Value.able: Ten Network
Cost cuts at Ten have given the share price a kick but the impact is likely to be fleeting. Roger Montgomery asks what is a fair price to pay?
PORTFOLIO POINT: It remains to be seen how Ten will perform after its restructure. Well run businesses don’t need restructures.
Warren Buffett observed that we are all “accidents of the womb”. If you will allow me to extend this train of thought to “accidents of business” there must be many successful entrepreneurs in Australia who might wonder how much bigger their empires could have been if they had perhaps been born or established their business in LA, New York or London.
And I suspect this is a question – give or take a few expletives – that must surely vex Lachlan Murdoch in the context of his latest management decisions at Ten Network where he has a maximum audience of just 22,638,747.
The way to think about the market economics of TV is like a giant card game. There are three high roller teams at the table: Lachlan, Gina Rinehart and James Packer at Ten; the private equity outfit CVC at Nine; and Kerry Stokes at Seven.
Each ratings season represents a hand that is dealt and must be played. Sometimes Seven gets a good hand, but next time it will be Ten and then after that it will be Nine. The order doesn’t matter much and the stakes don’t get any bigger (literally!).
The point is that the three teams are sitting in a room with the doors and windows closed, there’s a fixed amount of money in the pot and who wins will simply depend on the strength of their current hand.
It’s a card game without an end. New hands are being dealt constantly. Occasionally one of the players will have a good run, get cocky and overplay his hand by spending too much on programs that flop. Someone else takes up the mantle and round and round we go.
That anyone thinks this is going to dramatically and permanently improve is perhaps the only surprising thing about the television game.
Actually, on second thoughts, I may have been a little optimistic. I did say the amount of money in the pot stays the same. After we take inflation into consideration it definitely is smaller! Then there are the forces of fragmentation at work.
The upshot of all of this is that the share prices of these companies go through periods of favour – almost always at the expense of another – and then periods of rejection. In the long run, the aggregate performance is unlikely to be impressive, nor any improvement be permanent.
But as we all know the stockmarket is a popularity contest in the short term and there aren’t enough companies for fund managers to chase, so a turnaround story could translate to an improving share price.
Ten has just announced the run of bad hands is over and has changed its lucky cufflinks. Lachlan Murdoch at the weekend announced a restructure following a review of costs that commenced in February. With that in mind, what is Ten Network worth?
I thought it might be useful to run a couple of scenarios and, using the Value.able formula for estimating intrinsic value, produce a range of valuations below which the price of Ten Network could be deemed attractive.
As an aside, well-run businesses don’t need restructures or cost cutting drives to keep the business on track. A well-run business never gets “fat” in the cost department, just as a well-kept house never needs a wholesale cleanout. Keeping costs down at Ten Network should be automatic, a part of the culture and daily business life of the television station.
More worryingly, all the free-to-air stations are merely reacting to the structural challenges presented by the internet. There is arguably no clearly defined strategy among the networks that proactively embraces any online opportunity. Indeed one wonders whether there is any strategy at all.
But back to what it could be worth. From what I can gather, operating costs are running at just over $600 million, representing a rise of $200 million over the past five years. Costs are expected to rise further next year around news, the digital station Eleven and MasterChef – the popularity of which may begin wane this year or next.
It has been reported that headcount will be reduced by more than 100, possibly 200, and that the network will save about $45 million by walking away from AFL coverage. Attrition is already reducing headcount.
The digital station One, which has been losing about $20 million, is being relaunched but one expects that $20 million loss to be reduced rather than eliminated. Also rumoured to be eliminated is $20 million of additional costs associated with 100 staff hired for regional news bulletins and the 6.30 with George Negus program.
Assuming no new ratings sensations next year, the revenue may remain flat. The network employs more than 1300 people and last year salaries were $145.2 million, an average of $111,692.
Cutting, say, 150 people produces savings of $16.8 million. Add the $45 million saved from the AFL, the $20 million from cutting news and cuts to Sports Tonight, Video Hits and publicity and marketing departments in Perth, Adelaide and Brisbane, and you have savings of maybe $100 million.
Starting with $120 million in savings, some of which will be reversed because of the aforementioned cost increases, Ten may end up with net savings of $90 million pre tax.
The market might think like this: If market capitalisation is $1.2 billion and stays at 8.5 times earnings, and 70% of those savings drop to the bottom line, the measures could add almost $535 million to the market’s valuation of Ten. That is a big increase.
Predicting changes in price, however, is not the job of the value investor. Intrinsic value is what I am interested in and the intrinsic valuation changes from the cost cutting are significant but less so. The changes being proposed may add $63 million in 2012 to the profit expected this year of $86 million. The impact would be an increase in intrinsic value from the current 85¢ to 99¢. The shares recently traded at $1.05 and James Packer paid more than $1.60.
Because Packer & Co paid too much, they will need to extract a whole lot more to avoid an accident of the womb!