Nine’s profitable entertainment

While Seven West Media was covering gold being won at the Olympic Games in PyeongChang in recent weeks, it was rival Nine Entertainment (ASX:NEC) that won gold during the Australian earnings season.

Prior to this six-month earnings period, Nine Entertainment’s Television segment – which accounts for nearly 90 per cent of total revenues – had delivered four consecutive semi-annual periods of negative growth averaging a deterioration of more than 5 per cent per annum. In the six-months to December 2017, Nine’s Television business delivered positive 10 per cent growth.

What makes this growth even more remarkable was that it was achieved on a segment cost-base that did not grow. In fact, Nine’s Television business slightly contracted its operating costs compared to the same period last year. This resulted in the segment’s earnings before interest, tax, depreciation and amortisation (EBITDA) growing by a staggering 57 per cent per annum in the period.

These results took the market by surprise. The stock rallied 16 per cent on the day of the announcement.

Why was it so surprising to see Nine Entertainment doing so well? The answer lies in the structurally challenging environment in which all free-to-air television operators find themselves.

You see, any free-to-air television provider buys (or creates) content that is hopefully popular with viewers; and sells advertising off the back of said viewership. Today, advertising budgets are being increasingly allocated to the Facebooks and Googles of the world, which can provide highly-specified targeting that typically results in significantly higher return-on-investment per advertising dollar spent. At the same time, viewership of television in general is starting to wane, especially among younger generations.

And on the content side? Costs of high-quality produced television content is growing structurally. Consider that, in 2016 alone, Disney, NBC Universal, Netflix, Time Warner and CBS spent more than $50 billion on television programming. And this does not even include Amazon, Facebook and Apple which are increasingly comfortable spending billions of dollars on content to entice new users to their ecosystems. How does an Australian free-to-air television network with “only” $1.4 billion in annual revenue compete with these global behemoths?

Well, this is how Nine Entertainment is dealing with the very difficult environment in which it finds itself. Nine has successfully built a pipeline of programming which is popular amongst Australian viewers – even millennial viewers – but which is relatively cost-effective to produce. On its conference call with investors, Chief Sales Officer, Michael Stephenson, called out shows such as Australian Ninja Warrior, The Block, Family Food Fight and Hamish & Andy. These shows have been driving Nine’s growth in ratings – and yet, are significantly cheaper to produce than, say, Game of Thrones or House of Cards. This pipeline has been successful in driving Nine Entertainment’s top line back to growth, while keeping cost inflation in check.

The remaining question is: where to from here? High Marks and his team appear to be doing everything right. Their success in generating a pipeline of content that would translate into profitable growth for the business has been truly extraordinary. And, through Stan and other initiatives, they are trying to evolve the business in line with how their audiences are evolving. Does this mean success is assured?

Far from it. The fact remains that elsewhere in the world, audiences are rapidly turning away from the free-to-air television model. The cost for a viewer to switch to Apple TV, or Netflix, or Amazon Prime, or a host of other subscription video services is low. And the quality of content being offered on these platforms is typically high. If Australian viewers follow in the footsteps of their global counterparts, life will become increasingly difficult for the Australian television networks.