BSkyB looks set to reach rapid profit growth

INVESTORS in BSkyB have had a rollercoaster ride in recent years. Caught up in dotcom mania, the share price increased from £6.00 in November 1999 to a high of £21.58 on March 6th 2000, an increase of 360% over four months.

Then, the bubble burst, resulting in sharp price declines for highly rated stocks globally. Sky did not escape and nearly three years later, the share price is now back to pre-bubble levels.

Of more interest, perhaps, is the fact that fundamentals for the stock have improved significantly over the past three years and the company now looks set to enter a period of rapid profit growth.

The competitive environment for Sky has never been better.

Benefiting from the collapse of ITV Digital and the well-publicised problems of the UK cable industry, the company has emerged as the leading player in the UK pay-TV market, with a market share of over 64%.

Profits, however, have not yet reflected this improved competitive position. Instead, heavy investment costs incurred to transfer the subscriber base from analogue to digital and a dramatic escalation in programming costs during 1999/2000, have resulted in operating margins at the company declining from 30% at the peak of the analogue years to 7% currently.

The outlook for profit growth going forward, however, is very positive.

The migration to digital is now complete and the analogue service has been switched off.

In addition, with the competition constrained, programming cost pressure looks set to ease substantially. The Premiership League contract, for example, due to be renewed this summer, should cost the company at least £100m less than the £1.11bn price paid for the last three-year contract.

The profit impact will be substantial, as it is estimated that every 10% decline in programming costs increases earnings forecasts by 10%.

Two additional factors should also contribute to strong share price performance over the coming year. Firstly, the company appears well placed to reach its operational target of 7m subscribers ahead of schedule.

At the start of 2003, the company had over 6.5m subscribers, leaving just 438,000 to be added before year end.

This looks achievable, with the company having added on average 210,000 net subscribers per quarter over the past year.

Once the 7m target has been reached, there is a real possibility that new targets will be set by management. In addition, the company’s credit rating looks set to be restored to investment grade status.

Standard &Poor’s recent announcement that it has placed the company on positive outlook watch, provides an early indication of its intention to upgrade the company’s debt.

Because of the depressed nature of its profit base, BSkyB has been a very difficult company to value. However, with profits forecast to increase from a pre-tax loss of £200m in 2001 to a pre-tax profit in excess of £1bn by 2006, traditional valuation metrics will soon become useful once more.

The share price has performed well short-term, rising 12% over the past ten days in response to better than expected H1 results. Iraq-related weakness could see the share price drift back towards £5.50-£5.60 level, an attractive entry point for this stock.

BSkyB is one of a number of stocks highlighted in Goodbody’s recent report “Better Days Ahead”.

This report aims to identify a number of Irish and UK stocks expected to respond positively to an improvement in equity markets.

For a copy of this report, please contact Goodbody Stockbrokers; telephone [phone].