Will digital TV duo ever make it to the altar?

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The Independent Online

City fund managers aren't known for their profanities. But get them on the subject of Carlton, Granada or their faltering joint venture ITV Digital and the expletives flow.

"It's a total bloody mess," says one institutional investor in both companies, responding to news that they have called off merger talks and brought in Deloitte & Touche to help sort out ITV Digital.

"They don't need Deloittes to tell them what to do, it's f****** obvious. They should pull the plug immediately, no mucking around."

Investors' patience with Carlton chairman Michael Green and Granada chairman Charles Allen has been wearing thin for some months. And now crunch time has arrived for the ITV executives, with institutions planning meetings with the two men over the next fortnight.

ITV Digital has spectacularly failed to live up to expectations. Trounced by the Rupert Murdoch-backed BSkyB, it has absorbed £800m and is expected to gobble up £300m before it reaches its elusive break-even date next year.

There is now considerable pressure on Carlton and Granada to tear up the ITV Digital business plan and start afresh. One option, favoured by some shareholders, is to abandon the pay-per-view model, and in effect wave the white flag at BSkyB. ITV Digital has some residual value, given that the Government is committed to switching off the analogue television signal in 2010. This may be best realised by offering customers a stripped-down service of no-frills digital television for a one-off fee.

However, well-placed sources say the future of ITV Digital was one of the stumbling blocks to the Carlton-Granada merger. A potential deal was under way: the biggest clue is that the management structure appeared to have been established, with Carlton's Mr Green agreeing to take the chairman's role and Granada's Mr Allen taking the chief executive's seat.

But insiders say Mr Green and Mr Allen did not see eye-to-eye on ITV Digital and that Carlton wanted to invest more money in the service. There have also been persistent rumours that the two men, both headstrong and often outspoken, did not get on. Over the past few months, however, Mr Green and Mr Allen have been spotted dining out together, pointing to the recent merger discussions.

Granada and Carlton may have called off talks but the industry considers it a pause rather than a permanent split. As well as the cash drain from ITV Digital, both companies are suffering from falling advertising revenues. The potential synergies of a marriage – estimated at around £50m a year – cannot therefore be dismissed lightly.

"Yes, I do think they have to merge – it's inevitable," says Neil Blackley, an analyst at Merrill Lynch. The problem is that the terrestrial television market is tightly regulated by the Government and no company is allowed to own more than 15 per cent of the television audience. ITV makes up a quarter of the total so, under the current rules, Carlton and Granada cannot engage in a straightforward merger.

The two companies were considering how to get round these rules. However, if they're patient the problem may solve itself. The Communications Bill, to be published next month in draft form, is expected to propose the relaxation of ownership rules, leaving just the Competition Commission as the main regulatory hurdle.

The Commission is concerned with the concentration of power in television advertising sales, and a Carlton-Granada merger would lead to some 60 per cent of this market being controlled by one company. To keep the Competition Commission at bay, "the obvious thing to do would be to spin out one of the [advertising] sales houses," says Patrick Wellington, an analyst at Citigroup.

It is not at all certain that Carlton and Granada will be the masters of their own destiny. Bertelsmann, the German TV giant, is understood to have put in a 275p-a-share offer for Carlton in September.

And Mr Murdoch, always hungry for a deal, would also be keen to get his hands on UK terrestrial television. However, BSkyB, of which Murdoch's News Corp owns a third, is prevented from controlling more than 20 per cent of ITV or Channel 5, because he already owns The Sun and The Times.

Industry observers say any outsider is unlikely to want to buy Carlton or Granada separately. "If other people come in, they will buy both because of the £50m of synergies in a merger," says Merrill Lynch's Mr Blackley.

If Mr Allen and Mr Green can't sort out their differences on ITV Digital, their marriage plans could be spoilt by a rude ménage-à-trois.

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