October 4, 1998
David Smith: Is TV's Future in His Hands?
By BILL CARTER
Where do you go to find a visionary in the television business? One place to look, according to Wall Street analysts, is a spare cubicle in a bunker-like building in a neighborhood of aging, weather-beaten, frame rowhouses in Baltimore.
From that unlikely nexis of power and prestige, David D. Smith, chief executive of the Sinclair Broadcast Group, runs a group of TV stations that has grown so fast he is unsure exactly how many he now controls.
"I think it's either 61 or 63," Smith said.
It's actually 64, enough to put Smith in the same league as Babe Ruth and Roger Maris, if not quite Mark McGwire and Sammy Sosa. It also gives Sinclair control of more stations than any of the major broadcast networks -- by one measure, greater reach into the nation's households than the stations owned by one of the giants, ABC.
More important, the spending power represented by those stations is giving Smith and his ideas influence in an industry that has long seen local television as the seedy but rich uncle of the television business -- a salesman in garish clothes and diamond pinkie rings. Now, however, station group owners like Smith may have more say about what American television viewers watch in the future than the media elite on Broadcast Row in Manhattan.
Already, local stations control so much of the revenue generated by the television business -- more than $20 billion a year, versus the $14 billion produced by the networks -- that more network programming decisions are being made on the basis of what works best for local stations, not national ratings.
CBS, for instance, has shifted its programming priorities to attract more urban than rural viewers, specifically to try to benefit the stations it owns, most of which are in the nation's biggest cities. One example: This season, CBS canceled "Dr. Quinn, Medicine Woman," a Western, in favor of "Martial Law," a series about a martial-arts expert in Los Angeles.
Indeed, almost all the new programming in recent years on every network -- including the two would-be networks, UPN and the WB -- has been aimed at young urban viewers. At one point, the entire NBC lineup of Thursday-night comedies was set in Manhattan.
The Fox network is so committed to maintaining profits at the stations it owns that it has resisted expanding beyond 15 hours in prime time; the other networks fill 22 hours. "You have to consider the network as wholesale and the local stations as retail," said Fox Television president Larry Jacobson. "The growth is really in retail sales. That's why we're staying at 15 hours, to allow the stations to be more profitable."
So what's the vision in all this? In Smith's view, it is leading to a television world ruled by 10 to 15 enormous station groups like Sinclair that will hold sway over what programs get on the air. And when the day comes that digital technology takes hold, Smith envisions his company dividing each of his local broadcast signals into five or six different channels -- including some that viewers would have to pay for -- rather than transmitting high-definition pictures on a single frequency.
For good measure, Smith also intends to dominate the business of providing local Internet content in each of his markets.
The first step in this process would be to make Sinclair even bigger, if the government allows companies' reach to extend beyond the current limits -- 35 percent of the nation's households. In the last two weeks, many of the big station group owners have been calling for relaxation of the 35 percent limitation. CBS station group chairman Mel Karmazin told a Federal Communications Commission panel Thursday that "the 35 percent cap has to move and it's got to move quickly."
Under the present limitations, the big TV networks are struggling to reach single-digit profit margins. Smith, meanwhile, is upbeat about Sinclair's prospects -- even under the current restrictions.
"This is absolutely a great business," he said. "I don't think there are many other businesses where you can do a 50 percent profit margin without manufacturing anything. And I know. I tried manufacturing high-powered antennas, and I had to fight and die for a couple of percent profit."
Even underperforming TV stations often manage to hit 30 to 35 percent profit margins. Stations also continue to be sold at extravagant prices. Just last August the Hearst-Argyle station group bought an NBC affiliate in Sacramento, Calif., for $520 million. That price is about 15 times the station's annual profit, one of the highest multiples ever paid for a television station.
(The cost of acquisitions means the profits Smith brags about are on an operating basis only. Over all, Sinclair has lost money three of the last five years, and its stock has badly lagged behind the bull market -- up about 30 percent since the company went public in June 1995, versus an 80 percent gain in the Standard & Poor's 500-stock index. But revenues have climbed steadily, increasing sixfold from 1993 to 1997.)
Most network executives share Smith's bullishness about the local station business. CBS has such high hopes for economic gains at its stations that executives have taken to shrugging off likely losses at the network level. After all, the company is now being run by Karmazin, who gained fame in the last decade at Infinity Broadcasting for assembling an enormous number of radio stations and then bolstering their sales and profitability with his tough approach to management.
Some experts say local stations are bound to be hurt by a range of competitive incursions -- foremost, perhaps, the sale of local advertising by cable companies. But Jonathan Klein, the president of CBS's stations, dismisses the threat.
"No cable station is going to have 40 years invested in Pittsburgh, the way our station, KDKA, has," he said.
But with the media industry roiled by change in the last decade, some executives believe that local television will prove vulnerable: to what some see as an inevitable conflict over the issue of payments that the stations receive for carrying network programs, or to the same pressures of increasing viewer choice that have squeezed the economics of network television, or to a downturn in the national economy that will affect advertising sales, still the only real source of revenues for local broadcasters beyond those annual checks from the networks.
"Local television is still a great business, but I think there are concerns about the age-old issue of audience erosion," said Paul Sweeney, a media analyst for Salomon Smith Barney. "That sets up the classic squeeze on profits. Costs are rising faster than revenues, even though the squeeze is still less apparent at the local stations at this point."
Others see the future for local stations as truly cloudy. "The smart people I see are selling out," said a senior executive from one of the big broadcast networks, who spoke on condition of anonymity. "The people who say that stations are where the money is don't know what they are talking about. It's true today, but if you look out five years, you can start to hear people say, 'What's the reason for this station's existence?' Do you need seven local newscasts in New York? Can the seventh station in a market compete with a cable channel like TNT or USA?"
Looking ahead, this executive said local television might someday look more like the newspaper business. "There used to be 10 viable newspapers in New York," the executive said. "Now there are two and a half. That doesn't mean the newspaper business is over. It means for those that can't compete it's over."
The newspaper analogy certainly fits with what is already happening in the local television business: a move toward consolidation of ownership among media companies and away from local ownership by everything from mom-and-pop family companies to local newspapers or insurance companies.
"Ownership is where it's at," said Lowell Paxson, who has aggressively assembled a group of small stations with frequencies like Channel 67 in Wilkes-Barre, Pa., and Channel 61 in Fresno, Calif., into what he hopes will be a viable new broadcast network, PaxTV, which emphasizes family fare.
Making all this possible have been changes in federal regulations that allowed station owners to expand from what was once a limit of seven stations nationally. Besides Paxson Communications and Sinclair, other big group owners include the networks themselves and companies like Hearst-Argyle Television, A.H. Belo Corp., Young Broadcasting and Granite Broadcasting.
Among the people who run these companies, Sweeney says Sinclair's Smith is the "only true visionary in an industry not noted for producing visionaries." Salomon Smith Barney has a buy recommendation on Sinclair but considers it a "high risk" pick.
Yet Sinclair is an unlikely center of entrepreneurship, a company whose headquarters are, for the moment, housed in the former Baltimore Power and Light building just off Interstate 83, along with the offices of WBFF-TV, the city's Fox affiliate and the station from which the company grew.
Smith said he planned to move the corporate offices next year to a complex in suburban Hunt Valley. But until a few months ago, he didn't even have his own office, sitting instead in a large room that included desks for his three brothers, who are his partners, and all their secretaries. More recently he gave in and moved into a 12-by-13 cubicle of his own.
"It just got a bit too noisy when we were in the same room," he said.
Sweeney, who has visited the Sinclair headquarters, describes it as "a bit of a dump." But that does not mean Sinclair should be underestimated. "Dave Smith is years ahead of everybody else in the business," Sweeney said.
How so? First, Smith pioneered a technique known as the local management agreement, which allows one station to run another without owning it. By combining such functions as sales and administration, and creating additional newscasts, the arrangements can cut costs and improve profitability. Among the 64 stations Sinclair controls, more than 20 are in such agreements. (In Baltimore, for example, the company also operates WNUV-TV, an affiliate of the WB.)
Lately, too, Smith has been the most vocal advocate of dividing the signals at his stations into multiple services for narrowly defined audiences once digital television becomes possible, as opposed to using them to transmit high-definition pictures. If that begins to make the future of television sound like the present of radio, that is OK with Smith, who owns about 60 radio stations too, as many as six in a single market.
More than anything, Smith's vision is bigness -- the aggressive acquisition of stations, which has put him in the position to manage rapidly rising program costs. It isn't just networks, with their huge bills for professional football or series like "ER," that have experienced programming inflation. Local stations spend most of their budgets on newscasts and syndicated programming, both first-run shows like "Jeopardy" and "Xena: The Warrior Princess" and repeats of "Seinfeld" and "Frasier."
Smith negotiates with syndicators to buy programs for his entire group -- and if that contributes to the homogenization of local television, it makes the transaction more efficient for both the content provider and the station owner. "There are big advantages in scale," he said.
Like almost all the big group owners, Smith has also tried to spread his network associations around. Sinclair has stations affiliated with all six networks -- an ideal situation, he said, because it insulates him against the cyclical nature of success and failure at the networks.
But Sinclair has consistently preferred to affiliate itself with up-and-coming, less-than-full-time networks like Fox, and more recently the WB and UPN.
On one hand, Smith said, he simply likes to be "associated with gamblers like Rupert Murdoch," the chairman of News Corp., which owns Fox. But he also likes not having to share so much of his broadcast day -- and so many of his commercial slots -- with a network. (Local stations get to sell only a couple of minutes of commercials an hour during network programs.)
Moreover, the economic relationship that has bound local stations to the long-established networks is beginning to fray.
Since the days of radio, ABC, CBS and NBC have paid stations an annual fee, known as compensation, for carrying network programs. Today, each network pays its affiliates $175 million to $200 million a year.
But network executives increasingly attack compensation as a crippling anachronism in an era when NBC must pay $286 million a year for "ER."
This year, ABC and CBS engaged in fractious negotiations with affiliates about sharing the $500 million annual cost for new National Football League broadcast deals. CBS won some concessions; ABC mainly ran into a brick wall of resistance.
Network executives agree that more confrontations are coming -- probably by 2004, when many stations' contracts with their networks will expire.
Will there be war at that point? "I don't want to say war," said Klein of CBS. "But I'd be surprised if there weren't some serious disagreements."
Smith sees no reason for a fight. The problem, he said, is that at the moment, too many parties are sitting at the table for fruitful negotiations to take place. But if the government were to raise the limit on market coverage -- to, say, 50 percent of all households -- Sinclair and other big groups would kick off a new round of consolidation.
Then, he said, he might go to NBC and suggest that he be treated as a partner on a key show like "ER." "If I deliver 7 percent of the country for them," Smith said, "I'd want 7 percent of the show. And I'd pay for that. I would have done that if they came to me four years ago when the show went on the air. Why not? We all gamble everyday. You just have to be more astute in gambling."
No network, of course, has ever been willing to cede any percentage of its advertising profits to a local affiliate.
For the long term, Smith is looking to the Internet as a place where local station ownership will find its ultimate advantage. "What's going to be on the Internet is all sorts of new information," he said. "My stations will have more information than anyone in the cities we operate in."
But he sees the Internet developing as a powerful revenue base only at some indefinable point "in my lifetime." In the much shorter term, he said, Sinclair and other broadcasters will be able to open up an additional revenue stream from the division of signals under digitalization.
Last year, Smith endured some tough questioning by Sen. John McCain, R-Ariz., and others on the Senate Commerce Committee for his reluctance to explore the possibility of broadcasting high-definition television on new digital frequencies rather than splitting the signals of his stations into as many new program services as possible -- some of them carrying subscription fees.
"It makes no sense to want to be a single channel," Smith says. "Why should I continue to allow the cable guys to pick me apart?"
Other broadcasters question how stations can hope to fill five or six additional signals with worthwhile programs. "There's no way to fill even the shelf space we have today," said WB chief executive Jamie Kellner, who also controls a separate company, Acme Broadcasting, that owns six WB affiliates. "How many of the 70 channels that most people receive can you sit and spend even a half-hour a week with?"
Kellner argues that the far better pictures and sound promised by high-definition television will be so impressive that consumers will eventually demand it. "It will add a dimension to the viewing experience," he said. "Our industry needs another jolt in technology."
Each of the big networks is obligated by the FCC to establish a digital capability in three of its markets by November. So far, that looks like a lot of cost without much hope of return, said Mitchell Stern, the chairman of the Fox Television stations, the biggest of the network-owned groups.
"It costs a minimum of $1 million to convert a broadcast tower to digital," he said. "If you have to bring in all new equipment, it's a $7 million to $10 million investment. You may have to buy land; it can be nightmarish. And how many sets will be able to receive this technology in November? Two? The answer is essentially none. You have to go in the hole big time before you see any return."
Going in the hole is not how Smith foresees moving Sinclair Broadcasting forward. "The guys who are spending money to get a better-looking single channel," he said, "are just creating a better chance for me to go whack them."
