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Hollywood’s Q3 clue to future

Will provide answers on cord-cutting, 3D, B.O.

Are TV subscribers really cutting the cord? Can strong advertising growth continue? Are balance sheets still flush with cash? Is the 3D mania over, and did the domestic box office recover from its lackluster early summer performance?

These are a few of the key questions that are likely to be answered in the next several weeks and underscore big trends as large media companies begin to report third-quarter earnings.

“One of the biggest themes you will hear is all about cord cutting,” said David Bank, an analyst at RBC Capital Markets.

For the first time, the number of pay TV subscribers declined in the second quarter, by 216,000, raising speculation once again that people are dropping cable and electing instead to watch shows for instead to watch shows for free on the Internet. The second quarter is typically the weakest for cable, satellite and telco companies as college students quit services when they head home for the summer.

Some execs may blame the continued economic slowdown, but if outfits like Comcast, Time Warner Cable and DirecTV report further declines in TV subscribers, it will provide new evidence that cord cutting is a growing trend.

Carriage disputes like the protracted battle going on between Cablevision and News Corp., in which Fox stations have remained off the air, will just fuel subscriber ire toward cable companies, said Harold Vogel, a media economist and founder of Vogel Capital Management. “These kind of fights will only accelerate the cord-cutting instinct,” he said.

Further subscriber declines have an impact not only on TV distributors but on programmers too. The latter get paid a fee based on the number of subscribers. Cable channels have repped one of the hottest sectors in media and one that’s had Wall Street most excited in recent years.

Indeed, TV has become the crown jewel for many media companies, and they will most assuredly fight to protect it. “If you think about what Time Warner is today, Time Warner’s a TV company,” John Martin, the company’s chief financial officer, told a group of investors at a Goldman Sachs conference in late September. “Eighty percent of our profits come from the television business, and the TV ecosystem is thriving. Viewership is up. CPMs are up. Affiliate fees are up. There is more investment going into original programming today than perhaps ever before in the country’s history.”

One big reason for optimism coming out of the second quarter was the robust recovery in ad revenue at media companies, led by Scripps Interactive, which posted 13% year-over-year gains, or 27% if its acquisition of the Travel Channel late last year is added. The advertising growth “was beyond what anybody had expected,” said Bank.

By most projections, that ad growth continued in the third quarter, helped by stronger auto and political spending at local stations.

But with a lethargic economy and unemployment hovering near 10%, it is not clear whether advertising trends will be sustained in the fourth quarter, particularly as political dollars drop off post-election. “I see an overall slowdown in the economy ahead,” said Vogel. “Advertising in 2011 is just not going to look that good.”

That kind of uncertainty may be why media executives are exhibiting a heightened prudence when it comes to the balance sheet, spending more on stock buybacks and dividends than on costly acquisitions.

By the end of the second quarter, media companies had estimated cash balances of $18.5 billion on the books. While buybacks and dividends may not be exciting corporate moves, the fiscal discipline will likely continue as media companies navigate their way through new business models and evaluate new deals carefully. “Over the last year and a half, I think we’ve spent between $1 billion and $1.5 billion on probably close to a dozen transactions,” said Time Warner CFO Martin, “most of which have been to gain scale internationally in our networks business or to gain competencies in our (video) games business.”

As to the movie biz, eyes will be focused on opportunities in 3D and whether there will be a continued rush into the format following the enormous success of “Avatar” and other films.

It looks like the domestic box office is rebounding after disappointing declines of 11% and 3%, respectively, in May and June. In July, B.O. was up 13% in the U.S. to a record $1.3 billion. Much of those gains can be attributed to “Toy Story 3” and “The Twilight Saga: Eclipse.” B.O. fell back again in August and September, but international returns remained strong.

“The build-out of theaters abroad (especially in emerging markets) over the past few years has helped increase attendance in those regions,” said RBC’s Bank, “and Hollywood studios are simply taking advantage of this trend by focusing more on culturally neutral action/adventure movies.”

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