Sky Deutschland AG SKYD GR
July 04, 2013 - 11:30am EST by
cross310
2013 2014
Price: 5.73 EPS NM NM
Shares Out. (in M): 897 P/E NM NM
Market Cap (in $M): 5,139 P/FCF NM NM
Net Debt (in $M): 607 EBIT 80 150
TEV ($): 5,746 TEV/EBIT 72.0x 38.0x

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  • TV
  • Europe
  • Potential Acquisition Target

Description

Thesis

I believe Sky Deutschland is poised to significantly increase German/Austrian ‘Premium’ Pay-TV penetration with its exclusive sports and movie content and extensive HD offerings. With financing in place and Bundesliga broadcast rights secured, SKYD GR should experience accelerating subscriber momentum and a significant improvement in top-line and EBITDA growth. Ultimately, I believe FOXA will acquire the remaining stake in SKYD GR over the near/medium-term.

  • SKYD’s market opportunity is significant with ~45mm German/Austrian homes vs. ~3.405mm SKYD subscribers today (Mar 31 2013)
  • By securing the Bundesliga rights thru the next cycle, SKYD now has visibility on its business for the next four years until the next cycle of rights thru 2016/17
  • By partnering with the cable companies and Deutsche Telekom, SKYD can enable direct subscriber billing relationships in return for a revenue share to accelerate subscriber momentum – similar to its deals with KBW and UnityMedia; DT has said it is keen to such an agreement with SKYD, but it likely will take some time to negotiate
  • By completing the remaining €144mm of a total €300mm capital raise, SKYD will have fully-funded its business plan to breakeven FCF; bank debt refinancing should drop into place in the near-term
  • 21st Century Fox owns 54.5% of SKYD GR - now that FOXA is demerged from NWSA with $8B in cash and $4B in annual FCF - I would expect a consolidation of the remaining SKYD GR stake in the near/medium-term
  • Recent decision by German tax authorities declared that SKYD can retain a significant portion of its tax loss carryforwards (over €2B in NOLs) in the event FOXA were to take a larger stake in SKYD GR
  • SKYD is demonstrating record levels of customer satisfaction and growing levels of recommendations (>40% of gross adds came from friends and family vs. <10% historically)

 

Industry Backdrop

‘Low Pay-TV penetration’ is somewhat of a misnomer as the majority of German TV households pay a subscription fee for free-to-air content (either 100 digital or 35 analog channels) – running ~€16/month

  • Cable networks pass ~28mm households, of which ~19mm receive a TV signal from them
    • Roughly half pay the cable operator directly (B2C) @€16/month and the other half (B2B) pays through their housing association @€7/month
      • ~70% of B2C customers receive the digital free-to-air channels
      • ~10% of B2B customers receive the digital free-to-air channels
      • B2B customers pay for their TV thru an ancillary charge to the housing association which residents cannot opt out of; Housing associations has a long term contract with the cable operator ranging from a few years (for smaller organization) to 10+ years for the larger ones
      • Cable operators have steadily been increasing basic TV prices over the last few years:
        • 2006: KDG stopped selling analogue services to B2C households, leaving €14/month for the digital channels as the only option
        • Apr 2006: KDG increased to €16.90/month for new customers, providing a free set-top box to encourage the transition to digital
        • 2010: KDG increased €17.90/month
        • 2012: KDG recently increased the basic TV price to €18.90/month and included 6 HD channels (‘HD Private’ package)
        • Unlike everywhere else in the world, broadcasters pay cable operators carriage fees to transmit their channels to customers

 

Bundesliga: What happened with Premiere (now SKYD) in 2006?

  • In Dec 2005, the DFL announced that UnityMedia had won the Bundesliga rights for the 2006/7 thru 2008/09 seasons at a flat cost of €250mm/year
  • At the time, UnityMedia was only present in two out of the 16 German states – making for an odd decision to with Unity
  • The press reported SKYD GR (called Premiere back then) was offering around €300mm/year – significantly higher than Unity’s offer – but only on the condition the free-to-air highlights were moved back to 10pm from 6:30pm
  • Pressure from both sponsors and politicians mounted, causing the DFL to reluctantly go with UnityMedia on the assumption it would do a deal with Kabel Deutschland (in 13 states) for near-national coverage, but that deal never happened
  • Not only was Premiere weakened significantly, but UnityMedia could not effectively monetize the rights causing a large drop-off Bundesliga viewership as well as causing several sponsors to cease support
  • When it was announced Premiere had lost the Bundesliga rights in Dec 2005, its share price fell ~44% in a single trading day – and it proceeded to lose ~800k subs over the next three years
  • After the ensuing profit warnings and management shakeup, NWSA took a significant stake in Premiere and rebranded the company Sky Deutschland in 2009

 

Description

Sky Deutschland is the leading Pay-TV operator in Germany and Austria with ~3.4mm subscribers. SKYD has agreements with most major movie studios and a number of sports events, including exclusive Bundesliga football rights thru 2016/2017 and the Champions League. Sky Deutschland is 54.5% owned by 21st Century Fox (FOXA).

 

Bundesliga Renewal

  • SKYD GR won the exclusive Bundesliga rights across all platforms – cable & satellite, IPTV and mobile & internet – for the 2013/14 thru 2016/17 seasons for ~€486m/year over the four years
  • Previously, it had paid ~€250mm/year but it did not have mobile or IPTV rights

 

With full control of the Bundesliga rights – SKYD now has some scope to increase prices, reduce discounts and potentially adjust packages to include/upsell Sky Atlantic (Sky Movies) and HD channels

  • SKYD paid a ‘full price’ for the Bundesliga rights, and now must monetize the rights – likely with IPTV agreements with DT, and potentially both VOD and O2 (for Bundesliga and full-content offering
  • DT has already announced plans to terminate its LIGA Total product – taken by ~10% of its 1.7mm TV subs) and should lead to a marketing agreement with SKYD for its full-content offering
  • SKYD has all the leverage here, as the DSL operators really need a strong content offering to defend against cable churn
  • 2 free Bundesliga matches per season are available on Free TV
  • Kabel BW offers all SKYD’s HD channels, KDG offers most of them and today UnityMedia only offers one of SKYD’s HD channels – though this seems to changing
  • SKYD has exclusive content on other sports, as well as broadcasting Hollywood movies – though these movies are typically available to VOD after a small time lag (except HBO/HD)

 

Cable Partnerships

  • SKYD has announced cable partnership deals with UnityMedia (owned by LBTYA), KBW and (soon-to-be announced Kabel Deutschland
  • Under the current deals, they jointly market a triple-play bundle with cable offering the broadband/telephony (plus billing/customer service) and SKYD providing Pay-TV offerings
  • Customers receiving the SKYD service via cable will also get more HD content (up to 18 channels), as well as the new HBO Sky Atlantic channel
  • As part of the agreement, both UnityMedia and KBW will offer more of SKYD's HD channels plus its new HBO Sky Atlantic channel
  • UnityMedia will soon offer up to 15 SKYD HD channels (up from one), while KBW will offer up to 18
  • Bottom Line: I would expect higher HD uptake and higher subscriber growth with lower SAC – in return for a revenue share; would further expect deals with KD8 and DT over the medium-term

Outlook/Guidance

With the exclusive Bundesliga rights (starting in 2013), SKYD expects to see accelerating net adds (subscribers growth) from 2013 onwards. Official guidance is as follows:

  • Full year 2012 EBITDA expected to be significantly better than 2011
  • Full year 2013 EBITDA to be positive and to grow strongly thereafter

 

Consensus initially assumed a moderation or even tailing off in net adds next year – but I believe SKYD should gain subscribers for the following reasons:

  • Gain of the former DT Bundesliga subscribers mentioned earlier (~10% of the 1.7mm DT ‘Entertain’ customers subscribe to LIGA Total)
  • Growing critical mass with record levels of customer satisfaction leading to an increasing number of customer referrals/word of mouth in a relatively under-developed German pay-TV market
  • SKYD aggressively pushing growth by either giving away free Sky+HD boxes and/or offering their Sky Go service as a stand-alone OTT/online offering at a cheaper price

 

SKYD has been active in using promotions/discounts on its subscriptions to drive subscriber growth and try out its products. However, Bundesliga exclusivity should translate in some pricing power – leading to fewer discounts. Ultimately, SKYD may focus its promotional activity on giving away Sky+HD boxes (hardware discounts) vs. discounting subscriptions (software discounts) – leading to higher profitability over the longer-term.

 

Capital Raise

  • SKYD has stated that the Bundesliga cost was already factored into the existing financing plans, and they will need to raise more than the €300mm already outlined
  • Of the €300mm capital raise, €156mm was completed in Feb 2012 with the remainder initially to be completed by the end of Sept 2012
  • While management initially stated the financing would likely be thru a convert, shareholder loan or rights issue – the Bundesliga renewal and the implicit backing of FOXA may be sufficient to sway the banks into expanding their existing banking facilities when they expire at the end of 2013 – far cheaper than issuing further equity

 

Bear Case

  • Low Pay-TV penetration. Germans have historically shied away from paying for TV, impeding SKYD GR’s ability to grow subs. Germany/Austria has among the lowest Pay-TV penetrations among global developed markets at ~14.5% in ‘11 (vs. ~11.6% in ’10)
    • With exclusive content and an extensive HD offering, SKYD GR has been growing subs at an accelerated pace and gaining momentum among German households
    • Low barriers to entry. In theory, any entity with enough capital can acquire content and enter this business.  SKYD GR’s differentiation is exclusive sports (Bundesliga rights; Sky Sports News) and movie (HBO thru Sky Atlantic HD; first-run Hollywood movies) content, and extensive array of HD channels
    • Not fully-funded biz model.  From 2004 to 2011, SKYD GR’s share count increased from ~77mm shares to +700mm shares currently as they met funding needs thru a combo of equity offerings, rights offerings and shareholder loans (~$1.5B cumulative financing since ’05)
      • SKYD GR remains heavily levered with €580mm of debt and is expected to be loss-making again in 2013 on an earnings basis, but +ve on EBITDA  
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  • Q2 Earnings results
  • Bank refinancing. SKYD GR has €525mm of bank facilities set to expire in 2013. Given the positive Bundesliga outcome, management is likely move quickly to complete the refinancing
  • Unbundling Sky GO. Creating Sky GO as a standalone online/OTT product would likely drive significant drive subscriber growth
  • FOXA Takeout
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