If you ask almost any investor in New Zealand right now, “What about Sky TV?” you’re almost guaranteed to hear the following:
Obsolete.
Dying a slow death.
Won’t be around in five years.
That’s what initially brought me to it.
When everyone’s bearish, there’s usually an opportunity.
I first made a call on Sky TV at 17 cents (or $1.70 today, accounting for stock splits).
At the time, it was producing a strong amount of free cash flow, and was being punished by the market just based on sentiment.
It’s up around 50% since then, but I think today it is still offering good value considering it has been significantly de-risked.
Who Is Sky TV?
Sky TV is a pay-TV operator that operates exclusively in New Zealand.
It offers sport, movies, shows, documentaries, music, news, and kid’s content.
They also offer broadband services.
SKY Network Television was incorporated in 2005 and is based in Auckland, New Zealand.
How Does Sky TV Make Money?
Sky Box – Sky Box makes up more than 50% of Sky’s customer base, and accounts for 70% of revenue. Sky Box is a content aggregator device that gives customers access to Sky TV, streaming apps, recording, and the ability to switch between TV and mobile.
Streaming – Neon and Sky Sport Now are Sky’s two streaming channels, which account for 13% of revenue.
Sky Broadband – This is a new offering and currently accounts for 1% of revenue.
Sky Business – Sky’s offering to commercial customers such as hotels and bars. Currently accounts for 6% of revenue.
Prime – Sky TV has a free advertising-supported channel called Prime TV. Advertising currently accounts for 6% of revenue.
Why Did Sky Shares Tank?
Between 2018 and 2023, Sky shares tanked from $16 down to $2.50, a drop of over 80%.
This is interesting, because Sky TV runs a comfortably profitable business.
Take a look at its numbers since 2018:
I’ve highlighted two things on this table that I think are interesting.
The first is their total revenue and operating expenses, circled in green.
However, you can see their business was actually very stable over that time frame.
Revenue stayed around the $750m range, and expenses around the $550m range.
So why did the share price tank so badly?
It’s the highlighted figures in yellow – impairment of goodwill.
What does that mean?
Impairment of goodwill means, they acquired a business in the past, and that business turned out to be not as good as initially thought.
A quick example:
Say I run a restaurant company, and I want to buy a popular local pizza chain.
Say the pizza chain has assets of $1m, and I purchase it for $5m.
That $4m difference represents the amount I’m willing to pay for the pizza chain’s reputation, brand, customer loyalty, basically the goodwill the business has built up over time.
Because this isn’t a physical thing like a property, and it’s not something you buy, it is not recorded in the company’s accounts. However, it is definitely of value.
Looking at the chart again, you can see SKY TV impaired goodwill for $360m in 2018, $670m in 2019, and $177m in 2020.
That’s over a billion dollars in assets wiped from Sky’s balance sheet.
But what was the reason?
Let’s take a look:
2018 annual report:
Those of you who have been shareholders for some years may recall the background to SKY’s Goodwill asset. It arose on the merger of Independent Newspapers Ltd (INL) and SKY back in June 2005, and reflected the difference between the fair value of SKY’s assets at the time and the price that INL shareholders agreed to exchange their shares in INL for SKY shares. The SKY Board is required to assess the fair value of intangible assets at each reporting period, and this year decided to impair the asset.
2019 annual report:
The Board’s decision to impair $670m of goodwill is clearly a key decision for the business. It reflects the fact that we live in an uncertain world, and our assessment involved a range of different scenarios and assumptions, as set out in this Report. Those of you who have followed our business for a while will know that the goodwill asset came about as a result of the INL transaction 14 years ago. While the headline figure is a large one, I note that the impairment is non-cash and has no impact on our banking covenants.
Let’s explain that in simple terms:
Many years ago, Sky merged with another company called Independent Newspapers, and Sky was recognised to have a lot of goodwill.
Starting in 2018, management believed that goodwill dollar amount was no longer reasonable, and that the Sky business wouldn’t fetch that amount of goodwill on the open market if sold. Therefore, to make the accounts accurate, it needed to be written down.
2020 annual report:
2020 showed more of the same, further writing down the goodwill of the Sky business, but also a 27m writedown in its RugbyPass business as well.
So in the simplest terms possible, it can be explained like this:
If Sky TV had put the business up for sale before 2018, it was expected to sell for over a billion dollars. Then in 2018, they accepted the industry had changed and now they think it will sell for much less.
Now, this is very important for the accounting side of things, but for the day-to-day business itself?
It barely matters.
And it doesn’t change how much money the business makes at all.
However, it still caused the share price to tank.
Situations like these can offer exceptional buying opportunities.
How Much Money Does Sky TV make?
The most useful metric here is free cash flow.
This tells us how much cash the business generates that it can actually use freely (to pay dividends, reinvest in the business etc.)
It’s a more meaningful figure than net profit, because as we’ve seen above, net profit can be skewed by things like goodwill impairment, which are inconsequential to the business itself.
What we see here is – yes, free cash flow has been consistently falling for the last five years, and has only just turned around in 2022.
But the important thing here is – they’ve always been cash flow positive.
Each year the business has consistently generated a healthy amount of free cash.
Even more importantly, the company has zero debt, meaning it’s not under pressure to generate a specific level of free cash to cover interest, is not at risk of breaching banking covenants, and is almost guaranteed to not go bankrupt (you can’t go bankrupt if you don’t know anyone money).
What that means is the business is definitely worth something.
The golden question – how much?
How Much Is Sky TV Worth?
Based on their HY23 Interim Report, Sky TV did $14m in free cash flow in the first half of 2023, is debt free, and has $56m in cash.
Those numbers look weak to me, but according to the CEO, the company’s free cash flow will be weighted strongly to the second half of the year.
The official outlook was as follows:
“Sky remains on target to deliver full year results in line with the guidance provided at the time of
the full year results announcement, providing a narrowed Guidance Range of Revenue of between
$750 to $760 million, EBITDA of between $150 to $160 million, NPAT of between $55 to $60 million, Capex of between $65 to $75 million and Annual Dividends of between $20 to $23 million.
Sophie commented: “We have made significant progress over the past two years so that the Sky of
today is in a strong position and we will continue to aim higher as this work continues into the
second half.”
I think realistically, we could expect anywhere between $40m to $60m in free cash flow from Sky this year, based on their latest guidance.
Back-of-the-envelope valuation
Based on their current market cap of $360m, minus cash of $56m, we get an Enterprise Value of $304m.
Against free cash flow of $40-$60m per year, we get an EV/FCF multiple of 5x and 7x.
That’s not dirt cheap, but it is cheap.
Intrinsic value calculation
As we know, valuing a stock takes some estimating (aka guessing).
Let’s start with $50m free cash flow per year, and assume zero growth for the next ten years.
Our stock valuation calculator gives us the following:
This gives SKT shares a fair value of $3.86, versus $2.50 at the time of writing, offering a margin of safety of 35%.
Let’s do a more bullish scenario.
We will forecast 5% growth for the next five years, and then zero growth for years 6-10:
This gives us an intrinsic value of $4.65 per share and a margin of safety of 46%.
Let’s go the other way, and forecast some negative growth.
Let’s say free cash flow falls by 5% every year for the next ten years:
Even with falling free cash flows, we get a fair value of $2.88 per share, and a margin of safety of 13%.
- Bullish case: $4.65
- Neutral case: $3.86
- Bearish case: $2.88
- Current share price: $2.50
Catalysts For Growth
While these multiples all look like pretty good value, we also want the chance for some extra upside.
Boring businesses are great, because the cash flows are usually predictable, but if there are factors that are foreseeable that might give us more insight (either to the upside or the downside), it’s important to consider them too.
Any catalysts that might eventuate and push the share price up further buffers our margin of safety.
Sky is a monopoly
The biggest unknown right now for Sky is the future of pay-tv, and how the streaming industry will affect Sky’s business. This is the Netflix, Disney Plus, HBO Max situation.
All now have their own streaming services.
How this plays out is anyone’s guess, but to me the logical end-point is consolidation.
Rather than people paying for eight different streaming services, they will prefer to have all of this under one umbrella.
The interesting thing about Sky is they’re a small company in a small demographic, and the only satellite TV company in the country. New Zealand is a tiny country and statistically insignificant to players like Disney and Netflix. This creates a very unique (but beneficial) situation for Sky.
We have already seen Sky forming partnerships with many of these content companies. HBO Max, Discovery, and Disney have already formed a content partnership with Sky in some way (Sky Broadband customers get a free year of Disney+, and HBO Max and Paramount content is available through Sky Box.
I would not be surprised to see future Sky partnerships with Netflix, Apple TV, Amazon TV etc.
The simple reason is it’s more cost efficient. Rather than start an entire marketing campaign in New Zealand (which is essentially a waste of resources for such a small country), they can just take a cheque from Sky and let Sky do all the work.
And that’s good for Sky, because it gives them more exclusive content, and increases their monopoly.
Not to mention, with Spark Sport now out of the picture, Sky TV has a complete monopoly on sport in New Zealand.
What’s more – Sky is a natural monopoly, just like a railroad.
If you wanted to start a new satellite TV service in New Zealand, you would need to go head-to-head with Sky on securing rights for all the sports leagues and events, win their already existing deals from all the content companies like Warner, Viacom, Disney etc, and then convince 1 million New Zealanders to switch from Sky to your service, when you don’t even have any of the sports rights that New Zealanders actually want (because Sky has secured most of those until 2027 and beyond).
Sound like a bad business? That’s because it is! In a country as small as New Zealand, one pay TV provider is the naturally efficient model. This is also probably why Spark Sport fizzled out in just a couple of years.
Sky is a New Zealand necessity
By definition, Sky’s product is discretionary.
Nobody needs to watch television.
But in New Zealand, this is not really true.
And it takes someone who lives in New Zealand to understand this.
To be blunt – in New Zealand, there’s nothing to do. Literally. The country’s pastime is drinking beer and watching rugby.
At the office on Monday morning, all you hear is people talking about if their rugby team won on the weekend, or if we’re leading in the cricket, or what’s happening in the tennis.
People watch the two-hour game analysis of the All Blacks game with as much delight as they watch the game itself.
Half of New Zealand would go insane without cricket, the All Blacks season, Super Rugby and the Warriors.
Understanding New Zealand’s relationship with their sports teams is something maybe only New Zealanders can understand, but it is a wonderful thing for Sky.
Not to mention – New Zealand has a quickly aging population as we discussed in my Arvida analysis, and if people will be anything like my parents in retirement, they’ll be watching Sky 24/7!
When people say Sky TV is obsolete, I think they don’t have a sound understanding of New Zealand as a society. Culturally and demographically, Sky has a cemented place in New Zealand.
Management is performing exceptionally
I’ve followed Sophie Maloney’s time at the helm closely.
To be honest, I wasn’t confident in her at the beginning. She was appointed during Covid in late 2020, and her resume didn’t scream out that she could be the one to turn around a deflated Sky TV.
I’ve been wrong on that, and I’d confidently say she’s one of best (if not the number one) performing CEO in New Zealand right now.
Things she has achieved in less than three years:
- Returned the company to revenue growth for the first time in six years.
- Returned the company to free cash flow growth and net profit growth.
- Grown subscriber count back to 1 million customers.
- Developed and released the Sky Pod and Sky Box.
- Rolled out Sky Broadband and negotiated Disney+ partnership.
- Implemented the Sky Sport Now streaming service.
- Sold the Mt Wellington property (finally!) for $56m and a $14m gain on sale.
- Opened the new Sky downtown office.
- Returned $70m in cash to shareholders through a share buyback/cancellation.
- Started a $15m on-market share buyback scheme, which is underway.
- Reinstated the dividend and already paid out $13m, with another $8m declared.
- Implemented $35m of permanent annual cost savings through cost-cutting and outsourcing.
- Knocked Spark Sport out of the market, resecuring the rights for cricket and Premier League, and restoring Sky’s monopoly.
- Navigated the company through the world’s strictest and longest Covid lockdowns over two years with no significant setbacks.
- Invested $250,000 of her own money into the stock (mostly purchased on market), and now holds a $500,000 stake.
Compared to the previous CEO Martin Stewart, it’s practically a different company. Stewart led Sky for only two years, and most notably acquired RugbyPass for an overpriced $40m (since sold off by Maloney for a fat loss), scrapped the development of the SkyBox, canned the dividend, oversaw one of the most value-destroying capital raises ever, and saw the share price spiral downward 80%.
As a shareholder, your CEO is everything. Even if you have the best business model and product in the world, if you don’t have someone to execute, your money is going into the toilet.
Probably the number one thing that would make this company investable to me is having Sophie Maloney at the helm. I know I’ll sleep very easy at night knowing she’s running my company!
Share buybacks have started
Sky notified the market of their intention to start purchasing Sky TV shares on-market in a $15m buyback scheme.
This was communicated in the FY22 annual meeting, where Chairman Bowman stated the board believes the company is significantly undervalued and planned to buyback 6% of the float.
Buybacks are usually (but not always) a good indicator of two things:
- A strong cash position
- Undervalued stock
In this situation, I think Sky has a good case for both.
Insiders are buying
Peter Lynch says “There are many reasons insiders sell stock, but there’s only one reason they buy: They believe the stock price is going to go up.”
Both CEO Maloney and Chairman Bowman have been buying up the stock on market.
Here are their purchases since Maloney took over as CEO:
Maloney now owns a $500,000 stake, and Bowman owns $1 million.
Relatively speaking, these are quite low stakes (less than 1%).
However, it’s a bigger stake than longtime CEO John Fellet ever had, who was CEO for 17 years.
Whether they continue increasing their stake remains to be seen.
I think there’s a good chance they will.
Verdict
I believe Sky TV is significantly undervalued, with a monopoly-like business, strong cash flow, no debt and strong insider buying.
What I like most is they have a killer CEO who has made all the right moves and has achieved an incredible amount in just 3 years.
People may say their business model is obsolete, but my view is the opposite.
Not only do I think the business is here to stay, I think it’s a necessity in New Zealand and the company has the potential to cash flow its entire market cap within the next five years.
Along the way you’ll collect a 5% dividend, and share buybacks should provide a further catalyst to send the share price up.
Even if Sky TV does not grow cash flow at all in the next ten years, it still offers a discount to intrinsic value today.
When I first posted about it at a share price of $1.70, it was a no-brainer, but even at $2.50 I believe it’s still one of the best value plays on the NZX.
Disclosure: Long SKT
