The gloss has gone off the Seven Network, its core TV business and its reputation among key investment bank and broking analysts.
After yesterday’s average interim result, especially from the network’s core TV business, and the surprise revelation of extensive stockmarket investments, a number of brokers have reduced their ratings of the company, with Goldman Sachs JBWere going as far as to tell its clients to sell.
Merrill Lynch has moved to a “neutral” stance and Credit Suisse has downgraded the stock from “outperform” to “underperform”.
The common theme was the surprise that Seven had invested much of the $1.6 billion in cash left over from the half sale of Seven’s TV and magazine businesses to KKR in the stockmarket with all the attendant risks. Seven invested $715 million and at the end of December there was a nice profit, but it was the fact that the surplus cash had been deployed into a volatile market that worried analysts.
Goldman’s downgrade was the most dramatic, saying “the level of uncertainty and potential loss is high”:
We have downgraded our stock rating to SELL. We believe the risk/reward is unattractive for two reasons:
1. Expected return: Our SEV target price is $11.80. This effectively implies a flat 12-month total return (including dividends). This compares with the GSJBW market return estimate of c.15%.
2. Investment case uncertainty: Prospective investors in SEV are effectively buying: (1) a $1.7bn cash war chest; (2) a portfolio of listed shares; (3) a 47% stake in a highly-geared media joint venture; and (4) a struggling wireless broadband company (which we expect will be loss-making for some time and require significant capex).
In our view, an investment proposition comprising these four components is not compelling. The level of uncertainty and potential loss is high.
Merrill Lynch said the move into the market raised concerns about the increased risk involved:
Whilst we still believe the implied discount to Seven’s cash has the potential to narrow should the company make an attractive acquisition, we now believe a deteriorating earnings outlook, uncertainty over its telco/broadband strategy and risks relating to its listed investments portfolio will make it difficult for Seven to outperform.
In a surprising move, Seven spent $715m investing in “high yielding, highly liquid stocks with low capital risk” in 1H08 to generate cashflow and franking credits, which has led to a reduction in Seven’s net cash position from $2.1bn to $1.2bn. We would expect Seven to liquidate its holding in these securities if and when any attractive acquisition opportunities arise, however this move clearly introduces an element of market risk into its portfolio, and is likely to be viewed negatively by the market despite the portfolio generating an 8% absolute return to date.
And while Credit Suisse said the “good” from the result was that Seven’s TV business achieved its highest ever profit margin of 33% in the December half and Pacific Magazines did better than expected, the “bad” was;
Seven’s previously unannounced foray into investing in the share market. While it has set parameters for high yielding, highly liquid investments, the move to put more than 40% of its cash (including its investment in WAN.AX) into the stock market at such a volatile time creates added risk for the company and its investors, in our view. Seven will also not get the full benefit of the recent investment made in product, which is now flowing through to profits.
And in an ironic twist Merrill Lynch said West Australian newspapers, the company 19.4% owned by Seven and where it is trying to outs most of the board, was its best media stock pick: “Our preferred picks in the sector are WAN, FXJ, CMH and NWS, with Ten and Austereo our least preferred. We remain Neutral on APN, PRT and SEV at current prices.”