Investment columnist for the NZ Herald

Brian Gaynor: All the rules have changed

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Sky TV, Vodafone need each other in an internet world.
The Sky TV/Vodafone proposal involves Sky TV acquiring 100 per cent of Vodafone NZ from UK-based Vodafone Group. Photo / Brett Phibbs
The Sky TV/Vodafone proposal involves Sky TV acquiring 100 per cent of Vodafone NZ from UK-based Vodafone Group. Photo / Brett Phibbs

The Commerce Commission will have its hands full looking at the proposed merger between Sky TV and Vodafone NZ, as well as the planned union between Wilson & Horton (trading as NZME) and Fairfax NZ.

The commission has set August 22 as the date for its NZME/Fairfax NZ decision, while Sky TV shareholders will be asked to approve its deal with Vodafone NZ at a special meeting in Auckland on July 6.

Sky TV and Vodafone NZ have yet to lodge their Commerce Commission application and the former's special meeting of shareholders will be held before the commission hands down its decision.

The Commission has indicated that it can approve mergers on the following basis:

• "We will clear a merger if we are satisfied that the merger would not be likely to substantially lessen competition in any New Zealand market."

• "We will authorise a merger if we are satisfied that the merger would be likely to result in such a benefit to the public that it should be permitted even though it may substantially lessen competition."

These are the criteria under which the commission will assess the proposed mergers, which could substantially change the media landscape in New Zealand.

The Sky TV/Vodafone proposal involves Sky TV acquiring 100 per cent of Vodafone NZ from UK-based Vodafone Group. The consideration is $3.44 billion, consisting of $1.25 billion in cash and $2.19 billion worth of Sky TV shares.

The latter consists of the issue of 405 million new Sky TV shares to Vodafone Group at $5.41 each, giving the UK telecommunications company a 51 per cent stake in the merged group. Sky will remain listed on the NZX and ASX.

The proposal is subject to Commerce Commission and Overseas Investment Office approval as well as the support of Sky shareholders by special resolution (at least 75 per cent of votes cast) and by ordinary resolution (a simple majority of votes cast).

The transaction is in response to the dramatic changes in the entertainment sector, particularly the deterioration in Sky's strategic position. The pay TV operator is facing increased competition from high-speed broadband, changing consumer preferences and the entry into New Zealand of Netflix and other content providers over the internet.

At the same time, growing competition for content, particularly sports and popular TV series, is driving up Sky TV's costs.

A Grant Samuel independent report shows the TV operator's revenue is forecast to fall this year and next while programming costs will continue to escalate. The report reveals that Sky's net profit after tax is forecast to fall from $171.8 million in the June 2015 year to $148 million in the current year and $133.4million for the year ended June 2017.

These forecasts illustrate Rupert Murdoch's skill as an investor as News Limited sold its 43.6 per cent Sky stake at $4.80 a share in March 2013 to NZ and international investors.

Vodafone entered New Zealand in 1998 when it acquired BellSouth NZ. Its historic financial statements are difficult to analyse because they are prepared on a different basis to Sky.

The Commerce Commission will have a close look at the Sky TV/Vodafone proposed merger because telecommunications is one of the main industries that it regulates.

However, we can postulate that the IRD could be a big winner from the proposed merger as Vodafone had much higher operating profits than Sky but has had a much lower tax provision. This indicates that the combined group could pay more tax than the two standalone companies combined.

Vodafone is forecasting ebit (earnings before interest and tax) of $169 million on revenue of $2,024 million for the June 2017 year while Sky is forecasting ebit of $203.3 million on revenue of $920.4 million for the same period.

Grant Samuel believes the proposed transaction is on terms favourable to Sky TV shareholders and any alternatives are less attractive. However, the transaction results in a change of control but Sky shareholders will not receive the traditional "premium for control".

In addition, the combined group will have significantly more debt than Sky TV on a standalone basis.

The Commerce Commission will have a close look at the Sky TV/Vodafone proposed merger because telecommunications is one of the main industries that it regulates. It will have to assess whether this merger would substantially lessen competition immediately post-merger or in the future.

Even if the commission approves the transaction, it is important that Sky shareholders are aware that they will be moving from a company that has been lightly regulated to a combined group that will be closely monitored by the Commerce Commission on an ongoing basis.

The proposed NZME/Fairfax NZ merger is based on the same premise as the Sky TV/Vodafone proposal, namely increased competition in the media sector and deteriorating profitability. The newspaper groups argue "the media industry has been subject to exponential change over the last five years and this is set to continue, with print readership and revenue in decline and revenue from online news/information provision becoming highly competitive.

The change has been particularly felt in New Zealand, where internet penetration and smartphone ownership rates are among the highest in the world".

New Zealand is among the world leaders in internet penetration, with 91 per cent of the adult population active users in 2015. Smartphone ownership has gone from 48 per cent in 2013 to 70 per cent in 2015 and 2.5 million New Zealanders access Facebook every month. This includes 1.9 million visitors every day, with each of these checking Facebook on average 14 times daily.

NZME and Fairfax NZ claim they no longer compete with each other as they estimate "at least 40 per cent of people in New Zealand access news/information through a social media platform and nearly 50 per cent through a search engine, in addition to other sources of news/information".

The potential partners contend they operate in a crowded, converged print/digital advertising market with a large number of other providers of advertising services. They also say the proposed merger won't reduce competition in the daily newspaper sector because "there is limited 'heads-on' competition for subscription dailies today".

Matthew Horton, who runs Australasia's largest independent contract newspaper printer, has a totally different point of view.

Horton argues that news consumers have not deserted their traditional sources of current affairs news for Facebook and other social media sites. He cites Australian research showing that 76per cent of the country's adult population use newspapers as their main news platform compared with 72 per cent who access news through digital platforms.

He wrote in the National Business Review that NZME and Fairfax NZ are struggling "because their decisions have been mostly bad".

He wrote that "advertisers don't see all media as a homogeneous mass of direct substitutes. Indeed, the mere fact that any traditional media still remain 20 years after the internet's emergence proves that advertisers prefer individual platforms for particular jobs".

The Commerce Commission must consider a huge number of factors but there is the impression that the proposed NZME/Fairfax NZ merger is similar to a union between inner city horseshoe repairers in the early 20th century.

The horseshoe repairers wanted to merge because they were being decimated by the arrival of the motor car and a merger would give them the scale and financial resources to establish a chain of petrol stations.

NZME and Fairfax NZ are not predicting the demise of the daily newspaper but they are suggesting that they need to come together to compete against Facebook, Google and other providers of news, information and entertainment over the internet.

- NZ Herald

Brian Gaynor is an executive director of Milford Asset Management which holds shares in Sky TV on behalf of clients.

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Investment columnist for the NZ Herald

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular passion for the NZX and its regulation. He has experienced - and suffered through - the non-regulated period prior to the establishment of the Securities Commission in 1978 and the Commission’s weak stewardship until it was replaced by the FMA in 2011. He is also a Portfolio Manager at Milford Asset Management.

Read more by Brian Gaynor

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