Questor: at half Sky’s valuation ITV could be attractive to a bidder, so hold the shares

Russ Mould 17 July 2018 • 7:37am

Downton Abbey still - all main cast for series 6 — Downton Abbey was one of ITV's most popular programmes

This column nearly got its head cut off the last time it stuck its neck out on ITV, assessing the shares just before full-year results in February led to a plunge.

It may seem foolhardy to try again, as the broadcaster’s interims are due next week, but without (carefully managed) risk there can be no reward.

Thankfully, the shares have largely recovered their lost ground, helped by May’s reassuring first-quarter statement.

Revenues rose by 5pc in the first quarter, with non-advertising sales 12pc higher, to reaffirm the value of ITV’s strategy to create and sell more programming content. Advertising revenues rose by 1pc and forecasts of a 2pc increase for the first six months of 2018 looked encouraging.

That advertising growth figure will be a key benchmark for next week’s interims, alongside profits and the dividend. Pre-tax profits were £381m in the first half a year ago. Management has already flagged an increase in investment in programming and sports rights of £35m this year, and that will weigh on near-term profits. Analysts expect a drop of around 3pc in full-year pre-tax income on an adjusted basis.

The interim dividend a year ago came to 2.52p. For the full year, analysts are looking for a 5pc increase, although no one appears to have pencilled in any further special dividends, not least because net debt is now pretty much back to where it was in 2009 after a string of acquisitions and some meaty dividend payments.

It is possible that the World Cup has given advertising revenue a bit of a lift and, if so, that would be a welcome bonus, but it is not fundamental to the investment case. Instead, this lies with the stock’s valuation, and the company’s long-term strategy and competitive position.

Besides the actual numbers, all eyes will be on the “strategic refresh” planned by Dame Carolyn McCall, the chief executive. The term implies that radical changes are unlikely; possible themes involve investment in programming and technology, which would reaffirm and deepen the firm’s commitment to content creation.

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That makes sense for the long term and may increase ITV’s appeal to a potential bidder. John Malone’s Liberty Global still has a 9.9pc stake in the business and the ongoing tussle for Sky, discussed briefly below, could serve to highlight the value of ITV’s position in Britain’s broadcast market and its relatively lowly valuation.

Sky may have a firmer grip on prime content such as football and films but ITV’s content library is flourishing. And at Comcast’s offer price of £14.75 a share, Sky trades on more than 22 times forward earnings, while ITV trades on barely half that multiple and has a higher yield for good measure.

This attractive yield and valuation could reward patient support.

Questor says: hold

Ticker: ITV

Share price at close: 173.3p

Update: Sky

This column’s faith that a further round of bids for Sky would materialise has been rewarded: both 21st Century Fox and Comcast have launched fresh offers, of £14 and £14.75 a share in cash respectively.

That should put a floor under the shares at £14 but their breaching of the £15 level suggests that the market believes this particular drama to be far from over, as both the Murdochs and Comcast’s Brian Roberts have their strategic reasons for wanting to win. In addition, the numbers still stack up.

At last night’s closing price of £15.24 a share, Sky has a market value of £26.2bn.

It has £7.5bn in net debt for an all-in purchase price of £33.8bn, which compares with forecast annual free cash flow of some £1.5bn to £1.6bn, taking account of lower football-related costs.

That implies a free cash flow yield of 4.7pc, which beats cash in the bank, the rates paid by 10-year bonds issued by the British or American governments and the 4pc yield available from the FTSE 100 overall.

Investors have the luxury of waiting to see if a final bid does come, with their downside well underpinned.

Questor says: hold

Ticker: SKY

Share price at close: £15.24