The potential takeover of Ten Network Holdings Limited (ASX: TEN) is top of mind for investors speculating on corporate activity in the media sector, but this isn't the only deal we are likely to see this year.
I suspect Australia's largest advertising and marketing services company, STW Communications Group Ltd. (ASX: SGN), could also become a target with its share price falling 1.7% to a three-year low of 89.5 cents during lunch time trade.
The stock is one of the worst performers in the sector with a 40% crash in the past year compared with a flat return for the S&P/ASX 200 Cons Disc (Index: ^AXDJ) (ASX: XDJ).
The stock may look cheap on my estimates with a 2014-15 forecast price-earnings (P/E) multiple of 7.3 times and 12-month trailing yield of around 10% before franking, but the market thinks STW Communications is a value trap – meaning the stock only looks cheap on the surface.
The de-rating in the stock is part management's fault and part operating environment. The persistent weakness in the advertising market has been a drag, but shareholders have not forgiven management for two shock profit downgrades last year.
At its half year result in August, the group said it was expecting low single digit earnings growth for 2014 after including the acquisition of Australian Display Group (its financial year is the same as the calendar year) compared with earlier statements that full-year earnings would grow at low single digits before any acquisitions.
Then in December, management said net profit would actually dip to between $47 million and $49 million compared with 2013's net profit of $49.5 million.
STW Communication's largest shareholder, Cavendish Square Holdings (a subsidiary of London-listed advertising giant WPP) has been steadily buying stock and currently owns around 22% of the group.
There has been speculation for some years that it was only a matter of time before WPP made a full takeover bid and the stars could be aligning this year for such a deal.
It won't be only STW Communications' depressed valuation and loss of management credibility that would make the group an enticing target. The low cost of debt and the weak outlook for the Australian dollar will also make it easier for such a transaction to be earnings accretive to WPP.
Swallowing the Australian group would be a fairly easy exercise too given WPP's £18 billion ($A33.7 billion) market cap versus STW Communications' $377 million market weight.
My only concern is that STW Communications pursues acquisitions as a way to ward off a bid.
