Cost-cutting at online and news publisher Stuff is compromising the quality of its products, hastening a decline in its "very poor" earnings and could tip the balance to favour a revived merger with NZME, says investment house Jarden.
Stuff's steeply falling profitability and the failure of its new Australian owner to find a buyer for the New Zealand media assets is strengthening the case for reviving the merger with its main rival, NZME, which was rejected by the Commerce Commission and on appeal to the courts.
"Were the Commerce Commission to consider a merger of NZME and Stuff now, there seems little doubt that the counterfactual is looking increasingly problematic with not insignificant evidence suggesting Stuff will continue to shrink in size and importance," Jarden analysts Arie Dekker and Grant Lowe say in a note to clients today.
The competition regulator rejected the merger, first proposed in 2016, on the grounds that synergy benefits of between $40 million and $200 million a year did not outweigh the loss of a 'plurality' of voices and quality in the news media.
Jarden says the potential of Stuff "imploding" is "something we do not see on the immediate horizon at least" but the news publisher is looking "increasingly vulnerable".
Its 25 percent year-on-year decline in operating earnings over the past two years is mirrored in sharper declines in the circulation of its two largest metropolitan daily newspapers – Wellington's Dominion Post and The Press in Christchurch – than NZME is experiencing for its flagship NZ Herald masthead.
Since the merger rejection, Stuff had closed some community newspaper titles and "it seems possible more changes will be coming for Stuff which may only serve to worsen the rate of decline".
That was because, in Jarden's view, "there is a link between cost cutting and quality outcomes".
Stuff's new Australian owner, Nine Entertainment, had failed to find a buyer for the business although its latest accounts still anticipated a sale by the end of this year.
However, anyone stepping into Nine's shoes would be acquiring a business with just $20 million of tangible assets, mastheads and brands that had already been subject to substantial writedowns, and $65 million of non-cancellable lease obligations. Stuff was likely to be worth less than $100 million, Jarden said.
While NZME has begun operating a paywall for parts of the NZ Herald's news content with apparent success, "we question how well-placed Stuff is to move to adoption of a pay-gate model for online content in the foreseeable future".
Doing so would also require "not inconsiderable investment", with Stuff already committing scarce capital to developing its Neighbourly website and Stuff Fibre broadband offerings "on which there is limited visibility".
While Jarden rates NZME shares at 'neutral' and says the Auckland-headquartered publisher and radio station owner faces the same challenges as the rest of the news media, it believes the company's prospects show "reasonable upside risk" because of Stuff's declining position.
These range from "relatively modest" if the two organisations remain separately owned and Stuff does not attract a deep-pocketed new owner, through to "quite strong" in the event of a second merger attempt succeeding.
NZME and Stuff hadn't argued in 2016 that the merger should be allowed on the grounds of either firm's financial vulnerability. Jarden suggests the pair would "make the same arguments again but with stronger evidence in Stuff's worsening financial position and NZME's ongoing challenges."
In particular, Jarden suggests that NZME would be in a far stronger bargaining position with Nine than it was with Stuff's former owner, Fairfax, and that the merger's rejection had done NZME a favour by extracting it from unfavourable proposed terms.
"We can make a valuation argument that NZME is better off in the avoidance of the $55 million of additional debt that would have come with the merger and the 41 percent dilutive issuance of equity to Stuff's parent," Dekker and Grant say.
NZME shares rose 2.4 percent to 43.5 cents on a minuscule volume, having hit a record low 42.5 cents yesterday. They've shed 35 percent during the past 12 months, valuing the company at $85.3 million.