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Morningstar | Is Sky the Limit for the New CEO?

The challenges facing Martin Stewart, the incoming chief executive officer of Sky Network Television, are considerable. He will be taking control of a company whose monopoly position in the New Zealand traditional pay-television space has been punctured by the increasing popularity of broadband-enabled, a la carte digital streaming services. It is a structural headwind that has seen Sky's EBITDA decline from a peak of NZD 380 million in fiscal 2015 to NZD 286 million in fiscal 2018, a fall that we project will continue until fiscal 2021 when EBITDA is forecast to settle at NZD 200 million.

Stewart's prior experience as CEO of pay-TV operator OSN in the Middle East, introducing cut-price content packages and rebranding over-the-top subscription video on demand, will come in handy. He will have to strike a delicate balance at Sky. On one hand, there is a need to maintain the traditional pay-TV service for heartland subscribers. On the other hand, he must evolve the business model to also cater to younger demographics' penchant for on-demand digital streaming. All this will necessitate a hit on average revenue per user for the sake of stemming overall subscriber losses.

The key issue is whether Stewart is content with the pace Sky has already set itself for this transition from a traditional linear, set-top-box-based pay-TV company to a digital, on-demand, multiplatform one. The key architect of the current strategic agenda, the long-serving CEO John Fellet, will remain on the board, and his interaction with Stewart on how Sky refines its future strategic moves will be critical. This is especially the case now, with the shares of no moat-rated Sky trading at a 24% discount to our NZD 2.50 fair value estimate (or AUD 2.40 at the current exchange rate), demonstrating investor uncertainties about how successful Sky will be in executing the transformation program.

We remain confident in our intrinsic assessment of Sky. Our NZD 2.50 fair value estimate assumes five-year forecast EBITDA and EPS compound annual growth rates of around 6%--an earnings profile we believe appropriately factors in the structural and operational risks facing the group. At the current price, the stock is trading at an enterprise value/EBITDA of just 4.1 and price/earnings of 8.2, while yielding 6.8% fully imputed. These valuation metrics imply a too-pessimistic view of Sky's future, especially a company with a solid balance sheet (net debt/EBITDA at 0.8 times, free cash flow at NZD 100 million-plus levels) and a still-dominant 768,000 subscriber base in New Zealand. We forecast Sky's subscriber base will settle at around the 750,000 level in two to three years' time before resuming growth on the back of a hybrid distribution model (set-top box, SVOD), albeit at a blended ARPU of NZD 70.06, down from NZD 76.34 in fiscal 2018.

Circling back to the new CEO and his interaction with the former chief, who will remain on the board, the one area Fellet will be of immense help to Stewart is in the content arena. During his 17-year tenure as CEO, Fellet has developed valuable relationships with many key content companies, making Sky the undisputed market leader in terms of quality and breadth of programming in New Zealand (especially sports). This is an important competitive advantage Stewart must maintain.

Finally, much has been made of Stewart's prior role as the chief financial officer and executive director of pay-TV juggernaut Sky plc in the United Kingdom. His contribution in Sky, doubling its subscriber base to 7 million during his tenure, is clearly impressive, as was his role in renewing the all-important English Premier League football broadcast rights. On the other hand, this was at a time when the competitive and structural landscape in pay TV was vastly different from what is it now, and Stewart resigned from Sky in 2004--a quaint time when broadband was really narrowband and Netflix was still predominantly a DVD mail-order rental service.