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Is it time to sell your media shares?

On 1 March 2016, Communications Minister Mitch Fifield announced media reform measures designed to increase competition in the media industry. Broadly, the measures intend to scrap existing rules which limit any one media company’s ability to control or broadcast across multiple regions within Australia.

What are the changes?

The measures announced by the Turnbull government seek to abolish the “75% reach rule” and the “two out of three” rule.

The 75% reach rule

The 75% reach rule restricts a company’s ability to broadcast to more than 75% of the national population of Australia. The practical effect of these rules gave rise to a delineation of commercial metropolitan networks, such as Nine Entertainment Co Holdings Ltd (ASX: NEC), Ten Network Holdings Limited (ASX: TEN) and Seven West Media Ltd (ASX: SWM) from regional network providers such as Prime Media Group Limited (ASX: PRT) and Southern Cross Media Group Ltd (ASX: SXL).

Two out of three rule

The two out of three rule was introduced to prevent a single company from controlling no more than two media platforms out of the three media platforms: commercial radio, commercial television and print (within the same licence area). This rule effectively meant companies like News CDIS (ASX: NWS) and Fairfax Media Limited (ASX: FXJ) were restricted in the media platforms they could control in a given region.

Why does it matter?

The proposed changes imply that merger and acquisition (M&A) activity will ramp up within the media sector, as industry-wide consolidation becomes inevitable.

Natural synergies mean a marriage between regional and metropolitan networks is an obvious outcome. Nine Entertainment Co already appears attuned to these benefits, given its acquisition of a 9.99% stake in Southern Cross Media two weeks after the government’s announcement. Accordingly, regional media stocks like Prime Media and Southern Cross Media appear key takeover targets.

Another likely result is cross-media ownership. Companies like Fairfax Media and APN News and Media Limited (ASX: APN) benefit from the removal of the two out of three rule. As such, it is likely that they will look for potential suitors in the commercial television space to expand their media reach. I believe Seven West Media, Nine Entertainment and Ten Network would be prime candidates for a potential tie-up with conventional print media companies, implying potential benefits to shareholders if a deal ensues.

Foolish takeaway

Long-term investments should not be made on speculation of M&A activity. Instead, investors are better served focussing on the underlying business models of a particular industry and selecting a few stocks to buy for profitable growth.

Whilst reform to media laws could result in some big winners (and losers), the industry remains primed for disruption by other unconventional media sources (like Facebook, Twitter and Google).

Therefore, although the media industry may benefit in the short-term through consolidation, in my opinion, the industry is unlikely to experience the growth and profitability of years gone. Accordingly, I would stay away from the media sector for now.

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Motley Fool contributor Rachit Dudhwala has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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