Media Stocks Sitting Pretty

It’s accepted wisdom that if Australia’s media ownership rules are relaxed it will spark a takeover feeding frenzy. However there are risks to this scenario. First, there is still no guarantee the new rules will pass the Senate. Second, it remains unclear what rules will guide “competition Czar” Graeme Samuel.

Most media moguls express disinterest in media acquisitions (invariably citing competition from new media). But to quote an old expression: “They would say that, wouldn’t they.” I think there is a high probability of media ownership deregulation in early 2007. But in selecting some takeover candidates I want to ensure the fundamentals are reasonably solid as well. Here are four media stocks that grab my attention:

John Fairfax Holdings (FXJ): Fairfax has been the subject of takeover innuendo since at least its 1992 IPO. At various times over the past 15 years its register has been graced by the presence of Kerry Packer, Rupert Murdoch and the now-fallen Canadian media baron Conrad Black. Although never a significant shareholder, Telstra actively considered at least one bid. Today all the moguls are gone, and the share register is open.

At $4.07 Fairfax is trading on a 2006-07 fully franked yield of a little over 5% and a price/earnings (P/E) multiple of 16.3 times. Among large-cap media, Fairfax represents the best value. Last week, chairman Ron Walker doubled his personal shareholding and has continued buying this week. Risks include its high New Zealand exposure (a third of earnings) and the declining market share of classified ads.

The New Zealand risk is mitigated a little by its relatively defensive regional exposure, although there is no doubt the NZ economy is facing some significant challenges ahead. While the internet is stealing car, job and some housing ads, I’m still a believer in the long-term viability of newspaper franchises. Newspapers continue to set the daily public debate agenda, as demonstrated recently by the revelations of the 1994 Howard/Costello meeting. For many, newspapers remain a “must read”; and they are a “must buy” for most national advertisers.

Seven Network (SEV): I continue to be attracted by the Seven franchise. I believe it is now emerging as the dominant Australian TV network. Recent sackings and litigation in Nine’s newsroom, appear to me to be a “throwing in the towel”. Seven now regularly dominates the cornerstone news/current affairs TV ratings. AFL broadcasting returns next year. Like Fairfax, the Seven register has historically attracted its share of predatory interest. For many years, Murdoch was a significant shareholder, while at various times Telstra has also shown interest.

Seven recently sold Telstra Dome for $330 million, which was well above most analyst’s valuations. Given the stadium was barely break-even and the sale reduces Seven’s net debt by about 75%, this sale alone adds about 25% to 2006-07 earnings per share. Seven recently tied up with Global TV in a TV production joint venture that should also reduce costs.

Earnings for 2006-07 earnings are clouded by legal costs (about $54 million) as Seven “sues the industry”. Once these roll off, and allowing for earnings accretion from higher ratings and the stadium sale, Seven should be able to earn at least 65¢ a share, putting it on a P/E of 13.2 times underlying earnings. The 4%-plus fully franked yield (2006-07) is also useful. Unlike Fairfax, the Seven register is not open and is dominated by Kerry Stokes with 43%. No takeover is possible without his agreement. I think News Corp or some other foreign media company would be interested in Seven.

Ten Network Holdings (TEN): Ten continues to win the TV ratings in its core 16–39 year demographic. In the season to date, Ten is in fact the best performing network versus last year and is up in all demographics, for example up 4.5% in the 16–39 group. I’m not convinced the Canadian media company CanWest (56% shareholder) is committed to Australia long-term, particularly if a serious bidder emerges. In the early 1990s, CanWest devised a particularly complicated structure to circumvent the current foreign ownership rules. Unwinding that structure (post rule changes) would increase Ten’s transparency enormously.

Therefore Ten shareholders would be winners even if no bid emerges. Interestingly, over the past nine months Win TV (owner of the Nine TV regional franchise) has bought 10% of the company and now owns over 11%. Below $3, Ten is trading on a 5%-plus 2006-07 fully franked yield. The P/E multiple of 19.1 is high, so arguably some takeover premium is already priced in. Again, I think News Corp or some other foreign media company would be interested in Seven.

Southern Cross Broadcasting (SBC): This is a diversified media group covering regional TV (primarily Ten), Nine in Adelaide, metro talk back radio and TV production via Southern Star. Big Brother is a key franchise but other important productions include Deal or No Deal, Strictly Dancing and the ageing Blue Heelers. In my view, the company owns an attractive portfolio of predominantly regional media assets. Importantly it has a wide open share register. At the current $11.40, the fundamentals stack up too. With a fully franked yield of more than 6% and trading on a P/E of 14.8 times (2006-07) Southern Cross represents excellent value for a media company.

Disclosure: The author has been a long-term shareholder in Seven, Ten and SBC.