This ITV drama beats the Street

It's Dyke the ex-director general vs Allen the deal master. And the fight's only just begun

Greg Dyke, the mastermind of last week's audacious plan to take over ITV, does not have a listing on Friendsreunited, the website now owned by the broadcaster. Maybe Charles Allen, ITV's besieged chief executive, ordered that his entry be erased when he bought the site last year. Or, as one source close to ITV mischievously joked: "Perhaps it's because he doesn't have any friends."

Either way, the two media moguls have previous. They first crossed swords in 1994 when Mr Dyke's LWT was bought by Granada (later to form one half of ITV), where Mr Allen was finance director. In his no-holds-barred autobiography, Mr Dyke dismissed Granada, which at the time owned service stations, as a "cost-cutting caterer".

Last week, he turned the tables on his old rival. On Monday, a consortium of private equity groups - Goldman Sachs, Blackstone and Apax Partners, where Mr Dyke is an adviser - made an offer to ITV's board to take control of the broadcaster.

Rather than lodge an outright takeover bid, the consortium proposed installing Mr Dyke as chief executive of a newly restructured ITV. The private equity firms would inject £1.3bn in cash to buy 48 per cent of the company's shares, handing out £3.5bn in a special dividend to investors, funded by new debt.

Analysts at Citigroup said that ITV could increase its gearing levels and make this payout without help from the consortium. "The only reason to support the VC [private equity] offer," their note read, "would be for its differed management team/strategy." Or in other words, to replace Mr Allen with Mr Dyke.

ITV swiftly rejected the proposal, but the consortium is not about to give up. This takeover battle could run longer than one of the convoluted plotlines of The Bill, ITV's police drama. So how did the company, and Mr Allen, end up in this situation?

ITV has problems. For decades, its flagship channel has dominated commercial television. But with the rise of multi-channel TV, driven by the rapid success of Freeview, the broadcaster - like its traditional terrestrial rivals - is losing audience share. Last year, according to figures from the viewing watchdog Barb, ITV1 suffered a 5 per cent drop in audience share in all homes, to 21.6 per cent.

This fall has been exacerbated by new rules introduced as a condition of the merger of the ITV companies Carlton and Granada. These mean that the company has to set its advertising rates based on ITV1's audience share. As a result, ITV1 advertising revenues fell by £50m in 2005 to £1.46bn, and analysts expect they will slide even faster this year, by as much as £130m.

Not all the blame should be placed at Mr Allen's door. In fact, he was won praise from analysts for launching from scratch a "family" of digital channels - ITVs 2, 3 and 4 - to try to recover revenues lost from ITV1. These stations are enjoying strong growth, reporting a 91 per cent increase in advertising revenues in 2005, compared with the previous year.

But these figures are starting from a very low base. Between them, ITV2 and ITV3 (ITV4 was launched only last November) last year had an audience share of just over 2 per cent, according to Barb. Total advertising revenue for non-ITV1 channels last year was £111m.

It will get harder to show such impressive growth as the impact of the newly launched channels wears off. And none of this is news to Mr Allen, who last month outlined the ambitious target of generating more than 50 per cent of revenue from sources other than ITV1 advertising by 2010 (they currently generate 33 per cent).

Mr Allen has also won plaudits for his continuing negotiations with the regulator Ofcom to reduce ITV's expensive public service broadcasting commitments and the amount it has to pay the Government for its licence to lease analogue spectrum. In the City's eyes, Mr Allen - whom many gave only a year to survive at the helm of ITV when it was formed early in 2004 - is the best man for this haggling, certainly a better bet than the larger-than-life Mr Dyke.

Simon Baker, an analyst at SG Securities, says: "Charles Allen has proved himself a worthy negotiator with the regulator. This is in his favour in shareholders' eyes." But he adds: "Greg Dyke has a significant amount of broadcasting experience."

And there's the rub. Analysts and media buyers say that the quality of programming at ITV is not as high as it should be. Its veteran director of programming, Nigel Pickard, left last year (ITV insists he was not sacked) as part of a management reshuffle, with Simon Shaps brought in as director of television.

Andy Roberts, managing partner at the media buying agency Starcom, says he has yet to see any signs that ITV has got it right: "The current regime is probably highly efficient and focused on cost savings. But keeping programming fresh and innovative is another matter." The consensus is that while a decline in the audience share of ITV1 is inevitable, lacklustre programming is hastening this.

ITV has had some hits under Mr Allen. And since around £1bn was spent on scheduling last year, you would hope it has. But the fact that it still points to the reality show I'm a Celebrity ... (launched in 2004 and reformatted every year) as one of its success stories suggests it could do with some new programming "bankers".

It is not yet clear whether ITV would be any better under Mr Dyke, director general of the BBC before being ousted over the Andrew Gilligan/Iraq WMD affair in 2004. The consortium is understood to believe that ITV spends more than its European peers on content, for a declining audience. Under Mr Dyke, viewers might expect more to be spent on prime-time television and less on daytime programming. Increased investment in sport and bought-in American shows such as The West Wing has also been suggested to try to shore up audience share.

Bankers have also raised questions about Mr Allen's strategy. His acquisition of the Friends-reunited website was met with bafflement by most. "The website is a good business, but I'm not sure if Charles quite knows how to make it fit with ITV," comments one City adviser.

ITV says it will use the website's vast database to cross-sell products, and points out that online advertising - particularly for recruitment - is a growth area. But the City is not convinced that Friendsreunited and ITV's family of new channels are the answer, especially as the business model for advertising-funded broadcasting is under threat from the likes of Sky Plus, which allows viewers to skip ads.

Marco Sodi, managing director at Veronis Suhler Stevenson, a private equity firm focused on media, says the company would be in a less vulnerable position if it had moved more aggressively into subscription-based television. "It's a difficult time right now because of the fragmentation of audiences into cable and satellite channels. ITV should be in a position to capitalise on that market shift. It should have done more already."

The consortium's current proposal is unlikely to work. Paul Richards at stockbroker Numis argues that because ITV is a cyclical business, with advertising much higher in those years with major events like the World Cup, such a highly geared model is not suitable. But some of ITV's shareholders have taken the bait. Its largest investor, Fidelity, has hinted it is open to further talks with the consortium, which could change the terms of its offer.

This week Mr Allen begins meetings with shareholders to persuade them to stick with him; Stay tuned for the next episode.

INVESTORS DICE WITH DEBT AS PRIVATE EQUITY DEALS MOVE UP TO THE BIG LEAGUE

For chief executives of FTSE 100 companies, last week's offer for ITV from a trio of private equity firms must have felt like a tack stuck under their seats.

The broadcaster is a problematic target for private equity. The price of a full takeover is too high for the buyout groups to squeeze out the returns to make it worth their while. ITV has a nucleus of institutional shareholders less easily swayed to sell than a disparate shareholder base would be. In the past, those factors would most probably have been enough to convince buyout firms to leave ITV to its own devices.

Not now. The Goldman Sachs-Apax Partners-Blackstone consortium has come up with an unusual deal that would give them a controlling interest but grant current investors a stake in the publicly traded rump of the rejigged broadcaster. Try as they might to paint the "partial-private" structure as an altruistic, share-the-love effort to cut current investors in on the future payoff, the ITV bidders would prefer to do a straightforward buyout.

But their willingness to proceed with this convoluted structure reflects the current pressure on the industry. "This is another step down the road of private equity getting more aggressive," says a banking source. "It needs to do more public-to-private deals because those are the big deals out there."

With ever-larger funds and the continued availability of cheap debt, only the very largest companies are still off-limits; even those (witness recent rumblings about Vodafone) may not be safe for long.

Private equity firms generally go for companies with a certain profile: high-cash-flow businesses that may be unfocused or undermanaged, so leading the market to undervalue the stock. But as firms get more aggressive, the profile for a buyable business, and the way it is taken over, are becoming more flexible.

Private equity makes its money by taking over companies with a combination of their own cash plus up to seven or even eight times the target's earnings in debt. After fine-tuning the business, selling non-core units, improving margins and other bits of engineering, it then sells the company on to another buyer or to the public markets in a float.

Tired of being made to look the fool when private equity groups float a business at twice the valuation at which they bought it just a few years before, big investors are getting hard-nosed in their demands for higher take-out prices or a continuing stake.

But if they desire the latter, they will have to get used to debt levels still seen as very high for public groups. "A public company will in general look to have investment-grade credit rating," says Marco Gironi, a Merrill Lynch credit analyst. "Private equity [firms] are quite happy to take it right to the edge. It's the card they play."

Danny Fortson