The share price slump among broadcast stocks is creating ideal conditions for a media merger frenzy in the sector with speculation that Southern Cross Media Group Ltd (ASX: SXL) could be next to fall into the crosshairs of a bidder.
The radio and television operator has hired advisory firm Luminis to help it defend against takeovers and to evaluate its options, according to The Australian.
The move comes in the wake of Southern Cross' 11% slide in its share price and pay-TV operator Foxtel's $77 million investment in Ten Network Holdings Limited (ASX: TEN) ahead of an expected move by the federal government to relax media ownership restrictions in this country.
It's almost a given that Ten Network will be one of the first to be swallowed by a larger rival and its recent share price rally reflects this view.
The big underperformance of Southern Cross, Seven West Media Ltd (ASX: SWM) and Nine Entertainment Co Holdings Ltd (ASX: NEC) compared to the S&P/ASX 200 Consumer Discretionary Index (Index: ^AXDJ) (ASX: XDJ) is putting pressure on these broadcasters to consolidate. Media stocks form part of the consumer discretionary index.
Relatively high debt levels and a shift in advertising dollars away from free-to-air television to the net are forcing the painful de-rating of the sector.
We have seen this before haven't we? These were essentially the same problems newspaper publisher Fairfax Media Limited (ASX: FXJ) had a couple of years ago when its share price slumped to under 40 cents in 2012 from over $4 a share just five years earlier.
Nobody would touch Fairfax then, except for mining magnate Gina Rinehart who was trying to control the company, and the experience showed that it's too early to predict the demise of the broadcasters.
What's more broadcasters are attracting far greater merger and acquisition interest than Fairfax during its darkest days.
However, those looking to snag a bargain in the broadcast sector will have to keep an eye on three things before pressing the "buy" button.
- Only buy a broadcaster with a clear strategy to materially lower its gearing ratio;
- Target companies that can operate on a cash flow positive basis. Don't be too concerned about net profit as these companies will probably have to make more writedowns before they see light at the end of the tunnel as Fairfax did;
- Wait for stocks to trade on a one-year forward price-earnings multiple that's close to 6x. But you need to be reasonably confident in the earnings forecast.
Southern Cross could repay debt if it sold its radio assets and it could lift the performance of its regional TV business if it switched its partnership to Nine Entertainment from Ten Networks as the former has better content.
However, the stock needs to fall by around 40% before I think the risks justify the rewards; while I would stay away from Nine Entertainment for now at least.
Seven Media is the only one that looks interesting to me from a valuation perspective, although you'd require lots of patience and a strong stomach for volatility to buy the stock.
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