How do the pay TV providers compare?
For a digital company, it generates a whole lot of junk paper mail – at least if the Reading household letterbox is at all representative. But that's the price of Virgin Media's (LSE: VMED) full-on attack on British Sky Broadcasting's (LSE: BSY) customer base.
For TV and internet subscribers, it looks like a credible alternative. But as an investment, the rather obscure Virgin Media, with its primary listing on NASDAQ, is much less well known. Is it a viable play on the digital revolution? How do Sky and Virgin compare when it comes to investment?
Sky's familiarity with investors strayed close to notoriety last year when 39% shareholder News Corp (NASDAQ: NWS.US) tabled a bid and then withdrew it as the phone-hacking scandal broke over its UK newspaper operations. Sky's shares dropped some 20% as the bid premium evaporated.
Whatever ultimately happens with News Corp's stake, Sky has a decent franchise as an independent company. Originally created by the merger of struggling satellite broadcasting competitors Sky Television and British Satellite Broadcasting in 1990, advancing technology has transformed its activities.
The core of Sky's business is pay TV. It is the largest pay TV operator in Europe, with over 10 million customers (i.e. households), distributing 26 of its own channels and 160 third-party channels in the UK and Ireland.
It has always been a content-driven company, with rights to sports events explicitly used to drive up subscriber numbers. New technology is being exploited to boost average revenue per subscriber, including high-definition TV, video on demand and mobile applications. A quarter of customers take broadband and fixed-line telephone packages along with TV.
In contrast, Virgin -- formed from the merger of cable companies NTL and Telewest in 2006 -- is infrastructure-led. Its services are delivered through its fibre-optic cable network, making it much easier to sell bundled services including fixed-line telephone and broadband. Its superior broadband speeds of 10MB, 20MB, 30MB, 50MB and 100MB in parts of the country compared to Sky's 20MB appeals to a customer base that Virgin describes as "tech savvy and data hungry". What's more, Virgin today announced plans to at least double these first four speeds as well as increase its top speed from 100MB to a whopping 120MB, enamouring it yet further to both current and potential customers.
Ownership of Virgin Mobile also presents opportunities to cross-sell across four core technologies of mobile, fixed line, TV and broadband -- though revenues from mobile are relatively low.
Virgin has pulled out of content provision. It sold its TV production to Sky in 2010, and more recently sold its share in broadcaster UKTV. It delivers Sky's channels, including sport and movies, on terms largely dictated by Ofcom and the Competition Commission, which is the source of constant low-level friction between the two companies.
Virgin has about five million cable customers, half that of Sky, with a slightly higher average revenue per user of £48 per month.
How do they stack up as investments? Both companies have completed a period of massive debt-financed investment and are now at the stage of building their customer bases -- with Sky somewhat ahead. Although they come at it from different angles, the two companies are fighting over the same territory of family home-entertainment packages: hence Virgin's fierce attack on Sky's customers.
However, there is no comfortable duopoly as both companies face competition from fixed-line incumbent BT Group (LSE: BT-A), which is building its own super-fast broadband network, and video-on-demand providers such as Amazon's LOVEFiLM, the US's Netflix, HMV (LSE: HMV) and even Tesco (LSE: TSCO).
Quite what the shape of the home-entertainment industry will eventually look like is unclear. To me, that spells danger. What I find most troubling about technology is the difficulty in predicting what will take off among consumers -- I'm quite sure I would have backed the technologically superior Betamax over VHS. But for those with a better finger on the pulse of consumer products, now is a good entry point for picking winners.
Both Sky and Virgin are now throwing off prodigious amounts of cash, though Virgin has yet to achieve consistent profitability and made a small loss in the last quarter after a hefty depreciation charge.
|Quarter ended 30 Sept 2011||Sky||Virgin|
|Free cash flow||£96m||£136m|
Both companies are engaged in share buy-back programmes -- in Virgin's case, despite heavy reliance on debt funding, it is planning to repurchase £250m of stock out of its £4.3bn market cap. It is on track to bring its debt to EBITDA down from the current 3.4 to a target 3.0, but with shareholders' funds carrying a massive accumulated deficit, the £5.7bn of net debt makes balance sheet gearing 690%: a scary level for those of us old-fashioned enough to think such measures still matter. Sky's gearing is a more palatable (given its cash flow) 136%.
Both companies are well placed in the home-entertainment industry and, though it may not be entirely recession-proof, it should prove quite resilient. But will Virgin's superior and more flexible fibre-optic infrastructure beat Sky's content-driven approach -- or vice versa? I have an open mind. What do you think?
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