Better times in view as ITV begins its fight back to health

Merger report on Carlton-Granada delivered on eve of Edinburgh Television Festival

As the television industry gathers today for the start of its annual weekend of soul-searching in Edinburgh, the big business issue before it is the uncertain future of ITV.

The Competition Commission delivered its verdict yesterday on the proposed merger of the two big ITV players, Carlton and Granada. The 456-page report, now before the Secretary of State for Trade and Industry, will have huge ramifications for television in this country.

Even Greg Dyke, the director-general of the BBC, has said that a strong ITV is vital to maintaining a healthy ecology in British broadcasting. Squeezed between the BBC and BSkyB, the country's biggest commercial network has suffered badly. Once deemed a "licence to print money", in the past few years it has appeared to be a mechanism for destroying shareholder value. Carlton and Granada's combined revenues of some £2.2bn compares with £3.2bn at Sky and £3.5bn at the BBC.

Edinburgh will be abuzz with forecasts of the regulatory outcome and what that means. If cleared, the deal will hand Carlton and Granada over half the television advertising market. However, if the regulator imposes severe remedies, will the deal still be done?

David Elstein, the former chief executive of Channel 5 and a severe critic of ITV's management, says Carlton and Granada have to accept concessions. "Who has 52 per cent of a market? You've got to pick and choose. Only in Italy could someone take that kind of share of the media market," he said.

ITV's long-term loss of audience escalated dramatically in the last few years, just at the point at which advertising revenues fell off a cliff. It was also confronted with the disaster of its ITV Digital foray into pay television. Last year, many pundits were pronouncing ITV a spent force. Carlton's chairman, Michael Green, and his opposite number at Granada, Charles Allen, were lucky to survive the mauling ITV has received at the hands of investors, competitors and the press.

But ITV has fought back. The Carlton-Granada merger is the chief weapon in its armoury but a more unified strategy and presentation to viewers and advertisers has been put forward. The schedule has been revamped under the new director of programmes, Nigel Pickard. With the budget boosted by some £100m this year, ITV is now promising its best autumn season ever. The network still delivers 30 per cent of the UK audience, more at peak time.

Ben McOwen Wilson, the head of the commercial practice at Spectrum Strategy, says: "Although ITV has had three bad years, it's not a 'busted flush' at all. In a world where audiences are getting smaller, being a player that can deliver a big audience is increasingly scarce and valuable."

The regulatory outcome will determine just how easy ITV is going to find it to take on Sky and the BBC. The DTI is almost certain to follow the advice of the Competition Commission, given that politics is being removed from merger decisions. After getting an extension to its inquiry, few believe the Competition Commission will now simply block the deal. However, Carlton and Granada together have some 52 per cent of the television advertising market. It is hard to believe the regulator will allow one company to hold such power - normally a market position over 25 per cent gets anti-trust officials foaming at the mouth.

Much more likely is the watchdog imposing the remedies that it has flagged up. Chief among these is making Carlton and Granada divest both their sales houses (the Competition Commission seems never to have considered the separation of just one sales house). This is the structural response and would see the advertising sales operations being made independent of Carlton and Granada and independent of each other.

Alternatively, regulators could impose a behavioural remedy that will seek to stop the combined company from using its dominant position to ramp up the price of advertising. The main solution here is a "roll-over" arrangement that would extend current advertising deals, at the same price levels, for a number of years.

Many City analysts seem convinced the behavioural remedy will win out and, from Carlton and Granada's viewpoint, this would be hitting the jackpot. However, it is unlikely. Regulators would have to police the arrangement and the advertisers hate this idea and believe it to be unworkable.

The media buying agencies, and the big advertisers they work for, oppose any further reduction in the number of sales houses they can go to - with several rounds of ITV consolidation already through, the main sales points are now down to just Carlton, Granada, Channel 4, five and Sky.

Adam Smith, of Zenith Optimedia, the buying and research group, says: "ITV behaved like monopolists for a generation. There is a long legacy of mistrust. If they are given the power, they'll abuse it."

ITV is still the only way for advertisers to reach 10 or 15 million viewers on a single channel. Doubling the market share of the sales operation will lead, advertisers fear, to them being milked for revenues, having nowhere else to go.

The point of the Carlton-Granada merger is to bring together the channel for the first time under one company, able to work as a whole, rather than a semi-detached, squabbling group of businesses. That makes perfect sense. Mr Green has said making Carlton and Granada spin off the sales houses would make matters worse, not better. It would separate the company from its primary source of income, not an easy arrangement for any large business.

Mr Green wants to keep the sales operations for obvious reasons and his comments were posturing before the Competition Commission. But there are good reasons to believe that divesting the sales houses could be made to work. And that separation need not remain for ever - once ITV's market share is eroded further, it could be reviewed.

Mr Elstein is impatient with Mr Green's howls of protest over the sales houses. Not only is it a viable solution, he says, it would allow cost-savings, with an independent sales operation freer to cut staff.

"He [Mr Green] assumes the telephone is going to be abolished ... ITV is hugely undervalued as a potential asset. If the merger is driven hard, even if ITV is not an 800 pound gorilla like the other two [BBC and Sky], it still has a lot of market power - if only it gets its act together," Mr Elstein says.

He points to Channel 4 and BBC2, which have not seen their market shares pulverised over the last decade. Mr Elstein denies reports he is putting together an alternative management team, should shareholders or a bidder dispense with Mr Green and Mr Allen.

But Mr Elstein believes that, as it stands, the merger is not nearly radical enough.

There is a big upside for ITV. Ad revenues are forecast to grow next year, for the first time since 2000. The renewal of its regional licences, from 2005 onwards, should deliver large savings. It has a valuable place in the multi-channel world.

Mr Green and Mr Allen will not be coming to the booze-up at Edinburgh. But they should still be toasting ITV's future this weekend, whatever the regulators say.