@mistaTea and @TransversalIt's great to have intelligent and...

@mistaTea and @Transversal

It's great to have intelligent and like-minded input here. For quite a while there I was talking mainly to myself. The trick now is not to fall for confirmation bias (!).

This is a rapidly evolving situation with a high degree of uncertainty, as such, and in agreement with you both, precise estimates are of little value. We need rough numbers and fat margins.

@transversal, in my mind a low level of 'FCF' is to be expected here. The previous management team was attempting to preserve profits and dividends - and the consequences were that subscriber numbers were were rapidly headed for oblivion. The new management team has made it clear, right from the start, that they were going to try to re-position the business to actually have a future. They call it investing for 'growth', I call it investing for survival. In my mind this is the right way to go, as I believe vastly more value can be created here by simply surviving (for the long term) than by extracting the maximum amount of dying cash-flow. This is still a business with substantial scale advantages (within NZ) coupled with substantial supplier and customer relationship advantages in a niche that offers a degree of protection from 'Netflix et al'. These advantages were being eroded under the prior management. I think re-invigorating these advantages are the best path to wealth creation. I believe the current management is doing that - but it should be no surprise that it comes at a cost.

Though I do wish management had more skin-in-the-game (they currently have essentially zero).

The FCF (or owner earnings) that matter to me (as you have both mentioned as well) is the earnings that are available to either return to shareholders, or that can be invested in the business to grow it, or better, to strengthen it. So yes something along the lines of reported profits + DA less 'maintenance capex'. I am happy to just deduct all capex here, as it is very hard to determine 'maintenance' in a situation where the business is trying to reverse its course, and in any case, this is a situation that demands conservatism. However, I do not think it's fair to also deduct acquisition outflows.

The bad:
So the bad news is that yes, margins are continuing to get squeezed - in large part driven by escalating rights costs (essentially gross margins are being squeezed). This coupled with still declining revenues is giving operating margins a double-punch. On top of that acquisitions are depleting cash and equity based purchases and acquisitions are diluting shareholders. On the latter point, I'm willing to cut management some slack, for now, as the business was (and may still be) facing an existential threat.

The good:
I sense that rights costs may be peaking. Very importantly, Spark appear to be coming around to the idea of co-existence. Also the NZ Rugby League now has a 5% stake in SKT (that particular dilution may actually turn out not to have been such a bad thing?) and the RugbyPass acquisition may give them further incentive to distribute through SKT (?). Recent strategic decision seem very sound to me.

Whilst total revenue per subscriber is continuing to decline (hardly surprising given the need to compete with streaming services), there now appears the glimmer of possibility that subscriber growth may be starting to compensate.


If so,then it is possible that top line revenues may soon start to stabilise at current levels.

My stab at valuation:
On a TTM basis, operating cash flow before interest and tax (OCFBIT) is currently running at about $200m (if we adjust for working capital movements, mainly due to the very large investments made in programming rights in the latest period). It is likely that this number (of OCFBIT) has been influenced by the latest accounting changes (IFRS 16), and that it should be a little lower if restated to compare with prior periods.My EBITDA number for the TTM at Dec 19 (reconstructed to match the previous accounting standards, per the lower-left table of page 8 in the latest half year report) comes out at $170m. If we take management at their word, then there were nearly $20m in one-off charges in the TTM period (restructuring costs and acquisition related fees etc, as already mentioned by@mistaTea), then we could boost the TTM EBITDA at Dec 19 to about $190m.

I won't get too hung up on this. Suffice to say that OCFBIT has generally tracked EBITDA (pre the latest accounting rule changes) quite well, as shown below (TTM periods), especially after adjusting for WC movements:


Here is a history of margins:


The latest TTM period looks a little scary. But it needs to be acknowledged that this reflects the triple tyranny of a drop in revenues, a hit to the gross-margin and a rise in operating costs (SG&A).

If the EBITDA margin can settle at about 20% in a couple of years, and total revenues can stabilise at close to current levels (I see reason for hope here), then EBITDA will be about $760 x 20% = 150m NZD.If capex can be maintained at 9% to revenue (upper level of target range), then this implies an EBIT (using EBIT here in an 'owner earnings' sense, rather than in an accounting sense), of about 11% of revenue, which under these assumptions implies an EBIT of over $80m NZD.The business has about 440m shares on issue, and is currently selling for $0.57 AUD per share (on the ASX, or about $0.59 NZD), giving it a market cap of $260m NZD.The latest accounts indicate that the business is carrying debt of about $216m NZD. I will ignore my suspicion that cash levels are currently low, due to the very large inventory (rights) investments made in the period.I will also ignore the earnings accrued since Dec 19 (perhaps around $4m).On this basis, I can say that the EV is about $476m. My numbers suggest that SG&A costs can remain more or less unchanged from current levels, under the assumed revenue & margin scenarin this basis, I am prepared to assume this EV (*) at 'face value'.If this scenario eventuates soon (say in the next two years), then the current share price implies an EV/EBIT ratio of under 6.

On the other hand, if it takes 2 years to stabilise at these levels, the business will have made two years worth of earnings in the interim. I'm willing to say that the business is generating >50c of FCF (OCF - capex) for every dollar in EBITDA.As such, by year 2 (Dec 2021) it will have accumulated an additional $150m (approx), or approx $120m in PV terms (applying a 10% discount rate). On this basis, I'm willing to say that the EV is effectively $356m ($476m - $120m).This implies a EV/EBIT of 356 / 80 = 4.5, by year 2.

I like to invert that and to think in terms of a future after-tax yield of (1-T).EBIT/EV.If we conservatively apply a corporate tax rate of 70% (this ignore the current tax advantages being enjoyed due to the fact D&A is well ahead of capex) then we get: future yield = 0.7 x 80 / 356 = 16%.If it takes 2 years to stabilise at that level, and we apply a 10% discount rate, then we can say that that is equivalent to a yield today of 16% / (1.1)^2 = 13%.

Of course there is no guarantee that revenues and margins will not fall further than what I have assumed. Also, much is contingent on the efficacy of acquisitions made, and to be made, and whether or not further shareholder dilution is on offer. On the other hand, if the above scenario is realistic, then it is very likely that year 2 will not so much herald a stable new normal (with constant earnings), but rather that it will herald a turnaround of rising revenues. This is not captured by my analysis - but it would have enormous upside in terms of intrinsic value, way beyond what the above indicates.

Rugby pass
Coming back to the RugbyPass acquisition. This is currently adding to costs, but it is my understanding it is not currently adding to earnings (on the contrary).SKT paid a total of $40 (in cash & SKT shares, per the market price at the time). This, I believe, holds considerable promise. Under the pessimistic assumption (I would think) that SKT can only generate a mediocre return on this investment, then we can say that our EV can effectively be further reduced by this amount (ie we are today getting an additional $40m in value, not captured in our yield).We can then say that our future yield will be: (1-T).EBIT/EV = 0.7 x 80 / (356 - 40) = 18%.Or again, in present value terms (at a 10% discount rate), a yield of 17%/1.1^2 = 15%.



After considering all of the above, I have this morning added significantly to my holdings.




(*): The term Enterprise Value (EV) is not one I am comfortable with. The word 'value' just doesn't belong there. For me, EV is the effective price I would pay for the business if I retired the debt immediately. This is why an EV/EBIT ratio makes sense. IF I retire the debt, then my pre-tax earnings will be EBIT. So effectively my pre-tax earnings yield will be EBIT/EV (the inverse), and my net yield will be (1-T).EBIT/EV.