|Shares Out. (in M):||1,746||P/E||0||0|
|Market Cap (in $M):||300||P/FCF||0||0|
|Net Debt (in $M):||-120||EBIT||0||0|
|TEV (in $M):||180||TEV/EBIT||0||0|
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Sky NZ (SKT NZ, NZ$ .17/sh) is an extremely cheap turnaround in a tough industry. But, Sky is showing positive momentum with fresh and competent management, a cashed up balance sheet and indications of buyout interest. I am generally wary of cigar butts and TV businesses everywhere but got hooked here. I’ll try to lay out the good and the bad and would appreciate the collective wisdom of the board in judging if they can pull off the turnaround. The shares trade roughly US$ half a million a day, mostly in NZ but also in Australia.
At the current share price of NZ$ .171/sh, Sky has a market cap of NZ$ 300m, and EV of NZ$ 180m (21m of net cash as of Dec-20, 35m of FCF and working capital release as of Jun-21 and 64m of coming property and asset sales). For the year to Jun-21, Sky indicated they will be at or above the high end of their guidance of NZ$ 182m of EBITDA. But this excludes ~33m of lease expense on their Optus satellite contract moved below the line for IFRS 16, so adj. EBITDA of 150m. Capex runs 60m towards the upper end of their guidance of 7% - 9% of sales. So roughly NZ$ 90m of trailing EBITDA – capex and 2x trailing EV/EBITDA - capex.
They over earned this year (deferred programming and other costs and subscribers held up better than expected) and Jun-22 will be a reset year. Sky only said that FCF will come in a lot lower although comfortably FCF positive and indicated that they will give guidance when they release results. My sense is people are confused here. Programming costs are going up, there are some startup costs for broadband and maybe some more marketing costs – otherwise costs are coming out of the employee base and admin. Sell side is at NZ$ 120 – 150m of reported EBITDA, -33m of lease and -60m of capex, so lets say NZ$ 30m to 60m of EBITDA – capex. If all goes well, this will be a trough.
At an EV/sales of 25%, we don’t know what we’re getting next year but there are multiple ways to win – the turnaround gets traction, they start pulling cash out or they get a bid.
Sky is the legacy monopoly satellite pay TV franchise in NZ. The DNA and business model is the same as BSkyB in the UK and News Corp owned 44% but sold out in 2013. Sky was run by CEO John Fillet and Chairman Peter Macourt for most of its illustrious and profitable history. Under Fillet and Macourt, Sky behaved as a monopoly telco – fat, arrogant, slow, dismissive of customers and partners, and extremely cash generative. From 2015 to now, EBITDA fell from NZ$ 380m to whatever it’s going to be next year, the share price fell from NZ$ 7.00 to NZ$ .17 and the dividend went from NZ$ .22 to zero. In 2019, with the shares in free fall, Fillet and Macourt were out. The new CEO, Martin Stewart, was the former CFO of BSkyB by way of OSN in Dubai. The new Chairman, Philip Bowman, was the former CEO of Allied Domecq, Scottish Power and then Smiths Group and 10 year board veteran of BSkyB. The BSkyB DNA here is key.
Martin Stewart started executing on a turnaround but had a reputation for throwing everything at the wall – overpaid for sports rights, stadium and jersey naming deals, revamped the streaming efforts and broadband bundling. But he also lit a fire under the organization and got the pace of change up substantially. Over the course of 2019, the share price fell from almost NZ$ 2.00 to below NZ$ 1.00 and then to a low of NZ$ .10 when COVID hit. It isn’t clear what happened, but spooked by the tumbling market price of a NZ$100m bond that was due in Mar-21 and the escalating cost of sports rights, Sky did a massively dilutive rights issue in June 2020. The 2.83 for 1 rights issue was priced at NZ$ .12 and blew out the share count from 435m to 1,746m after nearly all shareholders participated and an additional institutional placement. This is probably the worst rights issue at the bottom that I have ever seen. Despite the cancellation of sports and worries about the consumer, subscriber losses remained manageable and cost cuts led to a year of excess profitability. And in Dec-20, Sophie Moloney, who followed Martin Stewart from BSkyB to OSN to Sky NZ, replaced Stewart as CEO.
Financials: I’ll post abbreviated financials for brevity. Revenue has been comping down MSD driven by MSD/HSD declines in the core satellite/set top box biz (75% of sales) offset by growth in streaming (10% of sales) and steady (excepting for COVID) commercial, advertising and other. These guys earned excess margins during their tenure as monopolists.
Sky has been losing satellite subs at a MSD rate with LSD ARPU declines to boot. But churn is improving – not clear how much of this is COVID related and how much is the turnaround effort, operating and marketing improvements. Talking to the company, there are massive changes going on under the hood.
Also of note, management pointed out some extraordinary effects in the larger than normal drop in 2020 ARPU – mostly around ending their reseller agreement with Vodafone. This is reflected in the Dec-20 adjusted revenue figure above.
There’s a tension between the terrible consumer reputation Sky had and the cultural mind share that this monopoly service occupies. In my conversation with locals, they pointed out the Sky has a deep captivity / loyalty around sports, older households and rural households that don’t have fast broadband. And that Sky has the history/DNA of a marketing machine if they can get things on track.
The recent investor day calls for top line growth and clearly the stock should do fine if they can staunch the bleeding. But this could also do fine if they manage the cost base and start pulling out cash. As a sanity check, my crude model has satellite revs comping down -5% while streaming continues to grow at a +10% clip. The math spits out -2% total revenue declines – these guys should be able to figure out their cost structure and pull out cash under this scenario.
As for the BS, we start with 1,746m shares at NZ$ .171 and a market cap of NZ$ 300m. For EV, deduct
· NZ$ 21m of net cash as of Dec-20.
· From guidance of $182m of full year EBITDA for Jun-21 less NZ$ 116m of fiscal 21H1 guidance gives 66m of 21H2 EBITDA (fiscal year ends in June). Less 17m of satellite lease payments and 30m of capex, these should do 19m of EBITDA – capex and let’s say 15m of FCF.
· In the half to Dec-20, Sky made NZ$ 57m in payables payments and total working capital came in by NZ$ 40m from -70m to -30m. Let’s give them credit for half the reversal or NZ$ 20m of FCF.
· In March, Sky completed the sale of their fleet of production trucks for NZ$ 14m.
· And in March, Sky announced the sale of excess property in the Mount Wellington neighborhood of Auckland. Here is the Colliers’ listing. This is obviously a unique property – a combination of office and industrial space with a bunch of excess land. Currently zoned for commercial but adjacent to expensive suburbs in a city where the property market is beyond booming. A very quick perusal of nearby commercial listings yield ~NZD 5,000 per sqm which seems reasonable. At roughly 10K sqft of space, some of its industrial but there’s a bunch of extra land, lets ballpark at NZ$ 50m.
And so total EV falls to NZ$ 180m and Sky is materially over capitalized. EV/sales at roughly 25%.
As a couple of other checks on value, not sure if these are still relevant. A couple years ago Brian Roberts bought BSkyB at an inflated multiple – I don’t have access to my model buy my memory says nearly 20x EBITDA – capex and above 2x sales. Sure BSkyB is better run, no turnaround and had the under earning German and Italian assets, but this was only two or three years ago.
In 2016, Sky inked a deal to merge with Vodafone’s NZ operations (no. 1 mobile and no. 2 broadband) but it was killed by the competition regulator. The deal would have valued VOD’s 51% interest (and therefore Sky’s 49% interest) at a NZ$ 3.4B vs. roughly NZ$ 2.2B in the public market.
Strategy, Turnaround and Investor Day Guidance: The plan is to recreate the consumer bundle around 1) sports, 2) managing the general entertainment rights losses and partnering/wholesaling international streaming services and 3) bundling in cheap broadband and then mobile. The idea is that with better back office admin and customer service, Sky can leverage the billing relationship to differentiate itself even when selling commodity services. This is the path being followed by Comcast / BSkyB with their Xfinity and Q boxes that can serve as a gate to streaming apps and search for programming across multiple services.
1) Sports – this necessitates seeing off a challenge from upstart Spark Sports. Spark is the renamed retail arm of Telecom of New Zealand from when Telco got broken up. In 2018, Spark attacked a hobbled Sky by buying domestic cricket and then whatever else was available at a reasonable price. I’m not native and don’t have a great feel for NZ sports culture, but my understanding is that rugby (owned by Sky) is by far the most important followed by cricket and then netball and then a long tail of the usual subjects, domestic and international. Last week, Sky saw off Spark to get League Rugby, putting them firmly in control of the big four important sports rights. Spark doesn’t have anything to pair with domestic cricket until at least 2023 when Sky’s international cricket rights come up - usually you would want something for the opposite season. In fact, despite getting the good luck of nabbing cricket rights just as New Zealand rose to the top of the world rankings, Spark faced the usual grumbling and complaining about lack of availability (not many people or pubs have Spark Sports), weak production values and occasional outages. NZ Cricket signed the six year deal with Spark but has been complaining about the drop in viewership.
The escalation of rights costs is always a problem and Spark’s continued investment in their loss making Sports package is my number one risk. But, it should be noted that Spark is an incumbent telecom managing voice declines and capex requirements and pays out all their excess FCF as a dividend. The new-ish CEO is an accountant/CFO type. I’ve heard second hand that Spark is very divided internally on the continued sports investments. And last summer, Spark offered Sky Sport as a bundle while Sky didn’t reciprocate – some analysts interpreted this as a weak hand at Spark. My contacts and Google Trends indicate that Spark Sports is still peripheral.
As part of the turnaround, Sky is going to reinvest in more sports related general content – documentaries, player profiles and interviews, that sort of thing. I view it as a sign of discipline that Sky seems to be investing in niche and not trying their hand at a big budget, must see, Game of Thrones type thing.
2) General Entertainment – Disney pulled their programming last year but Sky still has access to content from NBC Universal / BSkyB, Warner / HBO, Viacom CBS and Discovery. This content is shown on Sky channels and through their streaming app, Neon. It is unclear how this will evolve as these secondary US studios invest in their streaming apps and propagate them internationally. Sky says that they are open to lower cost non exclusive deals and recently structured their Discovery deal that way (consumers can also view the Discovery content on the Discovery app). It isn’t clear if these tertiary streaming services have the appetite to market in a small market like NZ. The end game is probably that Sky retains the channels for satellite subs and then allows sell through for the streaming services for broadband customers. I think this makes sense – Sky can probably add some value in customer acquisition and retention, the box will be able to search across multiple apps and subscription/streaming fatigue is going to be a real thing. Most importantly, this probably adds some variability to the cost structure and de-risks things. We’ll see.
3) Sky has started offering cheap broadband to its customers. Broadband in NZ was unbundled when Telecom was taken apart – Chorus owns the pipes and wholesales to anyone under regulated contracts. Spark and VOD are the leading services, but there is a long tail of upstart broadband providers. I’m not sure of the technical specs, but my guess is that Sky is investing minimally. They’ve indicated that they are happy to wholesale cheap plans as a customer retention / churn reduction plan. As revealed at the investor day, three year targets are for an 8 – 13% penetration of the subscriber base and 3% - 5% total market share – seems conservative. No concrete plans but they have mentioned that mobile would logically follow.
The recent investor day was disappointingly void of FY22 numbers but included some three year (FY24) targets. Stabilize the core box revenues while adding NZ$ 75m – 100m of revenue, largely from broadband, to get to NZ$ 800m of total revenue. Programming costs are resetting higher in FY-22 (Jun year end) and EBITDA should grow off the reset base. My sense is that if any of this happens – stabilizing the base, adding broadband growth, profitability comfortably above zero, and eventually capital returns, the stock should work fine.
Management: A couple of checks on Sophie Moloney came back positive – people seem to like her both internally (tough when you are slimming down) and externally. My guess is that Chairman Philip Bowman holds most of the power and that Martin Stewart fell on the sword for the abysmal share performance and inexcusable rights offer. I can’t get a feel for Bowman, an Aussie, but he seems to have had an interesting career at much larger companies. He came up through Bass Beer and then as CEO of Allied Domecq which was sold to Pernod and then Scottish Power which was sold to Iberdola in quick succession. In 2007 he became CEO of Smiths Group, a UK industrial conglomerate that always traded below the sum of its breakup value but was never sold despite ongoing rumors. Now Bowman exists as a professional international board member for an eclectic collection of businesses. The remainder of the board seems high powered and qualified. I think the BSkyB DNA is key here – BskyB was always the best run of the Sky’s and grew by following a similar bundling strategy and seeing off a challenge from BT on sports rights.
On the one hand, management owns shockingly little stock despite some small open market buys over the last year. On the other hand, I think they care about the share price, if only because it leaves them vulnerable to a takeover. They just hired new IR. And at last week’s investor day, Moloney pointedly revealed that they had received unsolicited, but informal, takeover approaches and had engaged Jarden investment bank to revue. “The board does not think the share price reflects underlying value of the company.” I think they were hoping for a bump but the stock has hardly moved. Local press and my contacts are speculating that both Comcast / BSkyB and local PE are circling. I have also heard the name Discovery who owns some NZ free to air channels. And any of these would make a ton of sense. Beyond being wildly accretive, a strategic could add scale and best practices and PE would really sharpen the pencils while putting on four turns of debt.
One other note is that the shareholder base has turned over quite a bit over the last year, from retail towards a handful of funds. I haven’t done exact math, but clearly this will be helpful. In my conversations with IR, they seem cognizant of the tension within the shareholder base between old retail who want dividends and new funds who want buybacks or to sell the company.
Looking for feedback/pushback…
This report is for informational purposes only and does not constitute investment advice. The author may buy or sell securities mentioned at any time. Please do your own work.
Turnaround, capital return, buyout.
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