Uncertainty hits ‘extreme’ at Seven West Media

No moat, precarious debt levels, weak earnings, intensifying competition, a poor stewardship rating and now the ignominy of being the only company under Morningstar coverage with an uncertainty rating of "extreme".

And it’s trading at a 60 per cent discount to Morningstar’s fair value estimate. The company in question is Seven West Media (ASX: SWM) and the outlook is grim, according to Morningstar analyst Brian Han, who recently turned the uncertainty dial on SWM from “very high” to “extreme”.

“The time has come to consider the possibility of there being no value in Seven equity,” says Han, who has cut his fair value by 56 per cent to 20 cents a share.

“We are prepared to assign a 50 per cent probability to this scenario.”

Not since Morningstar ceased coverage of beleaguered law firm Slater & Gordon in March 2017 has a stock under coverage carried an “extreme” uncertainty rating, which measures the predictability of a company's cash flows.

And it’s quite a comedown from the heady days in 2007 when the share price was pushing toward $14 as the ad dollars rolled in and the global financial crisis had yet to register on the radar of media proprietors.

Seven West Media (SWM) MAX

Source: Morningstar

Fast forward to 2020, and the coronavirus has heaped more woe on Seven West Media, which was already struggling because of a decline in television ad revenue and mounting debt.

“There is no hiding for Seven from the severe revenue pressure due to the coronavirus-induced slump in the advertising market,” says Han.

Seven West Media's assets include the Seven Network and the Seven Studios, as well as its print mastheads The West Australian and The Sunday Times. Seven West Media is also the broadcast partner of the Australian Football League, Cricket Australia and the Olympics.

The cancellation of marquee sporting events such as the Tokyo Olympics and the AFL has consquently clouded the forecast.

“While TV revenue market fell only 8 per cent in the March quarter, the real damage will begin from the current June quarter and likely to the tune of a 40 per cent-plus decline.

“Reduced TV rights payments for suspended sports (Olympics, AFL) provide some relief. However, there is no hiding from the severe revenue pressure, compounded by the absence of a sports-anchored promotional platform to lift ratings.”

And that hit to earnings throws into even starker relief the company’s debt pile, which Han says has reached a “precarious” level.

The pandemic's impact on earnings has substantially elevated Han’s concerns about Seven's $540 million in net debt, which dwarfs its market capitalisation of $130 million.

Han now forecasts the group's net debt/EBITDA to be about 3.3 for fiscal 2020 and fiscal 2021, up from 2.4 at the end of December 2019.

“If Seven survives the pandemic,” Han says, “an investment in Seven West Media requires weighing the strong positioning of its Seven Network division in Australian free-to-air television against the structural challenges facing the industry from proliferating competition for viewers and advertising dollars.

“We anticipate competitive intensity continuing, preventing any sustained improvement in Seven Network's margins.”

And that’s not to mention the structural suffocation of its newspaper assets, which continue to suffer from the move to online offerings.

“Free-to-air television's traditional strength of aggregating mass audience is waning, forcing advertisers to follow eyeballs elsewhere,” Han says.

“While the networks tout their declining viewers as still the biggest mass audience available in a fragmenting world, such an argument is unlikely to hold longer term. Worse still, costs of marquee content are escalating.

“This is due to increasing competition, not just from fellow competitors in the free-to-air industry keen to minimise the pace of viewer migration, but also from new media distribution channels hell-bent on signing up new subscribers.”

Stewardship: poor capital allocation

Morningstar measures stewardship largely on the strength of capital allocation, and on that score the performance of Seven West Media, which is 40.9 per cent owned by Kerry Stokes, has been mixed.

“While Stokes is an astute executive and one of the most respected business people in Australia, Seven West Media's capital-allocation track record has been mixed,” Han says.

The example he cites is West Australian Newspapers' 2011 acquisition of Seven Media Group, a media company which was owned at the time by private equity interest and Seven Group, another group controlled by Stokes.

“This was a related-party transaction as Seven Group also owned a 24 per cent interest in West Australian Newspapers and the combined entity became Seven West Media. It is now a company that has a material exposure to the structurally challenged print media industry.”

SWM fell 3.6 per cent on Thursday to close at 8 cents.