Predicting the Headlines

As one of the nation’s top media analysts, Ivor Ries suddenly finds himself in the hot seat following the Government's decision to relax Australia’s media laws. Ries is a former finance journalist (he was the Chanticleer columnist at the Australian Financial Review) and is now head of research at stockbroking firm EL & C Baillieu. His first move after last week's announcement by Communications Minister Senator Helen Coonan was to warn clients that if the proposed media changes do not get through the Senate, media stocks will drop back by 10–15% across the board.

But most analysts now expect substantial changes in the media landscape in coming months. Earlier today a story swept the markets, reported on crikey.com.au, that Fairfax had been in talks with News Corporation over aligning online recruitment sites to take on the all-conquering Seek Communications.

Over the coming weeks many more stories, tips and unsubstantiated rumours will wash through the market because it's reasonable to assume that everyone is talking to everyone about future possibilities.

What does it all mean for private investors? Top analysts such as Ries attempt to forecast future merger activity by assessing the most logical alignments. It's a worthy approach, although it does not allow for illogical takeovers and there is no law against commercial folly.

For his part, Ries sticks to deductive possiblities and he sees News Corporation, Foxtel and Macquarie Media as leading predators in the coming months. He names PBL (owners of the Nine Network) and Southern Cross Broadcasting as potential targets.

But underneath the froth of merger speculation, Ries is decidedly bearish about traditional media stocks claiming that Fairfax '” trading above $4 for the first time in many months '” would drop back to $3 if the “takeover premium” was removed.

The interview

James Kirby: In the immediate aftermath of the Government's decision to loosen media regulations, the two stocks that jumped on the ASX were Southern Cross Broadcasting and Fairfax. What does that tell you?

Ivor Ries: Well the lifts last week were basically takeover arbitragers. There’s no corporate action there. It’s just funds positioning themselves on the assets that they think most likely to be taken over. I disagree with their views. In my view the most likely targets are in fact Austar and the Ten network.

And the two media stocks that fell were West Australian Newspapers and the Packer family's PBL. What's the explanation there?

As for WA Newspapers, I have no idea why they would go down apart from the fact that the overall market was heading down at the time. PBL '” maybe the market’s trying to factor in the risk that they’ll over-pay for assets '¦ everyone will be trotting out the rumour they’ll make a bid for Fairfax. I think that’s unlikely.

So are you saying this lift in prices was driven entirely by hedge funds?

Mostly hedge funds.

You’ve been fairly bearish on traditional media assets. Why?

Traditional media in Australia is copping a double whammy at the moment. First, consumer spending is being squeezed by oil prices and advertisers are reluctant to lash out in big campaigns, so total advertising spending is flat. It is not showing much growth at all. Then online spending is growing at about 50–60% per annum as far as we can tell, so that means traditional media '” the big categories, particularly television and newspapers '” are losing. They're dropping maybe 5–6% a year. In that kind of environment it’s very tough for the traditional media.

Let’s look and see how this scenario actually affects individual companies and individual stocks. What do you think will happen at new-era PBL. Do you expect them to stay in media?.

I think the Packers really take a hard line on shareholder value. If they can get a really high price for the Nine Network '” and by that I mean well north of $4 billion '” they would sell it. They certainly wouldn’t be sellers at any price. You’d have to say Nine Network is no longer a core asset for PBL because their future depends far more on gaming in Macau than it does on the Australian television industry.

Which companies might buy the Nine Network?

I guess there would be a number of feasible buyers. The most logical buyer for Nine is Foxtel. Ironically Foxtel is a joint venture between Telstra, News Corporation and PBL '¦ but that’s the most sensible combination from a point of view of industrial logic.

Yes, Foxtel is often cited as a potential buyer for Ten Network as well. So you seem to think there will be takeover action in free-to-air TV?

Well, the problem with media mergers are that there are very few synergies. There are almost no revenue synergies. So you have to go looking for cost synergies and the main cost synergies come from merging similar platforms so the really big bangs for your buck in media mergers come from merging, for example, Foxtel with Austar '” two pay-television companies. You go to one marketing department, one telephone call centre, one engineering department..

In putting Foxtel and Austar together, we estimate they could take out costs of between $100 million and $140 million a year. That to us is the most overwhelmingly sensible merger to be done. After that it’s Foxtel with one of the free-to-air networks, and just whack them together and run them off a common platform. That makes a hell of a lot of sense and we estimate that would be again anywhere between $80 million and $140 million a year in costs.

When you get mergers between print and television there are almost no synergies. People will pretend there are synergies but they’re really just making them up as an excuse to rationalise merging one company with another. The overwhelming experience in the United States has been that trying to run print companies alongside television has been an unmitigated failure.

In that context let’s talk about Fairfax. What is the future for Fairfax as a target?

Certainly if there is not a takeover bid launched for Fairfax in this round then we would expect Fairfax shares to be trading at lower prices in a year’s time.
And Fairfax as a buyer?

Well, they’ve done a lot of buying in the last two and a bit years. They have been very acquisitive. And by and large the things they’ve bought have been sensible '¦ New Zealand newspapers and various internet properties. You can argue about the prices but they are logical, sensible add-ons for Fairfax. There is absolutely no logic in Fairfax buying a free-to-air television network. Absolutely none. There is powerful logic in Fairfax buying some of their competitors in the online space such as Seek, RealEstate.com.au and Carsales. Those are the so-called category killers that are making Fairfax’s life very unpleasant at the moment.

But being realistic, Fairfax is unlikely to purchase any of those three highly priced internet companies.

Probably unlikely, but those are the things as a shareholder you’d like them to buy because those are acquisitions that make sense from day one. They would pay for themselves from day one and you don’t have huge management integration issues.

Now looking at Rupert Murdoch's News Corporation '¦ there has been a lot of controversy over the exclusion of that stock from the ASX index. Does that really matter for retail investors?

From a retail investor’s point of view, whether or not a stock is in the index is utterly irrelevant really. The question is what can this stock do for me over the next 12 months. Newscorp’s had a pretty substantial run over the past 12 or 18 months and its probably unlikely to do the same over the next year.

Do you see Newscorp as active player in any forthcoming rationalisation?

News is one of the few print players that can actually make money out of buying a free to air in Australia because they already have a huge free-to-air cost base in the United States, so they can obtain some synergies. They’re an exception because they own programming. The number-one cost of running a TV network is programming. If you can jam your own programming through it then it makes sense. If you’re starting out from scratch and you don’t own any programming and you buy a free-to-air network then not a lot of money can be saved.

So do you see Newscorp as a contender for one of the listed TV networks?

I believe that News will have a very hard look at both the Nine Network and at Ten. They’d be crazy not to.

Speaking of people who are going to have a hard look as potential buyers '” have you assessed the prospects of Tim Hughes and his Macquarie Media fund?

Yes, Macquarie Media are a potential player. There’s no doubt about that. The only area where they have any advantage is in radio because they already have a radio cost base. So for them to buy a capital city radio network or even a stand-alone capital city radio station would make sense. There’d be some good benefits from that, particularly sharing the cost of programming.

Macquarie Media might also be a bidder for maybe a rural television network, purely as a financial play. The one that springs to mind is Southern Cross Broadcasting. It’s an asset-rich company with a fairly attractive regional television franchise.

Where does Telstra fit into all of this. It wants to be a media company, it's already got a stake in Foxtel. What next?

I don’t see Telstra doing anything on their own because there’s no benefit to them in owning traditional media outlets. But they do want to grow their online media content, so what makes sense for them is being in an alliance or a joint venture with someone who does own, for example, a free-to-air television network. And they can use the content, they can cross promote. So, for example, it makes sense for Telstra to be a joint venturer with Foxtel should it wish to purchase a free-to-air network and then maybe share some of the online content.

Why is nobody considering foreign buyers in local media now that the rules have changed to allow this?

I think it’s difficult to see a foreign network coming in here all guns blazing and lobbing a really highly priced bid for any of the existing assets. If we look at Fairfax, for example, the two natural acquirers for a company like Fairfax are companies like the Daily Mail and General Trust from the UK. Perhaps Gannet or even the Washington Post Company from the States. All of those companies have a lot of problems at the moment. They’re experiencing the same problems that Fairfax are facing, such as declining revenues '¦ classified revenue lines under attack.

I find it hard to see them doubling up and buying more of the same kind of assets with the same kind of problems.

Some analysts suggest that Fairfax '” at a market capitalisation of about $3 billion '” has online assets worth $1 billion. That’s a third of the company. Do you agree with that?

If you could take the new media out of Fairfax and create a separate vehicle I think that’s probably right. But you also need to say, well, what are the print media assets worth without the online assets? The answer is, a heck of a lot less than they were two years ago.

Probably half. To give you an example, up until recently, well up until about two years ago, conventional big city newspapers in the United States tended to sell for about 15 times’ cash flow. The last big newspaper chain in America with like publications was Knight Ridder, which was sold for nine times’ cash flow. But you need to bear in mind that that included the online properties of that group. So if you strip the online properties out of Knight Ridder, the traditional newspapers probably sold for something like about six times’ cash flow.

Do you think that’s irreversible, that level of discounting?

Well certainly, if you want to sell them on a stand-alone basis. If you sell a big city newspaper with a very vibrant and successful online business paired with it, then you’ll get a good multiple. But if you try and separate them you’ll get a very low multiple for the newspaper business alone. It was a multiple played by very intelligent people who’ve been around the industry a long time. Very experienced players. If you applied the same multiple to Fairfax, the share price would be about $1 less than it is at the moment.

So in the end it's all about what you hold and what you get rid of. What stocks are the buying opportunities here and what stocks should retail investors get out of now that they have the chance?

We have one rule here for making recommendations to clients and that is that you never buy stocks for takeover. Really, you should always look at fundamental value. So on fundamental value grounds, it’s very hard to find media stocks that would go up over the next 12 months in the absence of any takeover speculation. If the Government’s laws don’t get through, then the media sector will fall at least 10–15%. So there's the wealth warning.

Understood.

But if you assume the proposals were to get through, then sensible stocks to buy would be the big, obvious targets, which are Austar and the Ten network.