Carlton-Granada merger: A love-in or a TV massacre?

Lucy Rouse asks if the merger will come out of the competition probe in one piece

When Patricia Hewitt gives her decision on the £3.7bn Carlton/Granada merger this week, Michael Green will have scored at least one victory. Carlton's chairman pleaded with the Trade Secretary not to make her ruling tomorrow as it is the Jewish Day of Atonement.

After a six-month competition inquiry into the deal and its effect on the television advertising market that a single ITV would dominate, one thing is clear: the answer won't be an unqualified yes. However, the most extreme option for the regulators, an outright block, is also thought unlikely in the TV industry. "Everybody wants this [merger] to happen. A weak ITV is in nobody 's interest," says one insider.

But if the conditions attached to merger approval are too stringent and the deal is called off voluntarily, Carlton looks like being the biggest loser. Granada has a strong production business while Carlton's is relatively small, leaving it reliant on advertising income and exposed to economic downturn.

One plan B could see Carlton selling its licences to Granada, just as Lord Hollick's United sold its Meridian and Anglia licences to Charles Allen's Granada when its proposed merger with Carlton was blocked two years ago. Carlton would then have to develop its cinema advertising and content division, bolstered by a programme library which, with shows such as Thunderbirds, is bigger than Granada's.

Those involved in the merger accept that businesses rarely get what they want from competition probes. As one observer says: "They will have planned every eventuality."

Those eventualities range from behavioural remedies - whereby the companies agree to act differently, particularly in the TV advertising market - to structural solutions such as the sale or contracting out of advertising.

Carlton assumed early in the inquiry that it might have to dispense with its sales house - at least until ITV's overall share of advertising fell well below 50 per cent - rather than merge it with Granada's. Bob Wootton, director of media and advertising affairs for the Incorporated Society of British Advertisers (Isba), says the single sales house solution is now "dead in the water ... Even ITV realised selling one sales house was not a runner at this stage."

The sale of both Granada and Carlton's sales houses - has become the favoured option among Isba's 365 members, who represent Britain's biggest advertisers and fear that a single ITV could abuse its position controlling half the TV advertising market.

But it would be a terrible outcome for the two suitors, distancing them from the £2bn in ad revenue that ITV earns every year. Granada says that offloading the sales houses would seriously undermine the rationale for merger, but admits it will "look carefully to see if we can make that work".

Carlton's Mr Green dubbed the divestment solution a "deal breaker" early in the merger talks. Now, observers are sceptical about how binding that stance is. "Those two guys [Green and Allen] are pretty desperate. They will see ways round even a double divestment," says Lorna Tilbian, an analyst at Numis Securities.

The companies would have to establish two independent sales operations before they merged. There would be a limit on the stake a single ITV could have in the sales outfits.

And the units would have to be put beyond the reach of anyone who might be able to control TV advertising, such as leading media-buying agencies like Carat or Zenith-Optimedia. "The idea of media buyers being able to take up sales contracts would have to be off limits," says Mr Wootton at Isba.

If the separate sales operations were given incentives to win the greatest share of ITV advertising revenue, they would compete with each other, but if they aimed for the biggest share of all TV advertising, they would be natural allies.

Further down the line, these sales outfits might become quite powerful, feeding back more revenue to the single ITV. "In the short to medium term, what would you do to stop those companies becoming sales representatives for some pretty serious media?" asks Mr Wootton. The Telegraph group, for one, is said to be keen on a sales partner.

But would European or US investors be interested? A source suggests that when Power Rangers mogul Haim Saban insisted he wouldn't waste "one dollar" on an ITV which did not control ad sales, that was a negotiating stance. Viacom's Mel Karmazin has been more open-minded, suggesting he would look at ITV whatever the outcome of the merger.

Another solution - and one that would pose few problems to potential investors - is "contracts rights renewal" (CRR), a behavioural remedy allowing ITV advertisers to renew unchanged the terms in which they advertise with the network. This would eliminate inflation - and the threat of advertising rates rising as audiences fall - but the details would have to be negotiated.

Carlton and Granada would welcome this solution because it could offer them some gaping loopholes. For example, the vagaries of who qualifies for renewed contracts could mean that only one third of ITV's ad revenue was covered by CRR. If advertisers changed their target audiences, say, or their media agency, existing agreements would be torn up. ITV would be laughing all the way to next year's negotiation rounds.

In reality, the companies are preparing for a ruling that combines renewable contracts with a move to put the sales houses at arm's-length; or the double divestment remedy with a concession to ITV. There is also likely to be protection for the smaller ITV companies - Scottish TV, Ulster and Channel - that aren't part of the merger.

However it's formed, Carlton and Granada's single ITV is set to launch in January and many in the industry expect a change of management within a year. Most imagine Mr Allen will move on.

"Michael [Green] would like to be king of ITV," says an insider. "He's seen as entrepreneur- ial. Charles has got a lot more flak from the City recently."

Once the team has stabilised, a huge challenge remains. A single ITV must arrest spiralling audience share and improve the punitive deal under which it pays £300m to the Treasury every year for the privilege of broadcasting in a crowded market. Only then will ITV lose its tag of "sunset brand".