The radio industry is teetering on a precipice. Heavy debt burdens have forced owners to cut costs rather than invest. Alternative forms of media are creating mounting competitive pressures, and the core characteristics that give radio its competitive advantage are being squeezed out of the business. But structural changes could revitalize the industry.

While radio has faced a triple threat of structural, cyclical and secular challenges, the current environment could create significant opportunities for private equity investors, who could derive substantial value by unwinding years of industry consolidation.

In fact, there is pent-up demand waiting for a market to form -- a market that could soon take shape as owners, who spent years rolling up assets, begin to jettison nonstrategic portions of their portfolios and allow those assets to be operated by new owners in smaller, more manageable and, ultimately, better-performing units. The question is how to get there from here.

In many respects, the seeds of distress were sown in the wake of deregulation nearly 15 years ago. As part of a sweeping telecommunications act, the government essentially eliminated station ownership limits, which previously restricted any entity from controlling more than 14 stations in seven markets. With limits removed, a small group of companies emerged as the principal consolidators, acquiring huge swaths of prime radio properties at ever-higher purchase multiples.

By 2000, radio had transitioned from a mom-and-pop industry to a highly consolidated -- and highly leveraged -- sector with fewer than 20 dominant players. The largest operators faced the challenge of integrating hundreds or even more than 1,000 stations across the country. Since no operator, until 1993, had managed more than two stations in a market, this created unprecedented, and in some cases, untenable operational challenges.

While consolidation reduced in-market competition, it also created major operational and financial issues. Radio's share of ad revenues began to drop significantly -- even as the overall economy grew. Although digital media was becoming a factor, it was not yet stealing meaningful revenue share. Rather than secular or cyclical circumstances, radio's decline was directly attributable to the absence of a strategic blueprint for operating multiple stations in too many markets.

The recent economic crisis has exacerbated the situation. At a time when terrestrial radio faces mounting threats from all forms of digital entertainment, the industry has dramatically cut spending in live and local programming, audience research, marketing, digital asset upgrades and talent development. Round after round of layoffs have left staff spread too thinly across all station functions, causing significant morale problems. And cost-cutting pressures have never been greater.

Now, even with glimmers of hope for economic recovery, it is clear that radio's major players are too large to be optimally effective. What's more, since the largest companies operate in just about every U.S. market, they have a powerful influence on competitors, especially in the area of ad pricing. The industry would be better served if the largest consolidators' portfolios were pared down, leaving each with smaller, more manageable packages of markets and stations. In fact, smaller players in many markets outperform stations that are owned by large companies. Furthermore, by divesting nonstrategic portions of their holdings, large consolidators could repay debt faster and shift their focus from financial to strategic imperatives.

Companies that are first to divest noncore assets, as CBS Corp. recently did in Portland, Ore., should reap the greatest strategic benefits -- likely getting the best price for assets and seeing improvements on a per-station basis with their remaining portfolio. In essence, they will be able to refocus their business on growth rather than just survival.

Fixing what has been broken in this industry can present private equity with significant upside opportunities. Firms with an operational focus and a willingness to reinvest in the business should expect top-line growth in fairly short order, followed by margin expansion. Revalued, restructured and re-energized, terrestrial radio still has an important role to play in the audio entertainment space. It is still the premier outlet for live and local entertainment, and in a sea of limitless Internet audio URLs, radio stands out as a unique and free delivery system for local information, live personalities and heritage call letters. 

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Lee S. Simonson, a former radio industry executive, is a managing director with Alvarez & Marsal's private equity performance improvement group.