Spare a thought for the managers of free-to-air television businesses. In an age in which viewers can choose between Netflix, Apple TV, YouTube and a host of other video services; viewership of free-to-air television is in structural decline. The Australian free-to-air TV space is a notable example of this.
Shown below are the audience numbers watching the three largest free-to-air TV channels in Australia. As can clearly be seen, 2017 audience numbers are down by more than five percent since the same time in 2016. And 2016 was down from 2015; and 2015 from 2014. This is what we would call a “structural decline” in viewership. And we can’t see this trend changing any time soon, if at all.
Source: UBS
Structurally declining audiences are a big problem for TV businesses that rely on advertising as their primary source of revenue. As eyeballs disappear, so too does the entire value proposition of advertising on the medium. As advertising revenues move elsewhere (also to online platforms, such as Facebook and Google), the ability for the free-to-air TV channel to invest in new and entertaining content also contracts. More viewers leave, and so the cycle continues.
We can see this dynamic playing out in Nine Entertainment’s (ASX: NEC) financials. As of its most recent half-year, TV revenues were down five percent, but earnings were down nine percent. And this is despite the business cutting its program rights expense by four percent. But of course, cutting investment in program rights to slow profit decline is akin to cutting off your nose to spite your face.
Followers of this blog will know that “structural declines” are one of the four key elements we look for in an attractive short. Another is something we call “divergent expectations” – and Nine Entertainment exhibits this characteristic as well.
Source: Company Filings; Bloomberg; MGIM
As illustrated in the table above, consensus expectations are for Nine Entertainment’s revenue line to stop declining in FY18 and start growing by more than two percent per annum in FY19. We see this as very unlikely. When we examine the drivers that have led to the current decline in revenue (competition from Netflix, Apple TV; and increasing content costs leading to lower-quality content on free-to-air TV), we don’t see the situation improving any time soon. That is, there is a divergence between consensus expectations and our own.
Over time, we believe Nine Entertainment will underperform relative to the market’s expectations. When this happens, the stock price typically falls – and often sharply.
Montaka is short the shares of Nine Entertainment (ASX: NEC)
Andrew Macken is a Portfolio Manager with Montgomery Global Investment Management. To learn more about Montaka, please call +612 7202 0100.
