Is there value in Nine Entertainment?

For any money-making business, even those facing significant problems, there's a point where its share price offers value to investors. Nine Entertainment Co (ASX:NEC) certainly had plenty of the problems at the time of its float in late 2013 but we didn't see the value. We recommended members avoid the float, noting that ‘the success of an investment in NEC will most likely be determined by Nine Network, a business we expect to decline'.

Nine's share price has since more than halved, including a 15% fall on 2 August, that took it to an all-time low of $0.91 per share. We had been watching Nine for a while and coincidently had scheduled one of our ‘dragon's den' sessions to discuss the stock the day after. Had that ‘buy point' for Nine finally arrived? The verdict of the team was that, at current levels, no it hadn't.

Despite double-digit dividend and free cash flow yields, net cash, ongoing share buybacks and structural cost reductions such as lower licence fees, we believe the free-to-air (FTA) TV market will continue to deteriorate and today's multiples make it seem more appealing than it actually is.

The FTA advertising market has been declining around 1.5% a year since 2011 and advisory firm PWC expects this trend to continue, forecasting a 1% decline through to 2020. We'd argue that might be optimistic.

Despite FTA still reaching around nine in ten Australians over the age of 14, the people who watch it most are not the key demographics targeted by advertisers with most of the regular audience aged over 50. Nine's share of this declining market was also down to 37% from around 39% in 2014 and 2015 thanks to poor ratings in the second half from its cricket coverage amongst other programs.

With revenue under pressure, attention needs to focus on costs. Nine has a cost base of around $1 billion of which 70% relate to programming. Cut these costs too far and the quality of your broadcast will fall further pushing people away from your channel, thereby creating a vicious circle.

Another concern we had was the lack of a premium digital asset whose growth potential can more than compensate for the decline in FTA television such as other ‘old media' players like News Corp (ASX:NWS) and Fairfax (ASX:FXJ) have with Realestate.com.au and Domain.

We expect Nine's profit in the future will be lower than it is today and that the FTA advertising market will deteriorate faster than many expect. This struggle will only intensify if sporting bodies and broadcasters of paid content get their way and see the anti-siphoning legislation — which prevents the likes of Fox Sports from bidding for sporting rights unless the FTA networks have passed and there's less than 12 weeks till the start of the event — watered down. We'll continue to watch the stock, but we'll need prices to get a lot lower before we see any value.