STV Group (STVG.L) – Tidied Up, So What’s Next?

Back in 2006 STV was a diversified media group, with a presence in television, outdoor advertising, radio and cinema advertising. Its total group turnover that year was £191.2m, underlying operating profits were £18.4m, net debt was £157.3m and total assets were £313.4m. Despite the strong asset backing, debt was an uncomfortable multiple of cashflow, prompting management to take action to fix the balance sheet.

 

Since then, the group has sold its outdoor business, Primesight, radio unit, Virgin Radio and cinema business, Pearl & Dean. These disposals produced gross cash inflows totaling £94.2m. STV raised a further £91m from a rights issue in 2007. However, the significant restructuring did not come cheaply, with the group seeing a cash outlay of £35m on exceptional and other one-off items, while a net £14m in cash was expended on discontinued operations over the period to the end of 2011. Net debt was reduced by two-thirds since the end of 2006, to £54.5m at the end of last year.

 

So, the group now is a slimmed down operation focused on television. It holds two of the 15 Channel 3 licences, covering northern and central Scotland. The other franchises are held by UTV Media plc (one, Ulster) and ITV plc (the other 12). In 2011 it generated turnover of £102m (consumer £93.6m / productions £8.4m) and EBIT of £15m. That year it tidied up a legacy legal dispute over content with ITV, while this improved relationship was further cemented with a new networking agreement signed this year between the three Channel 3 licence holders.

 

So, with the business simplified and legacy issues resolved, where next for STV? As slide 26 of this presentation shows, it aims to grow ‘non-broadcast’ (digital and production) earnings to represent a third of group earnings, double STV Productions’ revenues, be the most used digital service in Scotland, launch two new market-leading digital consumer propositions and maintain its position as the “Voice of Scotland”. These are, as STV itself says, “ambitious but achievable” goals. Digital enjoyed margins of 33% in H1 2012, producing operating profits of £1m, or 12.5% of the group total. Given Productions’ low revenue base, doubling it should not prove too big an ask. Moreover, while advertising conditions remain challenging in the UK, any improvement over time should have a positive effect on earnings given the operating leverage inherent in the broadcasting business.

 

But will it have time to implement these goals? Last year ITV bought Channel Television, which held one of the 15 Channel 3 licences. This gave rise to speculation (such as here and here) that it could move to buy out the remaining ‘independents’. ITV certainly has the resources to do so, given that at the end of 2011 it had gross cash of £801m and net cash of £45m. But would a deal make financial sense? I note that in 2011 ITV generated an impressive ROCE of 18.6%. Assuming that it would want at least that from a deal with STV, this would imply an enterprise value for STV of £80.5m (based off STV’s EBIT of £15m). Strip out STV’s end-FY11 net debt and pension deficit (£54.5m and £30.9m respectively) and you’re left with effectively nothing for the equity. However, this doesn’t include the likely synergies that would arise from such a tie up. If you assume ITV could eliminate 10% of STV’s costs (that sounds punchy, but in cash terms it’s less than £9m) and also save on the £1.4m in directors’ emoluments, you can get to an equity valuation of circa £50m, or £1.26 a share – that’s around 50% upside to where the shares are currently trading at (£0.842). Moreover, as the company continues to pay down debt, there will be a further transfer of value from debt holders to equity holders (its underlying operating cashflow is circa £10m a year, or around a third of its market cap). My estimates do not look demanding at all, given that Numis (140p) and Peel Hunt (216p) have far higher price targets.

 

If a deal fails to materialise, investors in STV will be left with a stock that is trading on a forward PE of just 2.5x that: (i) with the ITV litigation out of the way is now poised to seriously start to pay down debt (net debt / EBITDA was 3.2x in FY11); (ii) offers a good possibility of dividends being reinstated (an update on dividend policy is guided for February) to compensate shareholders for their loyalty; and (iii) is well-placed to benefit from an eventual recovery in advertising markets.

 

So, either way it seems the outlook is positive for STV. You can look at this as a story of either: (a) debt paydown and a future recovery in advertising markets driving an eventual re-rating off a low base; or (b) an opportunity to get in cheap for what could very easily become a takeover candidate for ITV. I like the look of this one, and I think I’ll add it to my portfolio.