Allen bets on a new start for Granada now the digital nightmare has ended

Granada shareholders have seen nothing but trouble since the company was floated

Granada may be nearing the end of its digital débâcle but ITV remains an uncomfortable place for any company.

As the bigger and financially stronger of the two main ITV players, Granada seems certain to gobble up Carlton within the next couple of years, unless a foreign predator gets to them first.

Yet Granada's shareholders have seen a pretty vicious destruction of value over the last couple of years and will be fearful of what the future holds.

The managerial and strategic failure over ITV Digital, the Granada-Carlton pay TV joint venture, is stunning and both companies must take their share of the blame.

Around £1bn has been wasted on ITV Digital, which garnered 1.26 million subscribers and was supposed to be a key part of the future growth story. There now appears to be no prospect of ITV's own digital distribution channel, which is an enormous missed opportunity.

Rupert Murdoch's BSkyB comprehensively mauled its ITV rival, outfoxing and outspending it every step of the way. And it is the second time around for Granada, having been one of the companies behind the pay-TV British Satellite Broadcasting disaster in the early 1990s.

Paul Richards, an analyst at Numis, said: "Pay TV was probably the right strategy. It's just that the execution was wrong."

Heads may yet roll over the digital fiasco, most obviously that of Stuart Prebble, ITV Digital's chief executive, but Steve Morrison, Granada's chief executive since July 2000, may also fall victim to any demand for a scalp. City sources think Charles Allen's position as Granada's chairman is safer.

The Granada share price tells the sorry story of a very tough last couple of years, dropping from a rebased 279p at the July 2000 initial public offering, to just 91.5p in September last year. Investors who participated in that offering, at the height of the media boom, will be feeling pretty sore. The sharp fall in advertising revenues, Granada's main source of income, set in later that year and were an industry-wide phenomenon. Yesterday Granada shares closed at 124.25p.

Granada investors also got shares in Compass, the catering business that merged with Granada and was then demerged in February 2001. Compass has so far proved pretty unexciting. The Granada share price was at 633p before the merger with Compass. Taking into account the performance of Granada and Compass subsequently, that share is now valued at the equivalent of 456p, a 28 per cent decline. Media provided just 16 per cent of Granada's revenues in 1996, so in an investment environment in which focus is demanded, the company must be given credit for taking media revenues to 100 per cent.

The company outplayed Carlton to snatch United Business Media's ITV franchises in 2000, for £1.75bn. That certainly left Granada in the driving seat as the music comes to an end in the ITV consolidation game, accounting for some 51 per cent of ITV revenues, compared with Carlton's 37 per cent. However, Granada did the United deal at the top of the market and, with the benefit of hindsight, certainly overpaid. Granada has also failed to make its presence felt on the international stage, one of the few British media companies that might have become a global player.

Granada has developed its TV production business, which makes up 37 per cent of turnover, to a much greater extent than Carlton, and this is a growth area that must be an important contributor to the company's future prospects.

The sole surviving franchise holders from the original awards, Granada looks like it will be the only ITV company, certainly of any size, within the next couple of years. Perhaps it is no longer a "licence to print money" but ITV remains pretty much the only place to go for a major television advertising campaign.

Mr Richards said: "The ITV franchises are a dinosaur but they are a dinosaur with a very long tail."

Despite the long-term decline in television viewing numbers and ITV's proportion of television advertising, major advertisers have to turn to ITV if they want to hit 14 million peak-time viewers.

And, having been through a punishing drop in advertising revenues, Granada must surely have better times ahead. It is a classic cyclical business and whether the ad market rebounds later this year or next, there will surely be a recovery.

In the meantime, the earnings won't look pretty, with operating profits set to fall to £160m this year, from £220m last year. It will take until 2004 or 2005 for the company to get back to the boom times of 2000. But at least a line has been drawn under ITV Digital, which was a massive drain on financial resources and management time – although there remains a threat of litigation over ITV Digital's contract with the Football League.

Kingsley Wilson, an analyst at Investec Henderson Crosthwaite, said: "With management focus now 100 per cent on the core business, Granada is more likely to meet forecasts. I think, going forward, a positive story is likely to be the one to come through."

But where is the growth to come from? The advertising recovery is the obvious source. And, when Granada is allowed by an upcoming change in the law to take over Carlton, there are some £50m cost savings to be wrung from this combination, on top of Granada's existing cost-cutting programme.

Granada will also increasingly gain from a tax break, known as the digital dividend, which will have a quite dramatic effect on earnings – ITV will be gradually let off a tax that takes £300m a year from the network, as digital television is increasingly taken up by Britain's households.

Simon Baker, an analyst at SG, said: "Growth over the next decade will be driven as much by the digital dividend as anything else."

So while Granada may not exactly be sitting pretty today, now it has got rid of the festering sore of ITV Digital, it can look forward to running a single ITV and basking in the advertising recovery.

GERRY ROBINSON'S LEGACY THE LEAN, STRIPPED-DOWN MEDIA BUSINESS

The present-day Granada is still visibly the creation of its previous chairman, Gerry Robinson. With Charles Allen as his chief executive, they knocked into shape what had become an ailing giant and added the hotels and catering operations of Forte after a bruising takeover six years ago. They then sold the Forte assets and the rest of Granada's catering business to Compass, where the businessmen had met in the Eighties. That left Granada as a lean, stripped-down version of what Mr Robinson had inherited when he was recruited to sort it out in 1991.

Granada had, in effect, been founded by Sidney Bernstein. His family had gone into the fledgling cinemas business at the start of the last century, as a means of extracting more profit from their London property business. But Mr Bernstein saw the true potential of cinema and, later, television as mass media.

However, in the days before it was feasible to return money to shareholders, Granada generated huge profits which it reinvested in a series of not totally successful diversifications, including television rental, motorway service stations, hotels, books, nightclubs and tenpin bowling. Mr Robinson sold the weaker links and held on to television rental, hotels and catering and the core television franchise.

He developed Granada on two fronts. When he joined the group it was one of 15 independent television franchisees, but it was apparent that the government was going to permit mergers. So a race began to snap up the key properties, and Granada and Carlton soon emerged as the most powerful players.

But Mr Robinson's background in catering – he was famously dismissed by the actor John Cleese as "an upstart caterer" – led him to Forte. He recognised that Granada's motorway services business was not big enough on its own, and its growth prospects were limited by government regulation. He also knew Forte well and reckoned he could run it better than Sir Rocco Forte.

Long term, though, it was going to be difficult to keep running two such disparate businesses as catering and television in tandem, with television rentals as the cash cow. The obvious ploy was to sell the catering business to Compass, which is still run by Mr Robinson's one-time partner, Francis Mackay. And that, two years ago, was what happened.

The idea was that Granada shares would gain from the higher rating bestowed on television companies, and it would be in better shape to emerge as the top dog in the ultimate merger – with Carlton, once the Government agreed.

At that stage Mr Robinson handed the reins to Mr Allen with Steve Morrison, a former television producer who dreamed up the idea of taking stakes in football clubs, as his chief executive.

But they have had to face two big problems. First, ITV's share of the television audience is declining as satellite, cable and digital channels proliferate. Second, given BSkyB's stranglehold on satellite, Granada and Carlton have to establish digital as a credible competitor – but, as the Nationwide football débâcle has underlined, BSkyB already has a lock on the best content.

Mr Robinson, who has recently become non-executive chairman of Allied Domecq, can justifiably look back and feel that he got out of Granada at precisely the right moment.

By William Kay