BSkyB becoming a victim of its own success
While the recovery in profits was largely expected, this was 8% ahead of expectations, a good start to what is essentially the first of a four-year recovery in profits. Over the next three years, profits are expected to grow from £259.6m this week to over £1.2bn, driven by continued subscriber growth and falling programming costs.
Few now doubt BSkyB will hit its operational targets. With subscriber numbers up to 6.85m, it is only weeks away from surpassing the long-held 7m subscriber target. In addition, average revenue per subscriber is £366, implying annual growth of only 4.5% is needed to reach its target of £400 by 2005. This looks very achievable, essentially only in line with historic annual price increases. Management comments at the result’s presentation were also very upbeat.
As speculated, dividend payments, suspended at the time of the digital launch, are to be resumed. Two new targets were set: subscriber numbers to reach 8m by December 2005, and operating margins to recover to 30% by 2007.
The new targets, while unlikely to lead to a steep change in growth forecasts for the stock, certainly give comfort that existing profit forecasts are well underpinned. Management have often stated subscriber numbers could exceed 10m medium term, not an unrealistic number given the lack of credible competition. The margin target implies a near tripling of margins over the next three years; certainly ambitious but not out of line with margins achieved back in the analogue years. With digital conversion complete, costs look set to fall sharply, as shown by the recent re-negotiations of the Premier League contract, which saw reductions of 15.5% and 35% respectively on an absolute and per-game basis.
BSkyB’s share price response to both the results and new targets has been relatively muted. In part, it would appear the company has become a victim of its own success. Having consistently over-delivered at the operational level, investors have come to expect BSkyB not only to meet targets, but beat them comfortably.
The fact CEO Tony Ball and Finance Director Martin Stewart chose this week to unload £9.3m and £4.23m worth of stock respectively, also did little to help the price short term.
Valuation also remains an issue. While analysts suggest the company could be worth in excess of £10 a share, on a simple P/E basis, they do not look cheap. Trading on 37 times current year forecast earnings and 22 times next year’s, the multiple is undoubtedly hefty, though justified by the expectation of near 80% earnings growth per annum over the next two years.
A key question for investors is what growth will look like once margins are restored to historic levels? Trading now nearly 30% higher than the £5.50 level reached in the run up to the Iraq war, investors appear to be looking for clarification on two key issues before the share price can deliver a sustained push beyond £7.00. First, resolution of the European Commission investigation into the Premier League rights auction. Second, firmer signs from management on how the growth story might develop once current targets are met. A formal 10m subscribers target, for example, would add another leg to the growth story.
While undoubtedly one of the best managed companies in the UK, the issue for investors is that other names could see better momentum short term. With confidence growing in a global economic recovery, a stock with the defensive growth characteristics of BSkyB could lag.
For further information, please contact Goodbody Stockbrokers: 021 4279266, 01 6670400.
Rosemarie Flynn
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