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Morningstar | Internal Diversity Offsetting External Adversity While Nine Continues Reshaping for the Future. See Updated Analyst Note from 05 Jun 2019

Shares in Nine Entertainment have rallied almost 40% (inclusive of dividends) since the release of its fiscal 2019 interim result in February 2019, and are now trading close to our unchanged AUD 2.00 fair value estimate. This is a stellar performance against a weak industry backdrop, with both the overall and free-to-air TV advertising market down mid-single-digit percentage points since the start of 2019, notwithstanding a one-off boost from election-related expenditures.

The benefits of Nine's diversified earnings are beginning to be appreciated. Traditional free-to-air TV earnings now account for just over half of the group's total, down from 90% before the Fairfax merger. This partly shields Nine from the vagaries of TV advertising and ratings. The extraction of synergies from the Fairfax merger is also helping to offset external headwinds, with AUD 30 million incremental annualised cost benefits already banked and on track to reach AUD 50 million by the end of fiscal 2019. Viewed through this prism, it is not surprising management recently reiterated its AUD 420 to AUD 430 million proforma EBITDA guidance for fiscal 2019, in line with our AUD 427 million estimate on an equivalent basis, and up 11% from a year ago.

Critically, the transformation of no moat-rated Nine from a traditional advertising-dependent company to a digital-led, multi-revenue stream one is taking shape. Cash flows from legacy free-to-air TV (Nine) and media (Metropolitan Media, Radio) units are being reinvested to drive growth of digital businesses (9Now, Stan, Domain). The continued effective promotional power of the legacy units is also being leveraged to drive awareness and traffic to these new digital businesses. We therefore see Domain, Digital and Stan accounting for 52% of consolidated group earnings in five years' time, up from a forecast 24% in fiscal 2019 on a proforma basis. At current levels, we believe the earnings-reshaping story is reflected in Nine's stock price.

We are cognisant of the risks associated with integrating the Fairfax acquisition, especially in light of persistent cyclical and structural uncertainties. However, we like Nine's strong balance sheet which ended December 2018 with consolidated net debt/EBITDA of just 0.8. After the recent sale of Australian regional and community newspaper assets (for AUD 115 million) and the sports-events business (for AUD 31 million), coupled with continuing cash flows from underlying earnings, we expect the leverage ratio to fall further to 0.5 over the next three years.

In terms of our forecasts on a consolidated "reported" basis, we expect Nine to deliver continuing EBITDA of AUD 360 million in fiscal 2019, keeping in mind this includes just seven months' of earnings contribution from the recently acquired Fairfax assets. On a full proforma 12-month basis, our forecast EBITDA for fiscal 2019 is AUD 427 million, within management's guidance of AUD 420 to AUD 430 million. From this starting basis, we expect group EBITDA to reach AUD 529 million by fiscal 2023, equating to a CAGR of 5%.

Compositionally over the same timeframe, we expect the TV division to generate EBITDA CAGR of minus 6%, Metropolitan Media of minus 14% and flat for Radio. More than offsetting these declines are what we refer to as new-age digital properties. Exactly 59.2%-owned Domain is the second-biggest firm in the Australian real estate classified market, with considerable room for longer-term yield gains and audience/listings upside from exposure on Nine's national TV platform. We expect Domain to generate EBITDA CAGR of 15% between fiscal 2019 and fiscal 2023. The hub of Nine's Digital division is 9Now, a digital TV business that is growing at 50%-plus and commands a dominant 45% share of the fast-growing AUD 200 million broadcast video-on-demand market. We expect Nine Digital to generate EBITDA CAGR of 1% between fiscal 2019 and fiscal 2023. Stan is the second-biggest company in the Australian subscription video-on-demand market, with a subscriber base of 1.5 million that is still growing, thanks to its differentiated (and local original) content offering versus competitor Netflix. We expect Stan to turn from a pro-forma loss of AUD 33 million in fiscal 2019 to an EBITDA gain of AUD 70 million by fiscal 2023.