(FORTUNE Magazine) – ONE OF THE WORST things that could have happened to the television industry finally has: the financial markets have fallen in love with it. Like an Edenic resort that loses its charm as it gains popularity, the insular and immensely lucrative business of TV broadcasting is beginning to suffer from the hordes that have suddenly discovered its virtues. Says Warren Buffett, the longtime media investor who is acting as godfather to the merger of ABC and Capital Cities Communications announced in March: ''The secret is out.'' It sure is. The stock market has suddenly gone gaga for TV -- not high-tech video ventures, but plain, old-fashioned TV stations. Once a rarity, giant mergers all over the information and entertainment industries have become the regular fodder of the business press. In publishing, CBS last February bought a raft of Ziff-Davis magazines for $362 million, and Gulf & Western swallowed Prentice-Hall in December, paying more than $700 million. Warner Amex Cable Communications, the sixth-largest cable TV operator, is receiving bids. Rupert Murdoch bought half of Twentieth Century-Fox Film Corp. for $162 million in March. But the biggest action has centered on TV stations. Since December, enthusiastic investors have bid up the value of the typical broadcasting company by a spectacular 40%, compared with a 12% rise in Standard & Poor's 500-stock index. Buyers of TV stations find they can borrow unprecedented sums from banks and through junk-bond financings -- even though the licenses that are a broadcaster's most valuable asset cannot legally be used as collateral. Encouraged by falling interest rates, buyers ranging from Australia's swashbuckling Rupert Murdoch to Chicago's staid Tribune Co. are paying such high prices for stations that Thomas H. Wyman, chief executive of CBS, believes some will need ''celestial intervention'' to make their investments pay off. The closest thing to celestial intervention in broadcasting is action by the Federal Communications Commission, which has already intervened in a big way. In December the deregulation-minded commission announced a long-anticipated increase in the number of TV stations a company could own from seven to 12, so long as their signals don't reach more than 25% of U.S. homes. Then, around the time the rule became effective in April, the FCC, which has always stood in the way of hostile TV takeovers, unexpectedly thrilled speculators by suggesting it henceforth intended to be neutral. The result of this combination of regulatory and market changes could be the transformation of an enviably easy business into one that is damnably difficult. The great charm of a TV station has been the ability to generate far more cash than it needs. Because stations require only paltry capital expenditures, most of their cash flows are available for investment elsewhere. Last year the average broadcaster kept about 35% of sales as pretax profits, while standout Capital Cities milked an estimated 70% from its top station. New investors won't have it so easy. The effect of the so-called rule of 12 has been to jack up prices of TV stations to levels that, says Paul Kagan, publisher of the Broadcast Investor newsletter, ''probe the upper limits'' of economic rationality. And if, as some experts expect, companies continue to buy each other's stations in a mad scramble to exploit the new ownership limits, vastly increased debt-service costs will bite more deeply into the industry's rich profit margins. But many prospective buyers see the relaxed rules as a once-in-a-lifetime opportunity to expand in a business that has proved splendid, to achieve greater economies of scale, and to create groups of stations more powerful and potentially richer than any before. So what if the price is high in conventional terms? ''This is the time to buy stations that were never for sale,'' argues Kagan. ''If you take the conservative approach to the numbers, you simply won't own the property.'' That attitude makes the most sense for buyers who plan to hold a station for many years. Why more investors didn't glom onto this wonderful business long before is hard to understand. No doubt a narrow concentration on reported earnings blinded many to the subtler splendors of broadcasting's cash flows. The change in the market's perspective has also helped spur the recent investor invasion of other cash-generating media businesses such as publishing and cable TV. Escalating prices could eventually make these wonderful businesses less wonderful too. The prices investors are paying for stations are sometimes so high they could make profits impossible, at least for a while. For years buyers have found it difficult to earn a satisfactory return on investment in a typical station if its price exceeded roughly ten times cash flow, according to many security analysts, station brokers, investment bankers, and top executives at broadcasting companies interviewed by FORTUNE. In broadcasting, cash flow is defined as revenues less direct operating expenses, but before such noncash charges as depreciation and amortization and -- most important -- the cash outlay of interest. The most desirable stations -- those in the biggest or fastest-growing markets, and the affiliates of the CBS, NBC, and ABC networks -- have in the past couple of years come to command around ten times projected cash flow. The attributes of specific stations can raise or lower multiples by two or three points. Those guidelines count for less today. Generally speaking, market multiples are higher than they have ever been. That's why it was a coup when Capital Cities agreed to buy ABC for just an estimated eight times its projected 1985 cash flow, or $3.5 billion. Thomas S. Murphy, 60, the chairman of Capital Cities, is almost universally regarded as the most efficient manager in broadcasting; he can reasonably expect ABC's already substantial cash flow to swell under his stewardship. Capital Cities' and ABC's stations together will form the largest group so far, reaching about 24% of U.S. homes. Seemingly less shrewd was Rupert Murdoch, 54. Two months after buying half of the troubled Fox studio from oilman Marvin Davis, he signed a hair-raising agreement to buy six of Metromedia's seven TV stations for a net price of $1.55 billion. Privately held Hearst Corp. will pay $450 million for the seventh and richest station, Boston's WCVB, an ABC affiliate. Murdoch's six outlets (combined reach: 18%) are all in top markets, but they are independents, which generally spend far more on programming than network affiliates -- since there's no network feeding them shows most of the day -- and yet lure smaller audiences. ALONG WITH THE STATIONS Murdoch picked up their $1.3 billion in high-yielding junk-bond debt, the legacy of Metromedia Chairman John Kluge's May 1984 leveraged buyout of the publicly held telecommunications company he built. The Metromedia buyout had looked like a disaster: last year interest costs exceeded the cash flow of all seven stations by an estimated $80 million. Yet Murdoch, who seems to relish being up to his eyeballs in debt, not only took on the junk bonds but paid 16 times FORTUNE's projection of the six stations' 1985 cash flow. There aren't many buyers around as gutsy as Murdoch. Among others, Coca-Cola and Gulf & Western -- two nonbroadcasting companies that, like Murdoch, have invested in movie studios -- reportedly looked at the deal. Apparently none could rationalize paying Metromedia's price. ''Kluge said it was market value,'' remembers one executive who considered the deal, ''but he didn't say we could make money.'' Nevertheless, investor enthusiasm is encouraging some publicly traded broadcasting companies to accept risks that would have been unthinkable a * short time ago. In May, Tribune Co., a newspaper publisher that owns TV stations in five markets including New York and Chicago, agreed to buy Los Angeles independent KTLA for the record sum of $510 million. According to Tribune's own, perhaps optimistic, calculations, that works out to 12 times the station's projected cash flow. Yet the day the company announced that its per-share earnings would be diluted up to 15% as a result of the acquisition, the market price of Tribune shares dropped only 4%. If the Tribune deal is any indication -- and some station brokers think it is -- multiples of at least 12 times projected cash flow may become standard for important stations. Such prices could entice still more reluctant sellers out of the woodwork -- meaning that the once-in-a-lifetime opportunities and the buying hysteria might last for some time. But since, for the short term at least, such prices don't leave much room for profits, investors who bet with the buyers of stations must hope that, over the long haul, larger station groups will find ways to compensate for their higher interest costs. PERHAPS THE MOST fervent hope of investors, bankers, and bondholders has nothing to do with broadcasters' management skills. It is that prices will continue to rise, allowing buyers to resell stations later at a profit. So far this theory has worked -- most notably for the nimble John Kluge, 70, whose sale of his TV stations brought in $700 million more than he paid last year for all of Metromedia, which retains large holdings in cellular radio and other lines. But station broker Howard Stark, who knows Kluge's ways, warns that ''If Kluge is selling, it may be the top of the market.'' The relatively tough business of running independent stations like Kluge's is getting tougher. As a group, the 214 U.S. independents have sopped up much of the networks' lost audience share, but competition has increased. Much of it comes from the 141 new UHF stations (those with channel numbers higher than 13) that the FCC has allowed onto the airwaves since 1979. With more competition, the average station's audience is smaller. The added stations in many markets are creating extra-ferocious bidding for the hit shows that lure audiences. In Los Angeles, a market with nine significant stations, KTLA is paying $120,000 per episode for the right to air reruns of Magnum, P.I., a popular detective series starring hunky Tom Selleck. Investors betting with station sellers can take comfort in the FCC's intent not to block takeovers and in the fact that only one station group, Taft Broadcasting, has reached the new 12-station ownership limit. But broadcast raiding isn't yet a free-for-all because the FCC hasn't formally changed its rules to ease takeovers. It could still be a formidable obstacle to hostile attempts. Says James Quello, one of five FCC commissioners, ''The odds will favor existing managements.'' The FCC's cumbersome procedures delay even friendly mergers for about a year, plenty of time for a target to marshal its defenses. The only hostile TV takeover attempted in years is Ted Turner's offer to trade a package of junk bonds and other paper for CBS -- a deal the investment community has treated with scorn. Probably motivated by a sense of increased vulnerability, several appetizing broadcasters are taking themselves off the market by going private at prices substantially below their estimated breakup values. Metromedia, Harte-Hanks Communications, and Wometco are among those that have gone private already. Cox Communications, 41% owned by Cox family members, is completing a tender for the remaining shares at a price equivalent to nine times its 1984 cash flow. Two other companies are trying to forestall takeover. Multimedia, a Greenville, South Carolina, broadcaster controlled by insiders, says it will stick with a recapitalization plan that will increase management's ownership, while refusing rich buyout bids. Storer Communications, poised to reap the benefit of an impressive turnaround, has agreed to let Kohlberg Kravis Roberts & Co., the leveraged buyout firm that just sold KTLA, take the company private with management's participation. A dissident group led by Coniston Partners, a group of New York speculators, waged a proxy fight to force the unwilling company to encourage higher bids by third parties. In late May, Coniston won four of nine seats on Storer's board. The deal would leave Kohlberg Kravis Roberts, one of the first Wall Street firms to invest heavily in stations, with the sixth-largest group in the U.S., reaching 14% of viewers. The station-buying frenzy has left a few attractively priced TV properties on the market, though perhaps not for long. Two companies that some security analysts consider vulnerable are Viacom International and Taft Broadcasting. Viacom, a major vendor of programming, also owns four TV stations and major cable TV properties, including half-ownership of Showtime, the No. 2 pay TV service. Its recent price of $47 a share compares with a liquidation value estimated by Alan Kassan, a security analyst at First Manhattan Co., at $78. Taft has acquired five stations since the FCC raised the ownership limit, in the process weakening its balance sheet. Unlike the market for TV stations, in which potential buyers far outnumber sellers, the market for entire broadcasting companies is severely limited. Unless you count Murdoch, who owns TV stations in Australia and the Sky Channel pay TV service in Europe, no major buyer from outside the small community of broadcasting has bought a station group since December, when the recent mania took hold. But if the marketplace is right about the value of TV assets, the day may yet come when outsiders such as Coca-Cola and Gulf & Western will risk substantial earnings dilution to gobble up TV companies. At some point off in the future, when restructured station groups have repaid most of the extra debt they are now assuming, the pressure on profit margins should ease. In the meantime, more TV managers will be forced to master the unglamorous discipline of cost control and to find ways of attracting more viewers and ad dollars. Programming, the major operating cost at most stations and the only enticement stations offer viewers, will be the key to both efforts. It will be especially critical to groups of independent stations such as Murdoch's and Tribune Co.'s. In fact, both groups are justifying high station-acquisition prices by touting potential programming benefits. They hope to do what only the networks have done so far: use their massive station groups as a base from which to launch new shows that will attract vast national audiences. THREE ELEMENTS are essential to the launch of a new show. First is the agreement of stations in the largest markets to run it. The three top markets, New York, Los Angeles, and Chicago, are considered essential, but the more big markets the better. Five station groups -- the three networks' plus Murdoch's and Tribune's -- own or will soon own outlets in all three markets that could be forced to air in-house productions. The second requirement is a network, whether permanent like CBS's or just built around one show, through which stations across the country agree to carry the program. Thus far the economics of TV have quashed all efforts to create a permanent fourth network, but a few ad hoc assemblies have successfully introduced individual programs, such as Gulf & Western's gossipy magazine show Entertainment Tonight, to near-national audiences. The last and most crucial requirement for a launch is the creation of a program that viewers will like. This, even the most successful production companies will ruefully attest, is easier said than done.

The upside, as show-biz types like to say, is enormous. With successful shows the groups can more than offset their production costs by selling valuable rerun rights later, and their stations' ratings and revenues will rise. And independents, unlike the networks, are allowed by the FCC to own as many programs as they like. Owners of top shows can make the biggest bucks of all. MCA Inc. will book an estimated $200 million in revenues next year from licensing reruns of its megahit Magnum, P.I. Most of that will be profit. The cost of failure, however, is also enormous. If a station group's shows are flops, rerun rights are worthless, the stations' ratings and revenues may drop, and production costs could become write-offs. In 1982 Metromedia began working hard on in-house programming. None of its new shows caught on. Its most spectacular flop, a joint venture with two other partners, was a much- ballyhooed late-night talk show called Thicke of the Night, the brainchild of onetime programming whiz Fred Silverman. MURDOCH AND TRIBUNE plan to follow distinctly different programming strategies. Tribune, which has already made small profits on its movie review show At the Movies and a couple of other programs, is a cautious player. Its programs are made by joint ventures in which Tribune is a partner. Its primary contribution to these ventures is air time for the new shows on its group of stations, which will have much more clout with the addition of KTLA. The company's partners provide the capital and, Tribune hopes, the production expertise. Stations outside the Tribune group often pay no cash for the privilege of airing these shows. Instead they ''barter,'' allowing Tribune to sell part of the advertising time available during the show while selling the rest themselves. As evidenced by his public statements, Murdoch's dreams are mistier and far more ambitious. He has broadly hinted at his desire to create a fourth network around his newly purchased stations. Some industry observers think he expects the Fox studio, which has had a few major successes as a TV show producer (M*A*S*H), to feed the stations hit programming. Barry Diller, chief executive of Fox and one of the most accomplished executives in entertainment, will oversee the stations. Before joining Fox last year he had led Gulf & Western's Paramount Pictures studio to film industry leadership, and as a young man at ABC he invented the still popular concept of the made-for-TV movie. His stated ambitions for the stations are more modest than those of his high- rolling boss. ''Forget about synergy,'' Diller says. ''There isn't any.'' Nor is he planning to create a fourth network. What Diller does plan, with Murdoch's support, is to assemble a schedule of shows more alluring than the stations' drab diet of reruns, old movies, and sports events. Fox may own some of the shows, others may come from outside suppliers. But what Diller must really hope to do is outprogram the networks. In the strange new era that broadcasting is entering, that may be possible. The investors who have only recently discovered television's virtues may be facing a lot more uncertainty than they realize. While it is fashionable to compare TV properties with such valuable and irreplaceable assets as oil reserves, speculators might want to consider a more sobering analogy drawn by CBS's Tom Wyman. ''It used to be a farmer's truth,'' he says, ''that you couldn't go wrong by investing in land.'' But in TV as in farming, investors can always go wrong by paying too much -- even for irreplaceable assets.

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