"People are giving up on Channel 9 and are basically saying those traditional media assets don't have any future value. I think that's being overly pessimistic."

Joseph Taylor: Hi Brian, so we've all been watching the Olympics on Nine but we're not here to talk about the Olympics today, we're here to talk about Nine Entertainment (ASX: NEC) and its stock. It's down about 30% so far this year. What's been going on? 

Brian Han: Joseph, I think the number one concern is the current advertising market recession and the fact that there is just a lack of any visible catalyst for a recovery in the near-term horizon. And it really doesn't help Joseph that Channel 9 is kicking its own goals too in terms of for instance some harassment claims against former senior executives, chairman resigning by running over some journalist and journalists striking over pay. And amidst all of that you have a CEO that's relaying Olympic torches in Paris. So all of that I think is contributing to the derating that's happening in the shares. 

Taylor: So, the optics in the recent past have been quite poor perhaps. But in your research you mentioned that Nine has been on a journey from its legacy advertisement driven business to one that's more digital led and has more diverse revenue streams. What does that look like and how is it going? 

Han: Yeah Joseph, so in late 2018 before they merged with Fairfax, a significant amount of earnings were from mainly the free to air TV business and I believe only just over 30% of their earnings were from digital sources, digital assets. Fast forward to now after many years of transformation and synergy extraction over half in fact more than, way more than half of its earnings are from these digital assets. And that free to air TV business which so many people identify Nine Entertainment with, they only generate about 20% of group earnings from that free to air TV business. So you have a business that's got 6 different units now. Each of these units has a pretty strong market position and that includes STAN which might not be the biggest competing against Amazon and Netflix and all of that. But still it's carved out a really profitable niche in that competitive subscription streaming industry. So in about three to five years time we see those digital earnings probably generating more than 60% of group earnings. So that's where the journey has come from and that's where the journey is going. 

"Advertising markets are in a funk right now, but I think Nine is probably the most strongly positioned in terms of having that balance sheet flexibility."

Taylor: Great, so you mentioned Stan there and Nine also owns assets like the AFR, Sydney Morning Herald and also 60% of Domain (ASX: DHG), the property listing website. Those seem like quite attractive assets in a way, but you don't give the company as a whole a moat yet. What's behind that? 

Han: Yeah the first thing to say Joseph is that we do think Domain has pretty moat worthy assets but Nine Entertainment only owns 60% of it. Rest of the businesses I think they are solid assets but they are in that media and entertainment industry and I think it will take a brave man to say that will have durable competitive advantages over the next decade in that area because, as you know, technology is moving so fast and its disruptive forces are only accumulating as we go on. So we just don't think over the long term there's any sustainable competitive advantage to any of those media assets. 

Taylor: So you said there's been a lot of technological disruption to the legacy businesses. A big example of that is obviously newspapers. Is there a silver lining there? 

Han: I think so because if you look at say AFR, Sydney Morning Herald and The Age about 30% of their earnings are from digital sources in terms of digital advertising and banner advertising and another 30% is from digital subscription and licensing. So all those digital centric revenues are actually offsetting the decline in the traditional advertising we associate with newspapers. And I think there's more things to come in terms of management, perhaps better monetizing the premium audience demographics of these markets. 

"There are people saying that perhaps we should break up 9Now. We think that's rubbish."

Taylor: Earlier you talked about some of the things that are under Nine's control haven't been going so well recently in terms of optics. But in terms of other areas of the business that Nine can control things like the balance sheet, you're a little bit more positive on those.

Han: Yeah, so it's interesting you mentioned balance sheet Joseph because we know the advertising markets is in a bit of a funk right now, but out of all the media companies, I think Nine is probably the most strongly positioned in terms of having that balance sheet flexibility. So if the advertising recession goes on for much longer than we expect, it certainly has the balance sheet to withstand it and come out on the other side. And then the second thing to note there Joseph is that yes, the content costs are going up, but they are leveraging those expensive contents better across all of its media assets. So Joseph, you talked about the Olympics that we currently seeing right now, you'll notice that Channel 9 is basically leveraging that Olympic content, not just on TV, but on 9Now, on all their newspapers, on the radio and even Stan Sports. So that's how they're leveraging the expensive content costs. When it comes to non-content costs, they are using technology to improve operating efficiency. And of course, they are also trying to perhaps reconfigure their staff and workforce. And that's probably one of the reasons why, we had that recent strike by the journalists. So they are doing what they can in terms of things that are within their control. And I think they're doing pretty well. 

Taylor: And the headline on your research on this company mentions the possibility for corporate interest. Do you want to expand on that a little bit? 

Han: Yes, as I said before, Joseph, I think the share price is significantly undervalued compared to what we think Channel 9 is worth intrinsically. So for instance, if you take our Channel 9's 60% interest in Domain, at Domain's current share price, you have the rest of the business trading at very, very low multiples, basically people giving up on Channel 9, those traditional media assets having any future value. And I think that's being overly pessimistic. Now but then that leads us to another point. Joseph, I know that there are people saying that perhaps we should break up 9Now. We don't believe in that at all. We think that's rubbish. And we think most of that emanates from basically investment bankers and short-term investors. Because remember, these are the same people three years ago that encouraged Channel 9 to buy Fairfax. Now, who is to say three years down the track, they won't tell Channel 9 to merge again with these assets that they encouraged them to break up. All this is distraction. All we need is that advertising market to recover. And that'll provide the incentive for people to revisit the stock in terms of its fundamentals. And once they do that, I think people will realize that the shares are pretty cheap compared to what these assets are worth in the open market.

Nine Entertainment ★★★★★

  • Economic moat: None
  • Fair Value estimate: $2.70 per share
  • Share price on August 9: $1.37
  • Uncertainty: High

Morningstar Investor users can read Brian Han's full analysis of Nine Entertainment here.

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Terms used in this interview

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.