Reach for the Sky

By Jenny Ruth

Thursday 31st August 2006

Now a fixture in almost half of the country's living rooms, Sky began here as Sky Network Television back in 1987 to investigate pay-TV opportunities. It initially offered sports programmes to pubs and clubs, and started broadcasting in 1990 with three channels. It listed in late 1997 after a $135.6 million share float. From July 1 last year, Sky and its parent company, Independent Newspapers, were merged into its present form and its share price has since continued to rise. Today, Sky broadcasts more than 50 channels, a number of pay-per-view channels, all the free-to-air channels and some radio channels. It bought free-to-air channel Prime in February this year.

The numbers: Sky turned a major corner in 2003 when it reported a profit for only the second year in its history and the company's profitability has grown dramatically since. A key factor in its previous losses was its decision to switch from its UHF platform (which it still offers) to satellite delivery in 1997 and then to digital technology. The company says competitive threats from new cable entrants meant it was forced to be an early adopter of digital TV, which meant high development costs. They seem to have paid off, though, since all its pay TV competitors have exited the market and former rivals Telstra and Telecom now wholesale Sky's service. Currently, about 42% of New Zealand households subscribe to Sky, up from less than 30% in June 2001, and the company says it could eventually capture 70%-plus of the nation's households. Managing director John Fellet says pay TV penetration in the US is 90%.

Management: Fellet joined Sky as chief operating officer in 1991 and became chief executive in January 2001. In last year's annual report, Fellet said staff retention is as important to Sky as keeping its subscriber churn low and the company's average tenure was about 12 years.

Current strategy: Subscriber churn continues to fall and was just 13.9% at December 31, down from more than 30% a few years ago. In December, Sky launched its MySky personal video recorder, which allows customers to record programmes on two channels while watching a third previously recorded programme and pause live TV programmes for continued viewing later. It is also upgrading its 15-year-old television station to digital so it will be able to output up to 112 channels and offer widescreen and high-definition television.

Recent track record: In February, Sky reported a 17.3% drop to $29.7 million in first-half net profit but the result was dragged down by $24.2 million in interests costs relating to $500 million of new debt raised in the merger. In the previous first half, the company gained $1.5 million in net interest income. The company suffered a major embarrassment back in March when it lost its satellite signal for more than 13 hours. A replacement satellite will be launched in the September quarter and Fellet says, more importantly, the company already has a backup satellite in space. From late March to late June, Sky's shares plummeted from $6.70 to $5.50. Fellet attributes this to several factors, including the falling New Zealand dollar, which has undermined the value of Sky to the many offshore holders on its register (its major shareholder is Rupert Murdoch's News Corp with nearly 44%). Sky's programming costs are also in US dollars, which Fellet says makes it the biggest importer after The Warehouse. Fellet says they were also "somewhat unnerved" by the government's decision to end Telecom's monopoly of the local phone wire network. And he acknowledges that investors' worries about the likely impact on Sky of television services being delivered through the internet are a factor. "We think it's a great opportunity for us," but the market needs that to be demonstrated to it, he says, and he likens the situation to the digital challenge faced by the company in 1997. The government's intention to launch a free-to-air digital service isn't expected to have much financial impact on Sky.

Analysts' recommendations: Forsyth Barr's Rob Mercer recommends buying Sky shares, as does ABN Amro's Carolyn Holmes. Mercer values the shares at $7.71 while Holmes has a 12-month price target of $6.50. Macquarie Equities' Steven Hodgson has a neutral recommendation, even though his $6.12 valuation is north of the current share price. Goldman Sachs JB Were's Rodney Deacon has a hold recommendation and values the shares at $5.99.

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