience ratings. Should companies continue to rely on cost cutbacks to preserve profits during a lower revenue phase, concerns of a decline in competitiveness and earning capacity would be heightened over the medium term. This makes it vital to ascertain the level of costs that can maintain and strengthen competitiveness, based on considerations such as the level of revenues. Working to enhance program quality through creative ingenuity also is an issue. 2. View of individual firm risk In contrast to industry risk, which highlights the standard risks of the industry of which the subject firms are a part, the business risk of each company will differ depending on the individual firm risk as explained below. 4/9

5 (1) Broadcasting region and position in broadcasting network Broadcast licenses are granted for each region. A broadcasting company based in a heavily populated region with a high level of consumption will have greater earnings potential. The key broadcasting stations that form nationwide networks supply programs to the broadcasting stations of affiliates, enabling them to support the needs of firms that want to pursue advertising and public relations nationally. The broadcasting region and position in the broadcasting network determine a broadcasting company's value as an advertising medium and are important elements that affect the earnings base. (2) Content production capabilities Because there is a maximum limit to the amount of airtime available for television advertising, raising prices for television advertising is essential for expanding advertising revenue. Broadcasting companies must create appealing programs that will improve their audience ratings. If they produce programs that bring benefits to advertisers, this can be easily linked to continuously renewed contracts. In the rating assessment, it is important to check whether a company has popular contents, partly because they will expand its non-advertising revenue as well. Content production capabilities are the source of a broadcasting company's competitiveness, and R&I emphasizes these capabilities when evaluating the earnings base. The program production knowhow that broadcasting companies have built up over long years in program segments such as news, drama, variety shows, sports, and animated cartoons is difficult to accumulate in a short period of time. Because a key advantage is the ability to construct a balanced timetable for a broad audience in daily and weekly units, new market entry in the same business model is not easy. This is also linked to the high media value of television. Many of the streaming businesses that have achieved prominence in recent years procure their content from external sources, and even when they produce programs themselves they have remained in specific sectors. While the program genres that are each broadcasting company's strength vary, this can work to a company's dominance in securing time advertising if the programs are strong in specific sectors that are segmentalized by age group and sex, for example. In programming, a company's target strategy also is an important point. (3) Marketing capabilities If the marketing department is strong in areas such as building strong relationships with 5/9

6 advertisers, stably renewing contracts when selling time advertising becomes easy, and securing advertisers when beginning new programs becomes simple as well. This also works to positive advantage for ensuring revenues, by making it easier to fill spot commercial slots. Provided it has a broad customer base, a broadcasting company will be less susceptible to specific customers' operating results or their approach to advertising and public relations activities. Regardless of whether the advertising is time or spot, advertising unit prices are basically affected by audience ratings. If its marketing capabilities are strong there is a possibility a company can limit the impact of a decline in unit prices, even during periods when its audience ratings have dropped. (4) Diversification of earnings sources Television commercial revenue is affected by the external environment. The operating environment surrounding television commercials has become tougher, squeezed by challenges ranging from changes in viewing habits such as watching recorded programs to the spread of the Internet and an increased number of streaming services. From the perspective of ensuring stable earnings, how many earnings sources a broadcasting company possesses other than advertising revenue is a critical point. Instances of companies securing higher non-advertising revenues by effectively utilizing self-produced contents are growing. Prime examples are package sales in formats such as DVDs, conversion into films, and the use of self-produced contents in games. There also are cases where self-produced programs are used as popular contents on streaming services. One advantage when using self-produced contents is that companies can generate revenues without significant additional costs and secure profits more easily. Some companies run businesses that produce little synergistic effect with their main business. In this case, R&I reflects this in its evaluations based on a consideration of factors such as the company's ability to manage the risks peculiar to that business, and whether there is a financial buffer corresponding to the risk. (5) Cost management capabilities While broadcasting companies are susceptible to fluctuations in revenue because of the external environment, during periods of falling revenues their profits can easily come under pressure owing to the heavy fixed cost burden for outlays such as program production costs. Management's cost control skills will affect the level of profits during periods when the external 6/9

7 environment, including the economy and corporate operating results, is deteriorating. In the case of key broadcasting stations, companies spend roughly 40% to 60% of their advertising revenue on program production. Because it accounts for such a large share of outlays, the management of this portion reverberates on profits. Companies are constantly producing programs, however, and in that respect, cutting such costs in the short term is difficult. The control of other expenditures is therefore also essential. II. Evaluation of Financial Risk In addition to quantitative factors in the form of financial data, R&I evaluates qualitative factors, such as a company's financial management policy and liquidity risk, in its analysis of financial risk. For the broadcasting industry, R&I emphasizes the following financial indicators based on the industry's business characteristics. When a company engages in businesses that entail risks different from its main business, R&I will evaluate the company comprehensively, using its evaluation of the core television commercial business as a base, while taking into consideration factors such as the characteristics of the other businesses, the level of their contributions to earnings, and effect on the company's financial position. (1) Earning capacity Operating margin, EBITDA (earnings before interest, taxes, depreciation and amortization) margin, return on assets (ROA) Regardless of the volume of revenue, program production costs will generate a certain burden, but if a broadcasting company is highly competitive and able to sell advertising slots at high unit prices, its revenue will grow and contribute to a higher level of profits. As indicators for evaluating a broadcasting company's comprehensive competitiveness, R&I places the greatest emphasis on the profitability of sales as measured by the operating margin and the EBITDA margin. Profit margins during normal times are important for determining how much leeway a company has to maintain profits during a phase when advertising revenue has dropped following the deterioration of the external environment, without having to tamper with the expenditures for program production that are the wellspring of its competitiveness. 7/9

8 (2) Scale and investment capacity EBITDA, sales, equity capital The level of advertising revenue highlights the differences in advertising unit prices. In its rating evaluations, R&I focuses on the scale of sales. In order to raise advertising unit prices and improve the ability to generate earnings, having a capacity to make sufficient expenditures for program production-related activities is desirable. When a company has a high level of profits and cash flow, this amplifies its margin for investing funds to boost competitiveness. EBITDA is a useful means of judging that level. Moreover, an increasing number of companies are making investments to expand non-advertising revenue. Investment capacity has taken on greater importance for evaluating to what extent a company is able to undertake investments without causing deterioration of its debt-equity structure. With the business environment surrounding broadcasting companies becoming increasingly severe, there is a heightened risk of profits coming under pressure from a deterioration of the external environment. The level of equity capital as a risk buffer is therefore an important component of R&I's evaluation. (3) Debt redemption period Net debt to EBITDA ratio Capital investment of broadcasting companies normally is focused on broadcasting equipment maintenance and upgrades, and in most cases is kept within the range of depreciation and amortization expense. Provided it is profitable at the net level, a broadcasting company is more likely to have positive free cash flow. Therefore for the A rating category and higher, R&I looks at whether a company is in a net cash position. In recent years, some companies have increased debt to make investments to expand their non-advertising business. R&I evaluates the debt redemption period based on considerations such as the effects of the business expansion and the financial characteristics of the business. (4) Financial profile Equity ratio, net D/E ratio (ratio of net debt to equity capital) stability. R&I focuses on the equity ratio and net D/E ratio as indicators for evaluating financial When a company expands its operations and increases the amount of debt in a business that bears little relationship to its main business, and this has an effect on the company's financial 8/9

9 profile, R&I will comprehensively evaluate the impact based on the business characteristics, among others, and reflect this in its rating evaluation. III. Rating for Broadcasting Industry Issuer Rating Individual Firm Risk Financial Risk Importance Indicator Importance Broadcasting region and position in broadcasting Earning capacity Operating margin network EBITDA margin Content production capabilities ROA Marketing capabilities Scale and investment EBITDA Diversification of earnings sources capacity Sales Cost management capabilities Equity capital Debt redemption period Net debt to EBITDA ratio Financial prof ile Equity ratio Net D/E ratio Industry risk: Medium Note) Importance is indicated by : extremely important, : important, or relatively important. * This report replaces all previous versions that have been released to date. The Rating Determination Policy and the Rating Methodologies R&I uses in connection with evaluation of creditworthiness (collectively, the "Rating Determination Policy and Methodologies") are R&I's opinions prepared based on R&I's own analysis and research, and R&I makes no representation or warranty, express or implied, as to the accuracy, timeliness, adequacy, completeness, merchantability, fitness for any particular purpose, or any other matter with respect to the Rating Determination Policy and Methodologies. Further, disclosure of the Rating Determination Policy and Methodologies by R&I does not constitute any form of advice regarding investment decisions or financial matters or comment on the suitability of any investment for any party. R&I is not liable in any way for any damage arising in respect of a user or other third party in relation to the content or the use of the Rating Determination Policy and Methodologies, regardless of the reason for the claim, and irrespective of negligence or fault of R&I. All rights and interests (including patent rights, copyrights, other intellectual property rights, and know-how) regarding the Rating Determination Policy and Methodologies belong to R&I. Use of the Rating Determination Policy and Methodologies, in whole or in part, for purposes beyond personal use (including reproducing, amending, sending, distributing, transferring, lending, translating, or adapting the information), and storing the Rating Determination Policy and Methodologies for subsequent use, is prohibited without R&I's prior written permission. Japanese is the official language of this material and if there are any inconsistencies or discrepancies between the information written in Japanese and the information written in languages other than Japanese the information written in Japanese will take precedence. 9/9