For weeks now Crikey has argued that Australia’s struggling media groups — like the benighted Fairfax, APN and WAN — are better placed than their long-suffering peers in the US and UK. Today, media analysts at Merrill Lynch, led by Alice Bennett, have agreed — sort of.
In a research note looking at the early implications of the impact of the $43 billion NBN on publishers, Merrill’s analysts came up with a surprise: it upgraded Fairfax because of its digital potential. The news stunned the market with Fairfax shares rising three cents to $1.11 this morning.
But it’s not the first time Merrill Lynch has been upbeat about Fairfax: almost a year ago, on June 26, 2008, Crikey reported:
Fairfax is now so cheap it’s a screaming buy. That’s investment bank Merrill Lynch’s latest take on the media group.
Or, to put it another way, after helping to talk down the prospects for the media sector, analysts at Merrill Lynch now reckon the doom and gloom for Fairfax has gone too far.
So the upshot is: Fairfax has found a friend.
Which is handy considering the way the shares have slid. They finished at $2.82 yesterday after touching a low recently of $2.71.
That’s $1.60 higher than the price at around 11am this morning. Some friendship, but a lot has happened since then. The end of the world nearly happened and the bottom dropped out of advertising markets, leaving every media group here and worldwide high and dry. So Merrill’s new found optimism should be taken with a binary grain of salt, or two.
Merrill wrote in its latest client note this morning:
There is no doubt the NBN will accelerate the structural shift from print to online. However, we also think that high speed, affordable broadband will clearly present opportunities for content producers through the use of video, IPTV and products like Amazon’s Kindle (e-book).
The key issue is whether the additional online revenue opportunities will be enough to offset the lost print revenues. “Going ‘online-only’ is viable for FXJ, but not WAN and APN,” the firm said.
We have assessed the potential for FXJ, WAN and APN to convert their metro newspapers to online-only formats in 10 years time. Given the strength of FXJ’s existing online assets, we can envisage a time when shifting The Age and SMH online will make sense.
Fairfax the best positioned publisher — Our detailed analysis of the long-term health of FXJ’s print and online revenues gives us confidence that FXJ is likely by far the best placed of the Australian and NZ publishers to weather the storm. Indeed The Age and The SMH are the only newspapers in Aus/NZ that we think could feasibly move to an online-only business model, given the strength and premium pricing of their brands online.
Whilst we think it is too early to say definitively that the Australian advertising market has bottomed, we are increasingly confident that we are close. The rate of deterioration for the page counts we track for The Age and The SMH has steadied in March, April and May.
For example, assuming costs fall by 45% and 50% of lost print revenue is recouped online, FXJ could generate $149m of EBITDA in FY18 (vs $142m print + online) with a margin of 27% (vs. 16%). The case is much less compelling for WAN and APN.” Over the medium to longer-term, we see Fairfax is much better placed than APN and WAN (most vulnerable) to take advantage of any online opportunities given its very strong starting point in terms of online revenues.
In the nearer-term, whilst we think it is too early to say definitively that the Australian advertising market has bottomed, we are increasingly confident that we are close. We also believe that as we move closer to the FY09 reporting season, focus will begin to shift from the trough FY10 earnings to the growth expected to return in FY11.
APN’s late development of its online strategy has meant that FXJ’s NZ online auction player, Trade Me, has dominated not only the auction space but also increasingly the classifieds. However we think APN is better placed than WAN and with the stock trading -9% below our revised $1.40/sh PO, we move to Neutral from Underperform.
Why not a Buy? Because we still see modest downside earnings risks for APN’s NZ (c.32% of EBITDA) and outdoor (12% of EBITDA) operations.
Our long-term NBN-related analysis has led us to downgrade publishing revenues over FY13-FY18E (metro CAGR cut by 2-3% and regional by about 1.5-2% points), with a lift to online growth (4-5% points) partially offsetting this. In the near-term, we also cut revenue estimates for FXJ by 2% in FY10 and APN by 4% in CY09.
Finally, we have reduced the multiples used in our SOTP (Some Of The Parts) valuations for all three. Our POs (price objectives) for WAN and APN fall by -15% and -20% to $3.55/sh and $1.40/sh respectively. For FXJ, our PO lifts by 13% to $1.30 as we remove the 20% discount previously applied to valuation reflecting our view that downside risk to our FY10 forecasts is limited.
Meanwhile, Merrill maintained its underperform on West Australian Newspapers (bad news for Kerry Stokes who now controls the company and board with around 23% of the shares):
We think the stock will struggle to outperform over the next 6-12 months given a lack of diversification and heavy reliance on the WA economy and ad market at a time when commodity prices remain under pressure.
In the longer term, we believe that WAN’s sub-optimal digital strategy will increasingly become an issue, particularly when the revenue shift from The West Australian accelerates (currently accounts for c.90% of WAN’s total earnings.
While Fairfax basks in its upgrade, it seems there’s still a lot of work ahead for Mr Stokes and his management team.