You are on page 1of 13

SELL RECOMMENDATION

This report is published for educational purposes only by students competing in The CFA Institute Research Challenge.

Date: 14/10/2019 Recommendation: SELL Closing Price: $1.155 Industry: Media Broadcasting
Ticker: ASX:SXL Target Price: (AU$0.91) Sector: Radio & Television

SXL: SOUND PLAYER IN TOUGH INDUSTRY

INITIATING WITH A SELL


We issue a SELL recommendation on the SXL shares based on an SOUTHERN
CROSS
estimated price of $0.91, presenting a 22.37% downside. In our team's
view, Southern Cross Media Group is troubled by: 1) Deteriorating

AUSTEREO
Earnings, 2) Weak Market, 3) Valuation and 4) Weak Growth Strategy.

1) DETERIORATING EARNINGS
SCA’s earnings growth is anticipated to deteriorate due to
weak revenue growth attributed to difficult market
conditions, along with contracting margins trying to keep
market share.
2) WEAK MARKET
Based on the analysis of the Australian Radio and TV
broadcasting industry, online advertisement platforms are
forecasted to grow, diluting radio and TV advertising market
share. Demand for advertisement on traditional platforms
such as Radio and TV is also expected to decrease increasing
pressure in contemporary radio advertising market.

3) VALUATION
Utilising a blend of DCF analysis and Multiples valuation to
provide a current intrinsic value of $0.91 for SCA shares.

4) WEAK GROWTH STRATEGY


With the boom of online advertising (48% of the market), TV
and radio's advertising market are expected to decline with
the TV advertising market contracting at a much faster rate.
Since SXL’s main advertising revenue comes from its audio
assets (70% of FY20F revenue), it is expected to be cost
intensive going forward in order to maintain current revenues.

CFA INSTITUTE RESEARCH CHALLENGE | 1


BUSINESS DESCRIPTION

Southern Cross Media Group Pty Ltd. was established in July 2011 as a merger
between Southern Cross Media Group and Austereo Group. Since the merger, it
has grown into one of the largest players in the free-to-air commercial radio
industry as well as some market share in the television industry and online media
platforms across Australia. SXL has 2 main line of business; Audio and Television.

AUDIO
Segments: Operates in metro and regional radio as well as podcasting.
Two main radio brands: Hit and Triple M networks with over 7.5 million
listeners daily.
SCA operates PodcastOne Australia - the largest podcast service in
Australia. Expected to become cash flow neutral after 2020.
SCA’s largest revenue stream (see figure(X).
Leader in Australian radio broadcasting with 25% market share.
The industry generates $4.4 billion dollars annually.

TELEVISION
Segment: Solely operates in regional TV broadcasting.
Only affiliate of Channel 9 and Channel 7 in regional Australia.
SCA’s second main revenue stream.
Not a leading player in the Australian TV industry (see figure (x x)).

INDUSTRY OVERVIEW
KEY STATISTICS
RADIO REVENUE ANNUAL GROWTH ANNUAL GROWTH

BROADCASTING $1.7BN+
14-19
0.1%
19-24

-0.2%
SOURCE: IBIS WORLD

The radio broadcasting industry is capitalised at $1.70 billion with an


annualised growth of 0.2% 2019-2024F. There’s a positive correlation
between the current 0.9% decline in the industry and consumer sentiment.
Increasing demand from media buying agencies, radio resilient in the
advertising market and increase use of motor vehicles are forcing radio
broadcasters to consider radical innovation strategies within the industry.

CFA INSTITUTE RESEARCH CHALLENGE | 2


INDUSTRY OVERVIEW (CONTINUED)
FREE-TO-AIR TV KEY STATISTICS
ANNUAL GROWTH ANNUAL GROWTH
REVENUE
BROADCASTING $4.4BN
14-19
-3.6%
19-24

-2.8%
SOURCE: IBIS WORLD

The industry is capitalised at $4.40 billion with an expected decline in annual growth of 2.8% 2019-2024F. The shift in
Australians watching free-to-air TV has limited the for advertising time-slots thus decreasing revenue streams from media
buying agencies.

DOMESTIC OUTLOOK: RADIO BROADCASTING INDUSTRY


INCREASING DISRUPTION FORCING CREATIVE INNOVATION

INCREASED DEMAND FROM MEDIA BUYING AGENCIES


Radio broadcasting industry revenue is largely owed to media buying agencies paying for advertising time slots on radio
programs. The annualised growth of 2.60 % 2019-2024F implies a resilient market despite the robust demand across digital
media. Higher revenue is expected from increased competition as media buyers are anticipated to develop innovative
strategies to penetrate emerging markets.

RADIO RESILIENT IN THE ADVERTISING MARKET


Radio represents the 4th largest (8%) while FTA TV represents the 2nd largest (21.6%) in the advertising market. Since the
boom of online advertising (5Y CAGR: 7.9%) , the FTA TV has been dropping at (5Y CAGR: -5.9%) while radio has been
declining at a much slower rate (5Y CAGR: -2.3%). This shows that the radio industry is still able to attract demands for
advertisers despite the boom of online advertising.

INCREASE IN MOTOR VEHICLES


Traffic congestion in the cities and traffic present a strong positive correlation on the radio ratings. Drivers increase their radio
listening periods during traffic thus presenting a lucrative opportunity in which dense customer traffic can be attained.

COMPETITIVE POSITIONING
PORTER'S 5 FORCES

THREAT OF NEW ENTRANTS - LOW


The threat of new entrants into the radio and TV broadcasting market is low due to the
difficulties in establishing operations, market dominance from current players and the
costs associated with obtaining broadcasting licences. Existing radio broadcasters
benefit from established infrastructure, brand, customer base and contractual
agreements which takes time to create. These factors demonstrate the industry’s high
entry barriers. Similarly, TV high barriers to entry are associated with regulation, high
costs associated with establishing infrastructure and the market dominance of
established entities which benefit from existing audience loyalty, brand awareness,
contractual agreements and content. TV broadcasters require licenses which are
difficult to obtain due to limits in broadcasting spectrum.

BARGAINING POWER OF CUSTOMERS - HIGH


HIGH LISTENERS

SCA has a client base of roughly 1400 large national clients booked through
advertising agencies as well as roughly 45,000 smaller local clients which are
generally small to medium enterprises which may not have a national presence. LOW
STATIONS
HIGH
STATIONS

Customers who advertise in metro areas tend to have higher bargaining power due to
the option of alternative broadcasters while some regional clients may be limited in
options. The costs associated with switching to alternatives are low and there is no LOW LISTENERS

loyalty to broadcasters instead their loyalty is to the content they produce. Advertisers
are also highly price sensitive.

CFA INSTITUTE RESEARCH CHALLENGE | 3


COMPETITIVE POSITIONING
CONTINUED
THREAT OF NEW SUBSTITUTES - HIGH
The increasing fragmentation of advertising means Radio and TV broadcasters
compete
with other media platforms such as print, pay TV and the internet. Substitutes of
SCA’s Radio and TV segments threaten to provide alternatives which perform the
same function as SCA at a lower price.

BARGAINING POWER OF SUPPLIERS - MEDIUM


SCA’S suppliers comprise of specialist service providers which perform certain
functions with more efficiency, expertise and lower cost than SCA. The large size and
scale of SCA and alternative options means smaller suppliers have low bargaining
power. Larger service providers such as Broadcaster Australia which provide
transmission have higher bargaining power due to lack of alternatives and heavy
reliance on these services which without could disrupt SCA’s operations.

RIVALRY AMONG EXISTING COMPETITORS - HIGH


Competition in the Radio and TV broadcasting industry is High. Both industries are
highly concentrated with a few key players each. There is not a high degree of
difference in the services that are provided by Radio and TV broadcasters resulting an
increase degree of competition for clients.

FINANCIAL ANALYSIS
INCOME STATEMENT
REVENUES
Revenue is segmented into two categories, Radio and TV. As shown in Figure XX, over
the previous 2 years and forecasting into the future, their revenue has been
stagnating yet increasing. From 2020 onwards, the growth trend is a result of slow
growth in Radio and decline in TV, as well as our estimated shift in the product mix
towards more radio based revenue.

MARGINS AND SHIFTING PRODUCT MIX


Going forward we see a higher margin of revenues being earnt due to an increased
percent of radio share in the product mix, with overall TV revenues decreasing along
with their lower margins. Thus we could argue that that their ability to extract more
profit out of revenues is a positive. Gross porofit is expected to stay around 81.5%
range and is predicted to stay this way going forward, whilst EBITDA margin is
expected to be around the 22% mark.

DEBT PAYMENTS
Structurally, SXL’s debt is in a manageable and tax cost-effective position, with almost
all of their debt being long term arrangements. Thus SXL’s short term liquidity ratios
such as the current and quick ratio are ahead of industry peers. Holding at least some
long-term debt is advisable, as the tax affects would be beneficial, plus the large
upfront costs of some investments make it more of a requirement. SXL currently does
this well and is in line with current peers at a debt to equity ratio of 60% with the peer
median being 59%. SXL's leverage ratio is currently 1.76x -comfortably within
company's target range between 1.5x and 2.0x

INTEREST COVERAGE
Structurally, SXL’s debt is in a manageable and tax cost-effective position, with
almost all of their debt being long term arrangements. Thus SXL’s short term
liquidity ratios such as the current and quick ratio are ahead of industry peers.

CFA INSTITUTE RESEARCH CHALLENGE | 4


FINANCIAL ANALYSIS (CONTINUED)

BALANCE SHEET

LEVERAGE AND DEBT MANAGEMENT


Currently SXL's portion of debt is in long term agreements. Holding at least some
long-term debt is advisable, as the tax affects would be beneficial, plus the large
upfront costs of some investments make it more of a requirement. SXL currently does
this well and is in line with current peers at a debt to equity ratio of 60% with the peer
median being 59%. SXL's leverage ratio is currently 1.76x -comfortably within
company's target range between 1.5x and 2.0x

CASH
With poor cash flow generation forecasts (see Appendix) we believe SCA is in a
weak position to pursue growth opportunities without capital raising. We believe this
will harshly affect SCA in the future as high levels of competition will mean SCA may
lose its ability to compete. Property, Plant and Equipment is forecast to continue to
decrease as outsourcing continues to be a main objective of SCA to improve
operational efficiency. The recent outsourcing of transmission services to Broadcast
Australia is a sign of this. We believe this will increase the bargaining power of SCA’s
suppliers which will decrease its size leverage over its operators.

INTEREST COVERAGE
SCA’s interest coverage ratio is forecast to fluctuate however remain over 4. This
indicates that SCA can easily cover and pay interest on outstanding debt.
Furthermore, SCA’s short term liability ratios such as current and quick ratio are
decreasing as a result of weak cash generation and higher short-term liabilities, we
believe this issue is due to poor cash management my SCA.

CFA INSTITUTE RESEARCH CHALLENGE | 5


FINANCIAL ANALYSIS (CONTINUED)
CASH FLOW

FREE CASH FLOW GENERATION


SXL's cash flow generation is quite high when compared to peers, hence their ability
to pay their large dividend yield. Whilst net income has fluctuated year to year, cash
flow from operations has been rather stable but without growth. Going forward we
predict Free Cash Flow generation and their ability to pay dividends will come under
increased pressure and market growth slows and profit margins contract.

CAPEX
Capital Expenditure has been primarily spent on Broadcasting Licenses. Going
forward we predict capital expenditures to increase slightly as SXL attempt to hold
onto and try regain market share, putting CAPEX at 32,000 per year.

DIVIDENDS
We estimate a significant slowdown in SXL's dividend payout ratio and dividend
yield due to the contracting margins and greater need for capital expenditure to
retain market share. We estimate a payout ratio of mid 30% going forward,
contrasted to managements expectations of 65-85% of underlying NPAT paid out.

DUPONT ANALYSIS

VALUATION
We issue a sell recommendation on SXL, based on an estimated price of $0.90,
which presents a 22.37% downside.

Our target price calculation is based on a blend of the Discounted Cash Flow (DCF)
to Firm model with a target price of $0.91 and 6.7x EV/EBITDA multiple with a target
price of $0.86. The weighted blend of valuation models were 70% based on the
DCF model and 30% for multiples. We decided to use the lower weighting for
multiples due to the lack of comparable companies to SXL.

WACC
For our analysis we used a WACC of 10.01% for discounting the Free Cash Flow to
the firm, with our cost of equity factoring in a relevered beta from competitors. A
more thorough breakdown of our WACC calculation can be found in the table to
the right.

CFA INSTITUTE RESEARCH CHALLENGE | 6


VALUATION (CONTINUED)
VALUATION - FCFF
We valued the Radio and Television segments using both the Free Cash Flow to the Firm model as well as
the discounted cash flow methodology due to the stable nature of their growth,profitability, and cash flow
generation.

TERMINAL GROWTH RATE


We calculated our terminal growth rate as Australia’s long-term GDP growth projections at 1.25%. Since
geographically SXL operates solely in Australia and has no plans to expand out of this market. Our estimated
value for the firm, the terminal value consists a significant proportion of total value at 68%.

COMPARABLES ANALYSIS
SXL's two closest competitors we used for comparable analysis were HT&E and Nine Entertainment Holdings.
The multiple we decided to base our comparable calculation was Equity Value by EBITDA. We used this
multiple based on the comparables as EV/EBITDA provides a clearer picture of the financial performance of
peer companies since it removes debt costs, taxes and depreciation. SXL's peers have relatively high
depreciation costs as they are capital intensive businesses, so EV/EBITDA made the most sense.

Utilising our ratios of EV/Revenue, EV/EBITDA and PE ratio from comparable peers we derived intrinsic values
of $1.16, $0.98 and $1.11 respectively. We believe the EV/EBITDA supports the SELL recommendation as
implied by the DCF model.

CFA INSTITUTE RESEARCH CHALLENGE | 7


VALUATION (CONTINUED)

SENSITIVITY ANALYSIS
Based on our assumptions, we also performed a sensitivity analysis on the driving variables of the model by doing
a Tornado Sensitivity Analysis by changing the variables Beta, Terminal Growth Rate, Tax Rate, Cost of Debt and he
WACC up and down by 10% as shown in the table below.

INVESTMENT RISKS
MARKET RISKS

RISE OF ONLINE STREAMING (MR 1)

RIsk: Spotify and similar music streaming services are competing


directly with SXL owned radio stations.
Impact: As online music streaming services can often offer a wider, MR 4
MR 2
more tailored range of musical options, this naturally siphons away MR 3
traditional listeners of music on radio channels. Evidently in May 2018, MR 1
46 per cent of Australian adults had used a music streaming service in
the previous seven days, an increase from 37 per cent in 2017, and this
FR 1
number is sure to grow even more. OR 1
Mitigation: Maintaining and even growing music radio station RR1

audiences will have to take into account current online music


streaming options in order to remain competitive.

CFA INSTITUTE RESEARCH CHALLENGE | 9


INVESTMENT RISKS (CONTINUED)
SHIFTING ADVERTISING SPEND (MR 2)
Risk: Increased share of total advertising spend is being spent online
compared to traditional channels, SXL will have to manage and monitor this
shift in advertising spend in order to minimise the impact to shareholders from
their current options. On the contrary though, with the implementation of their
new podcast platform, SXL should even be looking to benefit from this
potential risk.
Impact: Radio and TV revenues are likely to stagnate or lower going forward.
Mitigation: Focus and have a prescence in online markets, capturing the shift.
FTA TELEVISION DECLINE (MR 3)
Risks: FTA Television currently accounts for around 30% of SXL's revenue
and with streaming platforms such as Netflix, Stan and Disney+ among
others, there is a real threat of declining FTA viewership resulting in lower
revenues from advertising. Adding to the risk is a number of the newer market
entrants are willing to sacrifice short-term profitability in order to create
quality content to establish long-term subscriber growth, thus putting
pressure established media companies' operating margins.
Impact: Lower TV adertising revenues from lower viewers. SOURCE: PWC GLOBAL ENTERTAINMENT & MEDIA OUTLOOK 2019–2023

Mitigation: Either greater TV market share to offset or explore other revenue


streams.

PODCAST MARKET (MR 4)


Risks: SXL's investment into PodcastOne Australia will have to compete with
other similar up and coming podcast platforms from other providers sharing
similar ideas on creating their own content on their own platform. Also with the
relatively low barriers to entry for podcasting, and easy uploading to Apple
Podcasts, SXL's premium content generation may face stiff competition from
the multitude of wide ranging potential podcasts.
Impact: Lower audience numbers resulting in lower advertising revenue.
Mitigation: Generate engaged and larger podcast audiences, higher quality
content.

FINANCIAL RISKS
DIVIDEND PAYMENTS (FR 1)
Risks: Southern Cross Media currently pays out a large portion of their FCF
through dividends at a current dividend yield of over 6% and has a current
dividend payout policy range of between 65% - 85% of NPAT. Understandably
this yield has attracted a large number of dividend investors looking for yields
on their investment.
Impact: Dividend payments to be scaled back or even removed completely,
affecting share price
Mitigation: Ensure a consistent and achievable payout ratio.

OPERATIONAL RISKS
TALENT RETENTION (OR 1)
Risks: Talent flight is a significant risk evidenced as the hosts of popular radio
shows are significant drivers and determinants of audience numbers,.
Impact: If keytalent are to leave, it can have a significant adverse impact on
the company audience numbers
Mitigation: Offer longer contracts for key presenters.

CFA INSTITUTE RESEARCH CHALLENGE | 9


INVESTMENT RISKS (CONTINUED)
REGULATORY RISKS
LICENSING CHANGES (RR 1)
Risks: Current metro radio laws in Australia only allow 2 licenses per
market, if these laws are to become stricter, SXL may have to sell a number
of licenses to comply with updated laws.
Impact: Less licenses meaning less access to radio listeners from different
stations
Mitigation: Diversify revenue streams and not rely too much on any one
license.

TARGET PRICE RISKS


The assumptions calculated in our analysis may not hold in the case of an
unexpected slow down in the growth of SXL's radio market, a faster than
anticipated decline in TV advertising revenue, or in the case that
PodcastOne fails to reach profitability and achieve growth. A small change in
growth and valuation assumptions in turn can significantly affect the final
target price per share. In order to get a better sense of understanding how
the target price may react to unexpected changes, we undertook a
sensitivity analysis in order to understand the impact of a changing WACC
and terminal growth rate.

CORPORATE GOVERNANCE
SHAREHOLDER BASE
SXL's ownership is compromised of 71% institutional owners, whilst the
remaining 29% comes from non-institutional ownership interests. When it
comes to board members holding ownership stakes in SXL, just below 1
percent of shares are held by board members. All totalled, the board
members hold 0.28% of all available shares. Currently the largest
shareholders of Southern Cross Austero is Allan Gray Australia, with a 15%
stake, with Ubique Asset Management holding 10%.

BOARD OF DIRECTORS
Southern Cross Media's current Board of Directors is comprised of six non executive
directors and one executive director which is CEO, Peter Bush. The Chairman of the
board and the CEO roles are separated, with Grant Blackley as Chairman and Peter
Bush as CEO. Four out the seven board members have previous experience in the
media industry, whilst the others have previous corporate finance and CEO
experience. All board members hold at least 100,000 shares in the company and all
have been a director at SXL for at least 3 years with Leon Pasternak the Deputy
Chairman having 14 years at the company. Two members out of the seven on the
board are female (28%), putting SXL ahead of the industry median of 20%

CORPORATE SOCIAL RESPONSIBILITY


SXL currently have a range of CSR initiatives focusing on diversity such as specific
mentoring and executive development programs aimed at women, policies that
encourage flexible working arrangements and return from parental leave, the
recruitment and succession planning processes that support high potential women,
as well as training for all managers on the topic of diversity and inclusion.

CFA INSTITUTE RESEARCH CHALLENGE 10


APPENDIX

INCOME STATEMENT

CFA INSTITUTE RESEARCH CHALLENGE | 11


APPENDIX

BALANCE SHEET

CFA INSTITUTE RESEARCH CHALLENGE | 12


APPENDIX

CASH FLOW STATEMENT

CFA INSTITUTE RESEARCH CHALLENGE | 13