NEC: Turning headwinds into plain sailing

Nine Entertainment Co (NEC) posted a strong result despite headwinds from a soft free-to-air (FTA) television advertising market and weak property listing volumes on Domain (DHG). NEC has navigated these challenges effectively turning headwinds into plain sailing, as the company gained FTA market share in the second half of FY19 and grew its Stan streaming service and digital publishing business.

Key take-outs from the result

NEC delivered on its guidance given at the half-year result of at least $420m EBITDA in FY19 despite c$25m in reduced earnings expectations at its non-wholly owned assets, Domain (DHG) and Macquarie Media (MRN).

The company was able to offset the DHG and MRN downgrades with a significantly better than expected result from the old Fairfax metro papers business. Print advertising was flat – demonstrating the cross-selling opportunities provided by Fairfax/NEC merger – and with double digit growth in digital revenue and strong cost control.

NEC is doing an excellent job in growing its digital assets as it manages secular headwinds in print media and TV. Revenue at 9Now, NEC’s ad supported streaming business, rose more than 60%. Growth in online video advertising is offsetting some of the lost FTA revenue, demonstrating the benefits of NEC investing ahead of the curve in this area.

Stan made its first ever profit in the second half. The subscriber base is growing quickly, having risen to 1.7m subscribers, up more than 50% over the past year.

Stan also successfully put through a $2 monthly price rise. This may not sound like much but it’s approximately a 13% price increase and that rolls across the entire subscriber base – with the cost base being relatively fixed.

Stan’s 2H run rate was fully loaded from a cost perspective, meaning that even if subscriber growth slows following the presumed loss of Disney content, NEC is going to have to spend a lot more on marketing than expected for Stan not to exceed its $30m EBITDA guidance for FY20.

NEC’s upside levers (What is something the market overlooks?)

The market still sees NEC as a legacy TV network. TV is now less than 40% of EBITDA and much less than 40% of the valuation of the entire group.

In the medium term, we expect NEC's digital growth assets – DHG, 9Now and Stan – will provide more than half of overall group earnings. We view Stan in particular as an excellent asset the value of which appears unfairly discounted by being owned by an “old media” company.

NEC has a number of upside levers available to it as Australia’s largest TV broadcaster.

The improvement in print advertising at the old Fairfax papers is an excellent indication of the benefits of scale in the media industry. In addition to bundling opportunities, NEC is able to leverage its relationships with media buyers and ad agencies that it has by virtue of owning the best performing TV network.

The upcoming acquisition of Macquarie Radio (MRN) also highlights the benefits of scale of the business built by NEC as the dominant media player in Australia.

Discussions with DHG have reaffirmed our belief that NEC’s ownership will prove beneficial for both companies (Domain content is already integrated into The Block and Nine is launching a Domain branded show on Sunday mornings). Following its move to take full ownership of MRN, we believe there is an opportunity to extract similar synergies on the cost and revenue side. MRN’s issue has always been that it takes a large share of direct advertising but agencies don’t advertise with the network given its relatively small scale. This will change once NEC owns 100% of MRN.

NEC has the size and strength to get in the room with agencies, so we believe there will be upside for NEC once it acquires MRN – and we believe there will also be newsroom synergies on the cost side.

In our view there is plenty of valuation support for NEC. We estimate that excluding its stake in DHG, the rump of NEC’s business is trading on about 5x EBITDA (falling to under 4x if Stan is also excluded at what we view as a conservative valuation).

As we see it, the market is focused on the benefits of scale and the cost side of NEC but is ignoring the real benefits of being the largest media company in the country – as well as the leverage that can be provided to some of the other assets that NEC owns, including DHG, MRN, the 9Now digital platforms and Stan.

Outlook in FY20

NEC management has set out guidance of 10% growth in EBITDA for FY20.

We believe this guidance is likely to prove conservative given the upside from a higher TV market share, a recovery in listings at DHG, and NEC’s expectation that Stan will move into profit for FY20 on the back of increased subscriber numbers - as well as from expected incremental cost and revenue synergies.

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