Austar, the regional Pay TV operator, had a loss in the first half of the year. Thought I’d just remind you of the fact because it was hidden very nicely in today’s announcement to the ASX in the Consolidated Income Statement. Austar naturally trumpeted its stronger performance before tax and all those inconvenient bits and costs of staying in business:

Earnings before interest, taxation, depreciation and amortisation (EBITDA) for the six months increased by 28 percent to $101 million compared to the previous corresponding period, reflecting a 12 percent increase in revenue to $307 million but only a one percent increase in operating expenses to $70 million. Profit before interest, tax and significant items was $52 million for the six months, a five percent increase on the same period in 2007.

And it’s true that EBITDA or EBIT is an accepted way of looking at how the operational side of the business is travelling, but it is not the most accurate guide to how the company as a whole went in the reporting period, in this case the first six months of 2008.

For example, concentrating solely on EBITDA enables comparisons to be made with other media groups, because tax and financing arrangements are different for each one and on this basis, Austar is making out like a bandit and needs some Pay TV competition. It is in the great pay TV monopoly with Foxtel, it shares resources and assets with its more urban-focussed peer and is part of the great Fox Sports carve-up of Australia.

If Austar had to spend money on its own sports coverage, it would be a very different business because sport is the first and only driver of pay TV subscriptions. Sports — mainly rugby league, AFL, soccer and cricket — dominate the weekly, monthly and yearly most watched programs on Pay TV, whether it be Foxtel or Austar. Its Fox Sports arrangement is its most valuable programming agreement and any threat or loss of that would see Austar virtually out of business, unless it wanted to spend more money arranging its own coverage of AFL and especially rugby league, its most important sport, given its strength in Austar’s market heartland of regional NSW and Queensland.

But on a more conventional basis, tax and interest costs are a fact of everyday life for businesses (and everyone), and in the six months to June Austar fared badly. In fact, a sharp rise in tax and financing costs for various reasons saw it plunge from a profit after tax and financing costs of $26.68 million in the first half of 2007, to a loss of $7.60 million in the first half of this year.

Costs rose from $101.29 million to $124.87 million, financing costs more than doubled to $26 million from $12.48 million and tax jumped to $27.97 million from $12.34 million. Those increases left a big hole in the solid rise in Austar’s gross margin from $148.1 million in the front half of 2007 to $170.92 million in the latest half. Austar explained the sharp rises this way:

Expenses have increased by $23,572,000 to $124,871,000 for the current period ($101,299,000 in the previous corresponding period) due to increased share-based payment expense as a result of the long-term incentive plan, an increase in depreciation due to additional capital expenditure as a result of customer growth and the write-off of broadband assets due to the cancelled broadband spectrum sale.

Net financing costs have increased by $13,521,000 to $26,009,000 for the current period ($12,488,000 in the previous corresponding period) due to higher average drawings on the Senior Debt Facility in the current period compared to the prior period, which were used to finance the 2007 Capital Return of $300,000,000. Included in financial income for the current period is a gain of $5,533,000 ($8,696,000 in the previous corresponding period) as a result of a movement in the fair value of $680,000,000 interest rate swaps. Included in borrowing costs is $1,107,000 in amortisation of deferred financing charges ($1,216,000 in the previous corresponding period).

Net profit before tax for the current period was $20,325,000 ($37,028,000 for the previous corresponding period). The decrease in profit is due to increased interest expense on additional borrowings and one-off broadband termination costs.

The Consolidated entity recorded an income tax expense of $27,928,000 in the current period ($12,346,000 in the previous corresponding period). Tax expense has increased largely due to the de-recognition of a $16,793,000 deferred tax asset recognised in December 2007 based on the expected spectrum sale.

Don’t you love that phrase “de-recognition of a $16.7893 million deferred tax asset recognised in December 2007 based on the expected spectrum sale”? In other words, the company grabbed the tax benefit but was forced to reverse the transaction when the spectrum sale didn’t happen. That sounds like a bit of accounting doublespeak, but it does represent a bit of financial engineering that backfired on Austar.

And the other beauty was: “Expenses have increased by $23,572,000 to $124,871,000 for the current period ($101,299,000 in the previous corresponding period) due to increased share-based payment expense as a result of the long-term incentive plan.”

Guess who’s getting the higher payments under the long term incentive plan? Austar’s managers, that’s who. But don’t shout the news. To keep the report to the market looking nice, Austar doesn’t highlight the fact that management is being paid more than what it seems.

You do have to exclude one-off items from profit statements to get a good idea of the underlying performance, but those higher payments under the long term incentive plan are becoming common now at Austar and should really be coming out of the company’s gross margin each quarter. It seems these incentive payments are now a regular cost of day-to-day business at the country’s number two Pay TV business.

Peter Fray

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