Business Analysis: Five seeking new partners after Channel 4 cools on merger deal

Sky rules itself out but Telewest's Flextech is seen as good fit for either C4 or five

Like a script-line from a trashy soap, has five, Britain's youngest terrestrial channel, been left alone and bereft at the altar?

Just a few months ago, five seemed all set to merge with Channel 4. That was when Mark Thompson ran Channel 4. He is now director general of the BBC and his successor, Andy Duncan, is much cooler on the deal.

The difficulty lies in marrying the privately owned and profit-maximising five with the publicly owned Channel 4 and its remit for edgy programming that caters to minority tastes.

Five insists that the Channel 4 option remains open and that, in any case, it has many alternatives available.

The problem is that, other than a deal with Rupert Murdoch's BSkyB, those alternatives look rather limited. Flextech, the content division of cable group Telewest, is the next most obvious partner.

Another troublesome issue is five's ownership structure: 65 per cent is held by RTL, a pan-European broadcaster controlled by the eccentric media giant Bertelsmann. The rest is held by Lord Hollick's United Business Media, which has repeatedly said that it is not a long-term investor in this business.

David Jowett, a director at MediaCom, the media buying agency, said that a tie-up between five and Channel 4 would provide a "powerful" alternative terrestrial platform to ITV.

Combined with Sky, five would give advertisers access to an attractive blend of terrestrial and multi-channel television. But a merger with Flextech lacks a "must-have" element for advertisers, according to the MediaCom director.

"Five's in a tough spot. There's no easy way out of this," Mr Jowett said.

Rupert Murdoch and Sky's management have said that they have no interest in acquiring five. That message was repeated publicly over the weekend by Dawn Airey, head of content at Sky, speaking at the annual television conference at Edinburgh.

Few believe that Sky or Mr Murdoch's parent company, News Corp, would never buy five. Insiders said that, at the right price, the satellite channel would benefit from having a terrestrial vehicle as a "shop window" it could use to promote its subscription service.

Furthermore, if a company that Sky regarded as a real threat - such as a big US player - tried to buy five or ITV, Mr Murdoch would certainly take a very close look at acquiring five.

Flextech is emerging as a lynch-pin in this developing strategic game. It does not have the high profile or glamour of five, Channel 4 or Sky. But it is now in a very valuable position. It is understood that Channel 4 and five are beginning to circle it, as a possible option if other deals do not work out.

"Flextech is attractive because it has a large footprint and its channels are really quite successful," said one television executive.

Flextech owns five digital channels - Livingtv, Bravo, Challenge, Trouble and Ftn. It also has a 50 per cent stake in a further nine digital stations through its UKTV joint venture with the BBC - UKTV Gold, UKTV G2, UKTV Drama, UKTV History, UKTV Documentary, UKTV People, UKTV Style, UKTV Food and UKTV Bright Ideas. Flextech stations reach 24.6 million viewers each month and together have a 6.9 per cent share of all viewing in multichannel homes.

The immediate competitive environment for five does not seem threatening. Five broke into profit last year and it has grown audience strongly since launching in 1997. Results yesterday from RTL showed that five had revenues of £135m for the first half and made an operating profit of £6m, up from £1m for the period in 2003.

However, the problem lies in the medium-term threat posed by digital television.

A single channel or even a collection of two or three stations is in danger of getting lost among the 300-odd channels that are available in a pay-television home. That is the reason why Channel 4 and five are urgently looking for an alliance or merger that would provide a bigger presence in digital homes.

Jane Lighting, five's chief executive, has pointed out that uniquely among terrestrial broadcasters, five actually does better in digital homes.

That is because of five's poor coverage in analogue technology which means that there are large parts of the country that cannot receive it or get a bad quality signal.

And Ms Lighting says she is "astonished" that anyone could suggest that without the Channel 4 deal, five looks stranded.

Gerhard Zeiler, the chief executive of RTL, yesterday acknowledged that five must develop a multi-channel strategy. He said it has three options available to it: acquire assets, forge an alliance, or go it alone. "Every day our position is improving. Five is growing, most of our competitors are not. We have a high-class problem," Mr Zeiler said, as he presented RTL's half-year results.

Five famously used to cater to the lower end of the market through its diet of "football, fucking and films" (as Ms Airey put it when she ran the business). It has now set its sights much higher, with a much more sophisticated programming scheme, which includes programmes such as documentaries on art.

Five recently out-bid Channel 4 to secure Joey, a spin-off series from the hugely popular sitcom Friends. Though programming budgets have increased, the rate of growth of the channel has slowed markedly this year. Its improved showing in digital homes is a short-term, technical effect.

And, few independent analysts view as realistic a strategy of five launching its own new digital channels - the route pursued by the BBC, ITV and Channel 4. Five does not have the programming budget to do it and it is hard to see where the gaps exist in the digital world.

Mr Zeiler stressed that "everyone is talking to everyone". It is true that Channel 4 has not ruled out a deal with five and it is understood that the pair are due to hold further talks. Also, it is perfectly possible that Channel 4 could do a deal with the BBC and five.

One of the main attractions for Channel 4 of an alliance or partial merger with the BBC goes back to the UKTV joint venture. The BBC's vast resources and technology would also provide a broadband strategy that would help "future-proof" Channel 4. One source said: "Five helps [Channel 4] in the analogue world, not in the digital world. That is where the BBC comes in."

Channel 4 has not given up on the five proposition but right now it has decided to focus on the new option of the BBC.

Channel 4 wants urgently to see if the BBC route can be made to work ahead of the Government setting out its conditions - early next year - for the upcoming renewal of the corporation's charter.

The BBC is looking for a favourable settlement with the Government over its licence fee and may well be willing to throw something to Channel 4, another publicly owned broadcaster.

It seems inconceivable that ITV would be allowed to buy another major broadcaster so it seems that Channel 4, the BBC, Flextech and five will be playing a game of musical chairs in the next few months that will shape the future competitive landscape of British television.