Business Analysis: Emap buys Scottish Radio for £391m - but is it a sell signal for investors?

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A second big player was created in the radio sector yesterday through Emap's £391m takeover of Scottish Radio Holdings (SRH), even as the new company's two big rivals warned that advertising sales had continued to plummet.

A second big player was created in the radio sector yesterday through Emap's £391m takeover of Scottish Radio Holdings (SRH), even as the new company's two big rivals warned that advertising sales had continued to plummet.

Further consolidation is expected in reaction to the Emap-SRH deal. In particular, the No 3 player, Chrysalis, is now a long way behind the leading two. It must now, surely, make its move.

But do the current advertising sales problems indicate that the much-hyped radio growth story has dried up? And, if so, why are radio companies continuing to do deals?

When radio ownership rules were freed up at the start of 2004, everyone warned that consolidation would be slow in coming. In fact, there has been frenetic activity in the sector.

Capital Radio and GWR tied the knot this year to form GCap Media, which has since put out two profits warnings, including a stinging downgrade yesterday.

Early last year, Emap took a 29 per cent stake in SRH and agreed a full takeover yesterday, at a pretty full price.

This year, Kelvin MacKenzie's Wireless Group was bought by Ulster Television. Chrysalis has made repeated attempts to buy Guardian Media Group's radio business. Lord Alli, the media entrepreneur tried to buy Virgin Radio from SMG but was told that it was not for sale.

Commercial radio makes its money from advertising. But it is actually losing ground against the BBC's powerful offering in radio, meaning it has fewer listeners to offer to advertisers. Capital Radio and GWR said the primary rationale for their merger - to form the runaway leader of the commercial radio sector - was to take on the BBC. There is no evidence so far that they are mounting any sort of challenge.

The last quarterly audience listening figures, released in May, showed the commercial sector as a whole again lost share to the BBC, with the private sector accounting for 44 per cent of listening hours. And 95.8 Capital FM, GCap's flagship station in the crucial London market, fell to its lowest-ever market share of 6.1 per cent and was overtaken by Heart 106.2, which is owned by Chrysalis.

GCap and Chrysalis put out trading statements yesterday, which echoed each other in reporting double-digit declines in advertising sales for recent months.

David Mansfield, GCap's chief executive, points out that the company launched only at the start of May, so results will take some time. "The [advertising] market is terrible, so we have not had the best start. But it is apparent that these are market issues, not GCap issues or even radio issues," he said.

According to Mr Mansfield the prize for the radio sector is still very much in sight: being able to offer advertisers a network of radio stations that amounts to national coverage. As bigger companies, radio groups can afford to spend more on their radio brands. It can then increase the 6 per cent share of the advertising cake that the radio sector currently has, the theory goes.

Certainly the Capital-GWR combination creates a powerful proposition, bringing together London's 95.8 Capital FM and the only national commercial music channel, Classic FM.

Mr Mansfield also notes that the most immediate opportunity for commercial radio is provided by the process now under way to renew the BBC's charter.

"We want to get the BBC's role defined and then get that policed properly," Mr Mansfield says.

The trouble has been that the BBC's Radio 1 and 2 have taken on the commercial sector head-on, by providing similar programming. Given the choice of listening to broadcasts that will not be interrupted by annoying advertisements, audiences have understandably gone for the BBC.

Now the BBC, under the new leadership of Mark Thompson, has indicated that it will be a much less commercial organisation. That may be enshrined in the corporation new charter, covering the 10 years from 2006.

Emap, for its part, is following the same logic as GCap, though with some interesting twists. Emap's takeover of SRH values the latter at £391m. After this transaction, Emap will account for 25 per cent of the radio advertising market and 23 per cent of audience listening hours, compared with 35 per cent audience share for GCap and 10 per cent for Chrysalis.

Tom Moloney, Emap's chief executive, says: "We would like to be the biggest but we are the strongest radio group. If I had to choose between being the biggest and the strongest, I'd choose the strongest."

According to Mr Moloney, that strength comes from the fact that it is more geographically coherent and in bigger urban areas. The deal extends Emap's network of city stations into Scotland and Northern Ireland.

GCap and Emap agree that the future of radio lies in digital. While GCap has put money into the DAB standard for digital radio sets, Emap has also bet on consumers listening to radio via digital television - it has eight of the 13 radio slots in the digital terrestrial Freeview television platform (nine after the SRH deal is completed).

As things stand, there is significantly more digital radio listening going on via television sets than through digital radio sets.

A further differentiating factor for Emap is that, as a media business which owns much more than radio, it has big, established brands from its consumer magazines that it uses for digital radio stations. Its glossy magazines have been turned into radio brands that play the music that readers of these magazines like. Among the titles used in this way are Kerrang!, a hard-rock format, and Smash Hits! for pop music. Other radio groups would need to spend vast amounts of money to create brands that are so readily recognisable.

That, says, Simon Mays-Smith, an analyst at CSFB, allows Emap to follow what he calls a "multi-local" strategy. That is, it owns a conventional heritage station in a conurbation and also has a funky new station for those seeking something more specialist - there is one analogue version of Kerrang!, in Birmingham, but otherwise, these stations exist only in the digital world.

Who the eventual winners in the world of digital radio will be will not become clear for years. No merger is going to be perfect. Although Emap-SRH owns Kiss100 and Magic in London, it still looks a little light in the south of England.

Conversely, GCap Capital is relatively weaker in the north of England. But GCap and Emap have now made their moves and are unlikely to be involved in further major deals.

It really is up to Chrysalis to respond, and its options are pretty limited. They amount to GMG, which has already rebuffed it, and Virgin Radio, which apparently is not for sale. There are other possibilities - such as the Wireless Group assets, which are now owned by Ulster TV, but these seem pretty unappealing.

The Chrysalis chairman, Chris Wright, who owns 26 per cent of the company, has been seen by many as an impediment to any deal. The company's biggest shareholder, Schroders, with a 27 per cent stake, is said not to be happy. So, it's over to you, Chris.