Shareholder detente can't last

The 2010 financial year saw some material changes to Consolidated Media’s profile. The company sold its stake in Seek for a big profit and used the proceeds to instigate two separate share buybacks. The share register has tightened considerably with two major shareholders now owning two-thirds of the stock between them. The underlying earnings at Foxtel and Premier Media Group are performing strongly despite the GFC impact on subscriber growth. Both investments are undervalued by the market.

“We remain unambiguously positive on the prospects for subscription television in Australia”

Cons Media’s full year profit for the 2010 financial year of $89.5 million was 27.2% ahead of the prior year. That was primarily due to the 21% increase in contribution from the Foxtel stake (25%) and $12 million of interest earned on cash holdings on the company’s debt-free balance sheet. Premier Media Group’s contribution was marginally higher than the prior year.

Having sold its 27% stake in Seek for a $305.1 million profit (total proceeds $436.1 million cash), Cons Media was left with a cash rich balance sheet and no debt. A lack of franking credits has meant the most efficient means of returning the surplus to shareholders has been through a share buyback. Cons Media initiated its first share buyback in the first half of the year and used $210.9 million of cash to acquire about 10% of the company’s shares. The average price paid for this buyback was $3.10 per share.

After gaining shareholder approval in May, the company commenced a second share buyback aimed at acquiring approximately $225 million of shares, again conducted on-market. The approaching reporting period has halted the current share buyback, but it will resume this week with about 49.8 million shares still to purchase before May 2011. As at 30 June 2010, Cons Media held $205.2 million. About $150 million of this will be used to complete the second share buyback.

The company paid an unfranked final dividend of 6 cents per share bringing the full year total dividends to 16.5 cents per share. That represents a net yield of 5.2% on the current share price.

Turning to the charts, Consolidated Media remains range bound in between support at $2.94 and resistance at $3.34. This consolidation has been in place since September 2009. As the current price action is towards the upper range, this suggests of a breakout likely favoured towards the upside.

Foxtel

Investors have been conditioned to expect solid subscriber growth each year as the key factor driving subscription revenue and operating earnings. In the last seven years this growth rate has averaged 9.6% per annum.

This year, the growth stalled as consumers understandably became more cautious about the economy. There was an additional distraction with the commercial free-to-air networks launching their multi-channel products which possibly dissuaded potential Foxtel subscribers from signing up.

Foxtel’s operating profit (EBITDA) still increased by 17.5% to $477 million, well ahead of the $448 million we had anticipated after the half year result (FAT464 and FAT471). Where did we go wrong?

Our miscalculation was in underestimating the growth in the second major revenue lever - the average revenue per user (ARPU). In FY10, ARPU lifted $6 per month to $92 per subscriber as more existing subscribers and all new subscribers increased the penetration of the iQ2 set-top-box. This box provides the basis for accessing high-definition channels which attract a higher rate and encourage more viewing of on-demand movies. This trend to using more services and the willingness to pay a higher monthly charge is a clear trend established in the UK by BSkyB – Foxtel’s big brother.

About 62% of Foxtel’s subscriber base – over 1 million homes – now has an iQ or iQ2 DVR. Of those, more than 250,000 receive high-definition services and more than one third of Foxtel homes have an extra set-top-box. All these services attract premium revenue. In the case of the extra set-top-boxes, these are reconditioned analogue boxes that have been fully depreciated on Foxtel’s balance sheet. The profit margin is therefore extraordinarily high once the cost of the simple installation process is recouped.

With the majority of subscribers now using the iQ boxes, Foxtel is expecting a sharp slowdown in capital expenditure related to buying new DVRs which will significantly boost annual free cash flow. Cons Media was non-committal as to how that extra cash flow will be deployed.

Foxtel has a strong pipeline of new services with perhaps the pick of them being the launch of the on-line movie download service in late 2010. This service will be enabled to around 780,000 already deployed iQ boxes and gives the customer access to a video store of movies and TV programs. The initial selection only numbers in the hundreds but should quickly accelerate to the thousands.

Additional initiatives include the new distribution agreements with Xbox Live and (soon) Telstra’s new T-Box which provide a limited selection of 30 channels at an appropriate price.

Foxtel has already experimented with live 3D sport broadcasts. We expect this trend to follow the UK example with a dedicated 3D channel to be offered at some future point.

Foxtel has launched a free iPhone app that gives subscribers the program guide on their phones and allows remote programming to the customer’s set-top-box. Over 200,000 apps have already been downloaded.

The innovations keep coming which underlines the point about increasing the revenue per user.

Cons Media received a $25 million distribution from Foxtel in FY10 and will receive a $30 million distribution in September 2010.

PMG

Premier Media Group’s equity contribution to Cons Media in FY10 was virtually the same as last year at $54 million. With flat subscriber growth across its platform customer base, PMG treaded water for the year.

It is worth noting the 9.4% increase in net advertising revenue to $70 million but subscriber revenue of $320 million still dominates total revenue which grew 2.9% to $447 million.

Some of PMG’s programming is sourced in US dollars, so the higher Australian dollar therefore impacted both the revenue and cost lines. We estimate the negative net effect was about $4 million.

As an acquirer of premium sporting content, PMG is awaiting the outcome of the government’s delayed review of the anti-siphoning legislation. The outcome is crucial to the AFL’s current negotiations on the renewal of its broadcasting rights contract with the free-to-air networks. The existing deal with the Seven and Ten Networks expires in late 2011.

The AFL is very keen to be allowed to negotiate directly with PMG for a number of weekly matches instead of the usual extending haggling with the free-to-air networks who then subsequently on-sell content to PMG.

Outlook

We remain unambiguously positive on the prospects for subscription television in Australia. Owning Cons Media shares is the most direct means of gaining exposure to the industry (other than Austar – also in the Fat Prophets Portfolio).

The bullish moving average cross formed in June 2009 continues to provide upside momentum. A break above the February 24 high of $3.34, should result in a continued move higher for a test of the September 2009 high of $3.44. Only on a convincing break above the $3.44 resistance level, will we see an accelerated move higher, commencing the beginning of a new upward leg.

The outlook for Cons Media as a listed company remains clouded by the actions of the two major shareholders. Consolidated Press Holdings (CPH) owns 47.1% and will increase this to 48.3% when the second share buyback is complete. CPH will limit its increase to the 3% allowed under the creep provisions.

The Seven WesTrac Group (Seven) owns 23% and will eventually own 25.1% when the share buyback is complete. Neither party has been participating in the buybacks hence the natural increase in their proportionate ownership.

Seven has a standstill agreement with CPH that is due to expire on 10 September 2010. It is not known if this agreement will be extended or if it will provide Seven with the opportunity to once again accumulate more shares in a business it clearly covets. The detente between Seven and CPH has survived since CPH allowed two of Seven’s representatives onto the Cons Media board in September last year.

This factor could once again become a catalyst for either an attempted takeover or a privatisation of the company. In combination with the remainder of the second share buyback, we see little downside and plenty of upside.

This is particularly so if one of the major shareholders tries to buy the whole company as a substantial premium would be required. We fervently believe the value of Cons Media to be at least $3.50 per share based on trading multiples of earnings for each of PMG and Foxtel. In a takeover scenario, these multiples could easily be much higher.

We are returning to a buy recommendation for Cons Media in the Fat Prophets Portfolio at $3.25 per share.