Channel 9 is not compulsory viewing

Co-founder of the Switzer Report
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When I think about Channel 9, the Wide World of Sports cricket commentary team always seems to come to mind – Chappelli, Bill Lawry, the late Tony Greig and of course, Richie Benaud. One of Richie’s more infamous quotes is “a cricket ground is a flat piece of earth with some buildings around it”. Sums up my sense of the much hyped Nine Entertainment IPO – a few things tacked on to a TV network in a flat, low growth market.

Nine Entertainment Company (NEC)

Nine Entertainment, which comprises the Channel 9 TV Network, Ticketek and Allphones Arena (Nine Events) and some digital properties, such as the ninemsn website, will be listed on the ASX following an IPO of approximately 305 million shares. These are priced at a range of $2.05 to $2.35 per share, with the final price to be set via an institutional book build. On completion of the offer, the group will have 931 million shares on issue, with an indicative market capitalisation of $1.93 billion to $2.17 billion. Key offer statistics are as follows:

* Exact number of shares will depend on final price, as $275 million from sale of new shares is fixed. Calculations based on price of $2.20. Also 6.0 million shares issued to employees and non-executive directors

Shareholder sell down and escrow

Nine Entertainment (NEC) is partly owned by two private equity firms (Oaktree and Apollo), which collectively own 53.5% of the company. For the IPO, existing shareholders including Oaktree are selling 179.7 million shares of the 800 million shares they own, or 22.5%. And 131 million new shares are also being issued. The offer will raise $670 million, with $390 million being paid to existing shareholders, $199 million used to pay down debt, $50 million for working capital and $26 million for the costs of the offer.

Post the IPO, existing shareholders Oaktree and Apollo have agreed to hold their shares in escrow until the results of the 2014 FY are released to the market – sometime in August 2014. Critically, the other existing shareholders (who will own 281.6 million shares post the IPO) are not subject to any escrow requirements. For potential new shareholders, this means that up to 620 million shares from current shareholders could hit the market in the next nine months.

Why would you want to invest in Nine?

Well, not for yield. The directors are forecasting the payment of a final dividend for the 2014 FY of 4.1c per share, unfranked. This won’t be paid until late 2014. Astonishingly, they have decided to describe this as a yield of 3.5% to 4.1%. Only in the “fine print” is there the disclosure that there won’t be an interim dividend for FY 14, making this an outrageous misrepresentation.

If an interim dividend for FY 2015 is paid, perhaps the yield for 2015 will be in that range – however, the yield for investors over the next 12 months is only 1.75% to 2.0%. Investors should also note that the directors don’t expect to be able to commence franking until the final dividend for FY 2015, and that there are overriding restrictions on the payment of dividends under NEC’s borrowing facilities.

If it’s not for yield, then it must be for growth – or a better bet than its nearest rivals, Seven West Media or TEN. Let’s deal with the “growth” perspective.

Of NEC’s total revenue, 89% comes from advertising (a small component comes from ticketing and events). The Australian advertising market has grown at a CAGR (compound annual growth rate) of 3.6% over the last 10 years. Television’s share of this has been steady at 27% to 30%, and according to NEC, is currently sitting at 29.3%.

Online media has experienced strong growth, and is now attracting 25% of advertising expenditure. However, growth has been strongest in ‘search and directories’, which accounts for 54% of the category. NEC is not in this segment. Rather, NEC through ninemsn and other properties (known as Mi9) is mainly in the ‘online display’ segment, which accounts for 26% of this market.

So, on a macro level, is NEC positioned in a “growth” industry? Well, a CAGR of 3.6% is interesting, however, it is not great – and while NEC has some exposure to the online market, it is still largely a TV business.

Peering into the company’s pro-forma financial results confirms that while there is some growth, it doesn’t really set the world on fire. As the following table shows, NEC’s revenue CAGR from 2011 to 2014 is 3.4%, and even allowing for perhaps an improvement in 2014, the increase on 2013 is only a modest 4.8%.

Not an impressive set of numbers (particularly the EBIT deterioration), and not really a “growth” story either. And that’s without considering the risk that internet TV and other technologies pose to NEC’s core free to air TV business.

And is NEC worth buying over Seven West Media? The argument being advanced is that NEC has “pure” exposure to the “higher” growth TV and online markets, and doesn’t carry Seven West’s exposure to the “negative growth” magazine and newspaper divisions.

While there is obviously something in this, television accounts for 67% of Seven’s revenue and 69% of EBIT. For NEC, the 9 Network is 79% of revenue and 79% of EBITDA.

In the market, Seven West is trading on a forecast PE for 2014 of 10.3, and is forecast to pay a fully franked dividend yield of 4.9%. It also has had a pretty good year on the market, rising from $1.64 to $2.41. That said, it still looks considerably cheaper than NEC, which at the indicated price, is forecast at a multiple of 13.8 to 15.5.

Bottom line

Avoid. It is not a buy for yield, the growth story rings a little hollow, and given the pricing premium, there is no compelling case for it over Seven West. And that’s without worrying about all that stock held (or more realistically, not held), in escrow.

If you do want to invest, you will need to go through a broker and secure a firm allocation. That shouldn’t be too difficult, as many of the major brokers are involved in the deal and getting paid to promote it, including Bell Potter, CommSec, Deutsche, Macquarie, Morgan Stanley, Morgans, Nomura and UBS.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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