Granada is forced to admit failure of Carlton merger plan

Deloitte & Touche called in to assist with ITV Digital restructuring as losses mount

Granada yesterday had to walk away from a planned two-phase acquisition of Carlton – the long-awaited deal that would have produced a single ITV.

It is thought that Granada had offered between 250p and 300p a share, or up to £2bn in total, to buy Carlton in cash and stock. It is understood that the two sides came very close to agreeing a deal.

However, the recent surge in Carlton's share price, including a 14 per cent jump to 228p on Tuesday, forced the issue. A statement had to be put out yesterday and they just could not nail the deal in time. Instead, the two companies simply owned up to unsuccessful "discussions regarding a possible combination of businesses".

Insiders said the deal was not in the interests of "shareholder value", an expression that usually means that they could not agree on price.

Certainly Carlton is trading at a historically cheap level and would have argued that this is simply a function of the current cyclical downturn in trading, which has savaged its share price.

Kingsley Wilson, an analyst at Investec Henderson Crosthwaite, said: "The starting gun has been fired. The finishing line is two years down the line, in a single ITV. We don't yet know who is in the race apart from Carlton and Granada."

Carlton and Granada are desperate to merge, a combination that would account for around 90 per cent of ITV. The advertising slump has decimated revenues and their joint ventures, the heavily loss-making ITV Digital and ITV Sport, have bled them dry. Having two companies providing a single channel is widely seen as illogical. A merger would save around £50m a year in costs.

As the friendly option did not work out, Granada may now be tempted to go hostile. The fact that the Carlton-Granada talks have been smoked out will not go unnoticed over at Bertelsmann, which has made no secret of wanting to get bigger in Britain through its RTL broadcasting business. Carlton and Granada's failed merger attempt will only damage further management credibility at the companies and reinforce the view that the two sets of executives cannot get on.

Paul Richards, an analyst at Numis, said: "This has played into the hands of Bertelsmann. With Granada walking away, now is the time for them to come in [with a bid for Carlton]."

Others suggest that Granada is now the more vulnerable group, with Bertelsmann likely to see juicy synergies with its Fremantle production arm.

While the idea that Carlton and Granada would merge one day surprises no one, the fact that the negotiations were already taking place startled the City yesterday. Clearly Granada wanted to move before the Carlton share price recovers.

But a change in the law that would make the deal possible, through the Communications Act, is at least a year off. So a creative solution was required.

Currently, no single commercial broadcaster is allowed to have more than 15 per cent of the total TV audience or to own both the London ITV licences. A Carlton-Granada combination fails on both counts but the Government has signalled that it will do away with these rules in new legislation.

The bigger question hanging over the proposed merger is how the companies thought they would get it past competition regulators. The sticking point is the combination's share of TV advertising, which is more than 50 per cent. The competition authorities usually have a close look at anything which gives more than 25 per cent market share. It was generally thought that if Granada and Carlton wait the deal could become acceptable to the Competition Commission: their share of advertising is being eaten away by rivals anyway, so, in a couple of years, it might be down to, say, 45 per cent.

So, if the two sides were ready to do a deal now, how would they tackle this? It seems they would try to convince regulators to take share of total advertising in all media, not just TV. If that doesn't work, it would have fallen to special pleading. Remember that letter from Granada's chairman, Charles Allen, to Tony Blair last summer, asking for a merger to be waived through as his group and Carlton were on their knees financially. We could expect more such appeals, together with the warning is that the alternative is German ownership of one or both companies.

The plan was a two-stage deal "in step with proposed legislative changes", as the companies put it yesterday. Granada would make an agreed bid for Carlton, put in place big break fees and take the deal to the competition authorities while they implemented the first phase of the merger. In this initial phase, Carlton and Granada would combine their non-regulated businesses, such as IT and production, and co-ordinate programme scheduling. Assuming the competition authorities give it the nod, by the end of this year Carlton and Granada would then simply have had to wait a few more months before consummating the transaction, once the law changes.

Neil Blackley, analyst at Merrill Lynch, said a "warehousing" structure would have guarded the combined companies until the law was reformed. But he added that it was likely that Carlton and Granada would already have quietly spoken to the Office of Fair Trading.

"The companies state that talks terminated on 'the complexity of regulatory issues', and we believe the companies took preliminary soundings with the OFT, who expressed concern that a Carlton/Granada merger would control too great a slug of total TV advertising," he said.

Thwarted on the big picture, Carlton and Granada moved yesterday to show that they were still making progress elsewhere. They appointed consultants from Deloitte & Touche to advise on cutting costs at ITV Digital.

It should not be assumed that the blockbuster deal is off altogether. Carlton and Granada will now retreat to lick their wounds but, such is the compelling logic of the transaction, a single ITV will inevitably be created.