INL confuses tax-loss swap and growth

By Shoeshine

Friday 13th December 2002

Quite why Independent Newspapers chairman Ken Cowley has been so concerned about his share price recently is a bit of a mystery.

Cowley has made two attempts once at the annual meeting on October 30 and again in a trading update last week to jawbone the shares up.

On both occasions he's insisted the market has failed to recognise the strength of INL's trading results since the end of the last financial year on June 30. If that's right and Shoeshine isn't convinced it is then INL has only itself to blame.

Cowley said last week he expected a December half-year net profit of more than 25% above the same period last year, when the company made $27.1 million so about $34 million.

The trouble is, he didn't actually say anything at the annual meeting (Shoeshine wasn't there but relies on INL-employed reporters' accounts) that the market could price, except that the company was "optimistic" even though classified and national advertising remained "difficult."

Moaning about your share price in the current environment is a bit of a waste of time. Almost nobody is enjoying a share price at historic highs and everybody has their own sector-specific tale of woe to tell.

Cowley told his own last week. He noted media stocks around the world were out of favour, like IT&T stocks, insurers and airlines.

INL's share price, in Shoeshine's opinion, is a pretty fair one considering the company's fundamental performance.

At the annual meeting new chief executive Peter Wylie trumpeted higher revenues and a 45% rise in net profit, to $37.8 million.

If that was a result of a significant lift in the profitability of the core newspaper and magazine operations it would be something to brag about.

But it wasn't. Almost all of the improvement came from playing games with 66%-owned Sky Network Television's tax losses.

In a year in which, admittedly, companies shut their wallets all over the world, advertising revenue at INL's newspapers and magazines rose only 2.4%. Circulation rose by the same modest amount.

In recent months media companies have been reporting some recovery from the choke-off in ad spending. Cowley reported last week that INL had seen "good growth in advertising revenue, particularly in the past three months."

INL's Stock Exchange release was prompted partly by the new continuous disclosure rules that came into force on December 1.

But if this is the standard of disclosure we can expect from the new regime it seems hardly worth it.

INL's accounts and disclosures are so opaque that's it's impossible, unless you're an analyst with one-on-one access to the company's executives, to tell how much of last year's profit lift - or the half-year lift Cowley has forecast - are down to Sky's tax losses and how much to improvements at INL's publishing operations.

In 2001, when INL owned 48% of Sky, the company reported a bottom-line profit of $26.1 million after paying $23.8 million of tax and equity-accounting $19.1 million of Sky's $42 million loss.

Last year, after moving to majority Sky ownership, INL's bottom line was $37.8 million.

But, using Sky's tax losses for the first time, it paid only $2.3 million of tax while consolidating Sky's $30 million loss, less the "minority interest" attributable to Sky's other shareholders.

In short, INL's vaunted improvement in profitability comes almost entirely from financial engineering. It looks disingenuous of the company's top brass to complain the market is underpricing its shares while trumpeting this as "growth."

That isn't to say the tax-loss swap isn't a smart way of maximising INL's overall value. It's just that it's hard to see how - or to put a value on the benefit.

INL's agreement with Sky is that it will have to compensate Sky for the use of its losses if and when Sky generates taxable profits.

The companies estimate that's likely to be from the 2004 financial year and analysts agree or think it will be even earlier.

It can only be assumed INL has calculated that the cost of repaying the tax-loss benefits will be more than compensated for by its share of Sky's profits. But by how much?

Meanwhile, Wylie appears to have some grand ambitions. The secret of success, he told the annual meeting, was to have a share of the entire communications action. INL would have to "dominate" and was in a position to do so. The entire communications action of course includes telecommunications.

Does INL or Sky have a plan to take on Telecom? And how does it plan to dominate the highly profitable (if only because of its own financial engineering) Wilson & Horton?

With its share price around its ankles this could be one to watch.

Fonterra speculation

Assurances from Fonterra that its 19.9% Wrightson stake isn't even under review haven't stopped speculation in broking circles that the dairy giant is close to deciding its future.

Fonterra subsidiary RD1.com, then the distribution arm of NZ Dairy Group, bought the stake from GPG in July last year for $1 a share or $27.1 million.

The stake is now held by Fonterra Enterprises, which holds various bits and pieces, including biotech assets.

With new chairman Henry van der Hayden pumping a "back to [milk business] basics" line the talk is that Fonterra must be tempted to realise a modest profit of about $4 million. It could easily parcel the shares around institutions but would get a better price from a trade buyer if one could be found.

An outside possibility is that it could go the other way and take Wrightson over. RD1's rural supplies distribution strongholds are Waikato and parts of the South Island and adding Wrightson would create a strong geographical spread.

Wrightson's seeds and grains business would also complement RD1's biotech but the livestock business wouldn't fit in.

Either way there seems little point in Fonterra hanging on to a minority stake in a non-dairy business.

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