Macquarie's Media Man

Tim Hughes, the executive chairman of the Macquarie Media Group (MMG) is sitting in one of the hottest seats in the investment market. As the internet threatens traditional media and the Howard Government finally appears serious about reforming media laws in Australia, the fund appears perfectly timed to exploit a lively market.

Hughes is a media insider of the first rank '” he was the right-hand man to television tycoon Reg Grundy for more than a decade. Now he's driving a billion-dollar multinational fund that's backed by Macquarie Bank.

Having said all that, Hughes has yet to capture the imagination of the retail market. Although it listed last November, MMG is trading barely above its issue price. Despite a record-breaking run on the ASX, accelerated takeover activity across the market and the looming speculation of media takeovers (Macquarie itself was rumoured to be looking at Fairfax only a few months ago) investors have been slow to warm to MMG.

It might be the backlash against Macquarie's fee, it might the absence of an 1980s style “takeover premium” in local media stocks or, as Hughes suggests, it just might be that investors are yet to “get” the attractions of this fund in the same way it took many months for similar funds such as Macquarie Airports to become successful.

Either way, despite it's unlikely array of assets '” currently split between Taiwan and regional Australia '” MMG is trying hard to win over retail investors with a pre-tax dividend yield of about 11% against a prospectus forecast of about 7.5% and a dividend reinvestment program '” a facility to reinvest dividends in new shares without paying stockbroking fees '” that has become very rare among Australian blue chips.

Exceptionally well connected (Hughes is also chairman of Photon, the listed media services company) and extraordinarily well financed, Hughes is a point man in the media market. Every possible deal in media goes across his desk. Consequently, his views on media as an investment market are highly valued. In today's interview with Eureka Report, Hughes clearly spells out what he's willing to buy and what he won't touch in the media sector:

James Kirby: Can we start with you telling our subscribers what your fund invests in and what you hope your portfolio might look like in, say, five years’ time?

Tim Hughes: Macquarie Media Fund was launched 18 months ago and we did an IPO in November last year. The fund has been set up by Macquarie Bank along the lines of the specialised infrastructure funds. In a lot of markets media is quite mature and it’s a very stable business. In a lot of cases it is underwritten by a protected position; that is, a licence. So when you’ve got a business that has a diverse revenue stream in a privileged position that spins off high returns to equity, or has very high and stable cash yields, it’s a perfect business to put in a fund like this. It’s not too dissimilar to a toll way, although a lot of people in media are a little bit upset when I said that '¦ compared them to a toll way (Laughs).

I can't imagine why? Is it possible you could have every form of media in the fund eventually?

We could ... the fund has not been limited by type of media because what’s the point of limiting what we can do in the future? We don’t want to limit to any type of media; however, any deal we do must have the following characteristics: They must have earnings stability and you get that through either geographic diversity or stable and varied buyers of your media. They must have an attractive growth profile '” in other words that we can take the asset and provide capital for it to expand. The media assets we’re looking at must have limited threats of new entrants, so they are protected by licences or the cost to build is too high. And most importantly, they must have experienced management teams.

Just now, with interests equally spread between Australia and Taiwan, you'd have to say that's an unlikely spectrum of media holdings?

I don’t think so because in terms of characteristics they’re the same. We launched the fund with Macquarie Regional Radio, which is 86 stations across regional Australia, and it’s Australia’s largest owner of radio licences and that business generates around $140 million in revenue and will make $46 million EBITA this year. In Taiwan, Macquarie Media Group will be acquiring 60% and Macquarie Bank acquired 40% of Taiwan Broadband Communications. That's not just a cable TV company; it’s what people call a triple play: it provides cable television but it also provides internet connections and telephony. It is a monopoly in that it operates in five areas of Taiwan and provides all the cable television, and it is the only alternative telephony provided other than the existing incumbent, a Telstra-type company called Chung Wah.

What percentage of MMG profits would be in regional radio and what percentage are in Taiwan?

We announced when we acquired TVC that it’s earnings are in excess of $A100 million per annum, and we announced with our results recently that if we’d have owned Taiwan broadband communications for the 12 months to December 2005 the distribution per unit to the holders of Macquarie Media Group Securities would have been 23¢ per unit and, by coincidence, the prospectus for MMG when we floated with just Macquarie Regional Radioworks had a forecast distribution on an annualised basis of 22–23¢, so they’re very similar in size in terms of the return to MMG shareholders '” around $46 million in each case.

And what did you pay for the Taiwanese TV and internet assets?

9.5 times EBITA.

And is there an estimation as to what your radio stations in Australia are trading at?

Well we floated at an EBITA multiple of around nine times, so again it’s very similar.

And in terms of earnings growth, they’re moving at about 6% earnings in Australia and about 15% earnings in Taiwan. Is that correct?

That’s correct, yeah.

Is the Australian radio earnings slow then?

Well, radio totally was only up 4% for the first six months and we were up 6.3%. That’s because we’re not reliant on national advertising and there has been a real strong growth in regional Australia, particularly in Queensland and Western Australia. So we’ve benefited from that so it’s a very stable business '” high margin and it’s growing.

If I was investing in your fund, my main concern would be the reliability of revenue streams for media groups. Aren't certain elements of media '” free-to-air television and newspapers particularly '” vulnerable to new forces in media? How does that affect the reliability of your earnings streams?

Well it doesn’t affect the reliability of our earning streams. It just means that we wouldn’t buy any business that has those attributes; that could be impacted by the internet; that has falling audiences. What we’ve done in this fund is about buying businesses that we believe have stable and sustainable revenue and earnings streams. So we’re careful. We probably wouldn’t buy a newspaper that was dependent on classified advertising; that’s been impacted by the internet. But we might buy a newspaper that had a national brand, that had very little competition and was more of a subscription paper '” didn’t rely on classifieds to make its profit.

Is there such a newspaper in Australia?

Well I think there’s a number of assets like that around the world. I’ll give you an example right away, and this is in no way any indication of what we’re looking at, but the Financial Times in London is a paper like that. It’s not dependent on classifieds. It’s a national or even international brand. It makes its profit from its subscription price. It’s a specialised focus, niche newspaper and it would be very hard to duplicate. So that’s an example, I think.

Would you be prepared to buy a pure play internet media company?

At the prices that they’re going for at the moment, I would say no. This fund is focused on returns to equity. In other words, we want to return all of the assets to equity, pay out 100% of our profits to shareholders. A lot of the internet businesses at the moment either are too expensive, or you have to pay a multiple that’s not going to give you an attractive yield, or require a start-up phase, and you’ll lose money. This fund will not buy a business that will need to go through a development phase.

Will you be taking advantage of changes in cross media?

I think our regional radio stations, which are locally based, would fit very well with a regional television network, which is more of a national model. But we’re not actively looking at anything at the moment and I think the prices are a bit steep. We’re not limited to here, so we’re finding assets overseas, as we’ve proven with the Taiwan acquisition, at a multiple that you can be very accreditive in terms of distribution per unit that we pay out and will be high cash yields.

Looking at ASX-listed media stocks, there's little evidence in the past few months the market is pricing in any takeover action.

No. And they won’t. The last time the media was deregulated in Australia there was a bit of a frenzy with the takeover of the Herald & Weekly Times, Fairfax went into play and all those things. Back then there was rivers of gold [classified advertising revenue]. There was no prospect of the internet nor cable TV, so a lot of these outfits were very highly sought-after. But today, as you said, the internet and digital media and mobile media, there’s lots of opportunities now to interact with people. Not just through the Sydney Morning Herald or Channel Nine any more, so I don’t think you’re going to see sort of a frenzy at all because you've got to justify it on the fact that it’s going to increase the returns to your shareholders and in most cases it’s hard to find too many synergies.

Could you give us some sense of the market in European media that you’re looking at?

We looked at some radio businesses in the Netherlands and we made an offer. That offer wasn’t high enough to get us into the next stage of due diligence. We’re looking at the cable market in Europe. We’ve got strict guidelines about the characteristics we're looking for, that the assets must have, and we’ve got the Macquarie offices around the world are scouring looking at the deals.

What's your most likely next move?

We’ve got the capacity, as we’ve announced, to probably make another acquisition around using about $300 million. The radio business is ungeared so we could probably borrow $300 million to make another acquisition before we needed to tap any equity.

And what sort of returns can we expect from this multinational media business?

If you look across this business you’ve got 46¢ on a fully diluted basis. Our shares have a deferred payment, which is due at the end of November. They’re currently trading at $2.77 and another $2 is due in November, so that’s $4.77. Based on our history, we’d be paying out 46¢, so most analysts have a yield of 10–11% on an annual basis

Now to be accurate, those yields are pre-tax?

Yes, those are pre-tax figures. The fact of the matter is the Taiwan acquisition is going to be very accretive; there’ll be analysts who’ve written that up and put that in reports, but the market hasn’t focused on that at all. So we’re trading at our issue price and we floated at about 8% yield, and now if you look at all the research that’s out there, we’re 10–11%. Remember: when Macquarie Airports first listed, it sort of struggled for the first six months to a year until the distributions were actually started to be paid, and then the stock then went up 50–60%.

What about fees? This issue is more intense with each passing month. Your fees are an MER of about 1.5% and then a performance fees on top of that. Is that correct?

Yes.

Is it true that unlike the other Macquarie funds, if you as the manager were voted out, there was a clause which meant that it would immediately flip over and you would get the fee anyway that was originally planned? Then there was some amendment that nobody could understand. Can you tell me: Is it the case that if you are voted out as the manager of the fund does the existing fee arrangement more or less replicate itself in a new form?

No. I think you're referring to a one-off item called an asset advisory agreement. When we bought the radio business and put them together two years ago, it was private and then the bank bought these businesses with a view to holding them and we (Macquarie Bank) hired the management team. So really if someone cancelled the management contract up above '¦ well we must still provide the management team because you wouldn’t have the management team for the radio group if you got rid of Macquarie Bank above, but that’s all it does.

OK, so it’s not for the fund as much as the residual assets of the regional radio group?

That's right. It was only because of the radio assets, because we owned them nearly 18 months privately prior to the IPO and the majority of the senior management team is employed by the bank.

So, there is this arrangement but it applies only to the radio business, which I expect will shrink as a proportion of overall assets?

Yes, I’d imagine so. It already has shrunk to half of what it was.

And finally: you’ve got a dividend reinvestment program. Are you committed to keeping it and what are the terms it’s on?

We voted it in and it’s there and you can re-invest. A lot of people like to let it ride. And particularly a fund like this is going to pay high levels of distribution [so] a lot of people put their money down and say,’Well, I’m happy to reinvest my dividends’, and that’s why we’ve put it in place for those people. And, you know, given that we pay a pre-tax yield of 10–11% at the moment, it gives an opportunity for people to reinvest '” not have to receive the dividend, bank it and then go and buy more shares.