Sunday, 11 January 2009

Classic FM - always check the expiry date before purchase

When Global Radio paid £375 million for GCap Radio in 2008, the portfolio of stations it acquired included Classic FM, the most listened to and most profitable of the UK’s three national commercial radio stations, and the only one of the three on FM. Classic FM was almost the only jewel remaining in GCap’s tarnished crown, after its management had destroyed the audiences/revenues of Capital FM and its other city FM stations by implementing disastrous content and commercial strategies. Classic FM presently has an 11% reach, a 3.8% share, 66% of its adult hours listened derive from the desirable ABC1 demographic, whilst 85% derive from ‘housewives’. Its only competitor in the classical music format is national BBC Radio Three, which has only a 4% reach and a 1.2% share but, of course, carries no commercials. Classic FM is a cash cow. [ratings: RAJAR]

There is only one problem for Global Radio. Classic FM’s licence expires on 30 September 2011 and it cannot be automatically renewed. This is a big problem. Whereas local commercial radio licences are still awarded (and re-awarded) by Ofcom under a ‘beauty contest’ system, national commercial radio licences are not. The system for national commercial radio licences is simple. Sealed bids are placed in envelopes. Ofcom opens the envelopes. The bidder willing to pay the highest price wins the licence. That’s it. This system is enshrined in legislation. Even if Ofcom wants a different system, it cannot change it without legislation.

As Classic FM’s new owner, Global Radio definitely wants a different system that will enable it to hang on to this most valuable asset. Global has been busy bending the ears of anybody and everybody who it might be able to persuade to interpret the broadcasting rules in a way that lets it keep Classic FM after 2011. Even Ofcom has had its lawyers busy examining the legislation to see what flexibility it has to interpret the rules in a way that might maintain the status quo.

Unfortunately, the legislation in the Broadcasting Act 1990 is quite specific:
“[Ofcom] shall, after considering all the cash bids submitted by the applicants for a national licence, award the licence to the applicant who submitted the highest bid.”

There is one, and only one, caveat in the legislation:
“[Ofcom] may disregard the requirement imposed by subsection (1) [above] and award the licence to an applicant who has not submitted the highest bid if it appears to them that there are exceptional circumstances which make it appropriate for them to award the licence to that applicant; and where it appears to [Ofcom], in the context of the licence, that any circumstances are to be regarded as exceptional circumstances for the purposes of this subsection, those circumstances may be so regarded by them despite the fact that similar circumstances have been so regarded by them in the context of any other licence or licences” [emphasis added].

Nothing more explicit is mentioned in the legislation about these possibly “exceptional circumstances”. The problem facing Ofcom is that, if it were to award the licence to Global Radio in a hypothetical situation where it had not been the highest bidder, whoever was the highest bidder would be likely to seek a judicial review, forcing Ofcom to explain in front of a set of judges the precise nature of the “exceptional circumstances” it had invoked. This would not be a pretty sight. There are no precedents because this part of the legislation has never been used before.

So what is the precise meaning of the ‘cash bid’ that has to be submitted to Ofcom in a sealed envelope? It is an amount to be paid annually by the winner throughout the licence period (increased annually by the rate of inflation). When Classic FM won the licence in 1991, it agreed to pay £670,000 per annum, plus 4% of its revenues as demanded by the regulator.

Later on, the Broadcasting Act 1996 allowed the regulator to extend Classic FM’s licence once, but on new terms, if the station agreed to simulcast its output on DAB. The regulator set Classic FM’s new licence payment as £1 million per annum plus 14% of its revenues from 1999. This new licence would have expired in 2007.

Then, the Communications Act 2003 allowed Ofcom to extend Classic FM’s licence again for a further four years but, once again, it could re-set the terms. Ofcom reduced Classic FM’s licence payment to £50,000 plus 6% of its revenues from 2007. This is the licence that expires in 2011.

Why did Ofcom decide to reduce the payments so substantially in its 2006 decision? It
argued that the growth of listening via digital platforms was “leading to a decline in the scarcity value of the analogue spectrum”. Additionally, it argued that the licensee’s “share of advertising, derived as a result of access to the analogue spectrum, is likely to fall.”

Ofcom had forecast in November 2006 that digital platforms would account for 33% of radio listening by 2008, and 50% by 2010. By the time the Classic FM licence was due to expire in 2011, Ofcom anticipated that digital platforms would be responsible for 60% of radio listening overall. In other words, the FM licence would, by 2011, be accountable for only the minority of listening to Classic FM.

Ofcom’s forecast proved to be extremely wide of the mark. By Q3 2008, only 18.7% of radio listening accrued from digital platforms, little more than half of what Ofcom antcipated. The 50% threshold is unlikely to be reached even by 2015, and certainly not by Ofcom’s target of 2010. As a result of these forecasting failures, Classic FM (along with the other two national commercial stations) is now paying Ofcom an amazingly discounted rate for the licence fee to use analogue spectrum. The combined licence fees of the three national licensees
would have been £7 million per annum under the previous regime, whereas these were reduced by Ofcom to less than £1.5 million (by Ofcom’s own estimate).

The net result of these changes is that Global Radio has a bargain licence on its books. Classic FM probably generates more than £20 million revenues per annum, but Global now pays only £1.3 million for its licence. The bad news is that Global Radio’s cash cow will end in September 2011. If Global does not win the re-advertised national FM licence, the value of its balance sheet could be up to halved. On the other hand, to keep this prize asset it will have to bid significantly more than the £50,000 annual licence fee it is paying now, so that Classic FM’s future profitability would be impacted anyway, even if Global managed to keep the licence.

However, there are plenty of other media owners out there who would like to have the UK’s only national commercial radio FM licence in their portfolio. The fact that the DAB platform has not grown anywhere near as quickly as anticipated in the UK simply makes this FM licence more valuable. The last time the licence was advertised in 1991, bids were only open to European Union applicants. Since then, legislation has opened up the bidding process worldwide. The licence format does not have to be classical music – the licensee can operate any format of its choice, apart from pop music (this caveat is in the legislation).

The fly in the ointment is that Ofcom
adopted a new policy in 2007 that all its analogue local and national radio licences would be scheduled to expire on 31 December 2015, or five years from their commencement, whichever is longer. For Classic FM, this means that its next licence period would theoretically run only from 1 October 2011 to 1 October 2016. If a new bidder won the licence by offering the highest cash bid, five years is hardly enough time for a nascent business to establish itself and become profitable, particularly if it were to adopt a format other than classical music. The Ofcom policy seems unworkable in practice, and also seems biased in the incumbent’s favour.

Now, with an understanding of Global Radio’s desperation to hang on to its Classic FM licence almost at any cost, it is useful to
re-read Paragraph 2.3 of the Final Report of the Digital Radio Working Group. Remember that Global Radio owns about 50% capacity of the UK’s commercial radio DAB transmission capacity and Global Radio accounts for 39% of commercial radio listening. The Report said:

“In exchange for its ongoing and future commitment to DAB, we believe the radio industry must have greater certainty and control of its future. Therefore, we propose that the government must relax some of the existing legislative and regulatory burdens placed on the radio industry, which will require parliamentary time, as outlined below and Ofcom should consider how to reduce some of the existing regulatory burdens.

First, the commercial radio industry must be granted a further renewal of its analogue services which are carried on DAB, and of DAB multiplex licences. [emphasis added]”

Now read this quote once more but replace the phrase ‘the radio industry’ or ‘the commercial radio industry’ with ‘Global Radio’. Aha! Wouldn’t it be great for Global Radio if the government could be persuaded to step in and somehow automatically renew its “analogue service” Classic FM licence, thus avoiding a licence auction in 2010? Even moreso if Global could be allowed to continue paying only £50,000 per annum (plus 6% of revenues) for the FM spectrum it uses? If you were Global, would you not be eager to offer the government a deal whereby you maintain your costly DAB infrastructure (and maybe even extend it) as the price you have to pay for securing the future of your most significant balance sheet asset?

From reading its Final Report, it certainly looks as if the Digital Radio Working Group bought into this argument. The next hurdle for Global Radio is to persuade Lord Carter and his Digital Britain team to buy into the same deal, which is: we promise to keep the DAB platform alive, despite it losing us a small fortune, if you ‘arrange’ legislation that enables us to keep the Classic FM licence for another decade. Thus, the government avoids the embarrassment of the DAB platform failing in the UK, and Global Radio might stand a better chance of staying in business.

To date, the other commercial radio owners have seemed happy to go along with this plan. They, like Global, would get to renew their radio licences automatically too (although none of their licences are as individually valuable as Classic FM’s). On the other hand, they too will be burdened with the continued costs of simulcasting their services on the DAB platform, with almost no financial return. However, despite most radio owners’ private dislike of the whole DAB ‘fiasco’, publicly they continue to stress their continuing support. Nobody turns down a ‘free lunch’, and a free licence renewal is an enticing offer for a radio industry still built upon oligopoly power rather than open competition.

The only question now is whether the government considers it politically worthwhile to ‘help’ the commercial radio sector with new legislation that would extend the licence status quo, in return for forcing onto consumers a ‘new’ DAB radio technology that is more than a decade old and has long been superseded by innovation.

Lord Carter’s pronouncements during the next fortnight might give us an idea of how important/unimportant it is to the government to: 1) bale out privately held Global Radio; 2) force further investment in improving/developing the DAB platform.

1 comment:

Paul Rusling said...

An excellent summary.
I might add though that when INR 2 was advertised in the early 1990s, Virgin's wasn't the highest bid. That was by INBC whose offer of a higher amount was described by the Radio Authority as uneconomically viable, and they plumped for the second runner, Virgin, instead. SO there is something of a precedent for rejecting the highest bidder on financial viability grounds - and thats probably "in the eye of gthe beholder" in the current economic climate, and a distinct possibility.

Paul Rusling