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Structural Issues Dog Seven West Media

Australia | Aug 03 2016

This story features SEVEN WEST MEDIA LIMITED, and other companies. For more info SHARE ANALYSIS: SWM

Seven West Media reported a surprisingly weak outlook for FY17 due to rising sports costs and falling TV advertising share.

-Olympics broadcast benefit won't recoup costs
-Inflation in TV sports broadcasting costs
-Digital revenue expected to surge in FY17

By Eva Brocklehurst

Seven West Media ((SWM)) is looking subdued in FY17 and the market has marked the stock down heavily to incorporate weaker guidance, on the back of rising costs and falling TV advertising revenue.

Guidance for FY17 is for earnings to be down 15-20% year on year and the TV ad market to be flat or weaker. Earnings fell 10.7% in FY16. Costs fell 4.2% in the first half but these reversed to be up 2.1% in the second half, or up 3.8% if the benefit of the lower TV licence fee is stripped out.

Overall guidance was not inconsistent with forecasts but the main surprise for Deutsche Bank was costs. Management signalled operating costs could be up as much as 9% in FY17, including the Olympics cost of around $80m. Deutsche Bank expects a revenue share improvement of 150 basis points in FY17 for the Seven TV network, given the benefit from broadcasting the Olympics, but notes that on a standalone basis, this uplift of around $40-45m does not recoup the costs incurred.

Seven West also confirmed it is in the early stages of discussions with Verizon, which has proposed purchasing Yahoo! Inc. Limited detail was provided on the options under the Yahoo!7 joint venture agreement in the event of a change of control. Given Yahoo!7 is currently generating earnings of $26m Deutsche Bank views the buying out of its 50% partner as manageable for Seven West, but not insignificant.

Meanwhile, Presto subscriber growth was up 193% in FY16, although Deutsche Bank notes industry feedback continues to suggest it is lagging Netflix and Stan in terms of subscribers. Whilst the broker agrees that streamed video on demand (SVOD) presents an opportunity, intense competition is expected to hinder near-term earnings growth potential.

Macquarie notes the deterioration in the second half in terms of operations, which reflects the slowing in the TV ad market. The broker believes the main driver of rising costs is the new AFL rights deal, which is estimated to add $25m to incremental costs in both FY17 and FY18. Cash conversion was also weak, which the broker attributes to a large pre-payment on the Olympics as well as the impact of onerous contracts being written off and restructuring and redundancy charges.

The broker notes earnings at The West Australian declined 24.3% in FY16 as the paper remains challenged by structural factors and a softer WA economy. Seven West is awaiting approval to acquire Perth Now and The Sunday Times from News Corp ((NWS)), with the company noting scope for operational synergies from combining these two businesses.

Macquarie downgraded the stock to Underperform ahead of the results on the basis headwinds were increasing and would pressure the outlook. Given the significant share price correction, subsequently, the investment case is considered more balanced now and the broker reinstates a Neutral rating.

Credit Suisse moves to a Neutral rating from Outperform as the broker's valuation falls on lower earnings because of higher costs and higher net debt. TV ratings are considered solid and there will be a boost from the Olympics, but the broker expects negative momentum and ongoing TV ad market weakness will present a major barrier to earnings growth going forward. Credit Suisse assumes a 1% decline in TV advertising in FY17 and a TV market share for Seven of 41.5%.

The weak outlook is consistent with Morgan Stanley’s view on the structural changes confronting the business. These including losing revenue share in the TV market and inflation in TV sports costs. Moreover, the broker does not confine its view to Seven, believing TV and radio peers will also deliver a weaker outlook.

There were no new comments on acquisitions or capital allocation at the results nor on changes to media ownership rules, the broker notes, outside of the comment that options are still being considered regarding Verizon’s bid for Yahoo! Inc.

Morgan Stanley notes upside risks for Seven West include a potential de-merger or spin-off of the print assets, which could result in a re-rating, and the possibility of Seven Group ((SVN)) lifting its stake. Seven Media has stated it may look at M&A in the media industry and the broker expects the market would greet this news positively, if the terms were accretive. On the downside there is the risk that the economy softens and TV ad spending falls further with an equity re-capitalisation subsequently possible.

Macquarie notes Seven West is actively pursuing digital revenue opportunities and may have the opportunity to integrate is own advertising partners into digital media content. The company has reported early-stage investment losses of $23.9m in FY16 as part of its new ventures, with entities making up these losses including Presto, SocietyOne, HealthEngine, Newzulu and Starts at 60.

Macquarie makes the point that the decline in TV ad market revenues is against a backdrop of strengthening trends in digital advertising revenue, reflected in companies such as Facebook and Google. Seven West's digital revenue is expected to be up more than 150% in FY17.

FNArena’s database has one Buy rating for Seven West (UBS, yet to update on results), three Hold and two Sell. The consensus target is 86c, suggesting 8.0% in upside to the last share price. This compares with a target of 95c ahead of the results. The dividend yield on FY17 and FY18 forecasts is 8.2% and 8.3% respectively.

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