Sky has a dominant market position but rising costs curb its profit growth.
One of the major leisure activities in modern Britain is watching television; about 98% of all households have television sets which most of us watch for over 20 hours per week. However, we watch less TV than we used to because computer games and the internet are continuing to draw people away from their television sets.
30 years ago the television business was very simple; we had the state-owned BBC with its two channels and investors had but one option, ITV (LSE: ITV), which at that time was split into many regional companies. The increasing demand for advertising led to the launch of Channel 4 in 1982 and commercial television took arguably its greatest step forward in 1988 when British Satellite Broadcasting (BSB) was awarded a broadcast licence.
BSB began transmitting some 13 months after Rupert Murdoch's Sky Television was launched and, following a fierce battle, Sky and BSB merged in 1990 to form British Sky Broadcasting (LSE: BSY) which is more commonly known as "Sky."
Fast forward to 2009 and Sky is the dominant British commercial broadcaster whilst ITV, once considered to be a licence to print money, makes massive losses as its dominance of the TV advertising market continues to be eroded.
The March Of the Satellite Dishes
Many people consider that having a satellite dish on the side of the house is a sign of great vulgarity. To them satellite TV is only watched by the likes of Harry Enfield's Wayne and Waynetta Slob. This attitude was extremely common in the early days of satellite TV and persists to this day.
Of course, many of these people became converts when they saw the choice of programming on Sky, particularly for sports events, and today roughly one in three British households have Sky television. Even the former Prime Minister found it essential to have Sky Sports, though unlike the rest of us he can charge the taxpayer for his subscription!
A Look At The Finances
A major fear of investors, that satellite TV subscriptions would be cancelled in droves during the recession, has not materialised. Sky's annual report, published last June, showed that its subscription income had increased by over 11% in the previous twelve months. Clearly the British are reluctant to cut back on their home entertainment.
The figures below are taken from Sky's 2008-2009 accounts and show how the business has performed for the past five years.
| Year | 2009 | 2008 | 2007 | 2006 | 2005 |
|---|
| Diluted earnings per share | 14.8p | -7.3p | 28.2p | 30.1p | 30.2p |
| Dividend | 17.6p | 16.8p | 15.5p | 12.2p | 9.0p |
| Subscription income (£m) | 4,390 | 3,950 | 3,614 | 3,381 | 3,193 |
This table shows us that Sky's income from subscribers continues to grow whilst its profits have declined over a five year period. Note 3 to the 2009 accounts shows that Sky's fastest growing costs are for marketing and transmission, rather than programming, although some of these costs relate to Sky's recent expansion into the telephone and broadband markets. Sky has been spending heavily in order to attract new customers, as well as to retain existing ones, and this has depressed the profitability of its business.
Back in March 2000, at the height of the dotcom/IT bubble, Sky's shares peaked at over 2,150p, so with its share price currently hovering around the 575p mark shareholders have had a rough time since. However, you should remember that if you buy a company's shares you are getting a stake in its future rather than in its past.
Prospective investors should note that Sky's 3% dividend was not covered by its profits and that its shares sit on a high historic price-earnings ratio of almost 39 which assumes a fairly rosy future for the company. Sky's debts might scare off investors who focus on asset values as the 2009 balance sheet gives Sky a negative net asset value of minus £64 million.
Last month it was reported that more money was spent in Britain on internet advertising than on television advertising. Sky is protected from the worst of this change because most of its income comes from subscriptions; whilst ITV's predicament shows us that the combination of smaller audiences and cuts in advertising spending plays havoc with free-to-air television companies.
Sky released good first-quarter results last Friday showing that its quarterly diluted earnings per share increased by 74% to 7.3p. If this was replicated for the rest of the year, the 2010 earnings would be 25.7p putting the shares on a more reasonable PE ratio of 22.4.
Prospects
Sky is now the dominant player in the British Pay-TV market and the recent collapse of Setanta has further strengthened its position. Furthermore, Sky is all but guaranteed to receive a big boost in subscriber numbers once the analogue TV signal is switched off in 2012.
Shares only have a P/E ratio as high as Sky's where investors are expecting to see strong growth in earnings per share over the next few years and, whilst its last quarter's results were very good, past performance tells us that it's a debateable as to whether Sky's costs will grow at a slower rate than its income from subscriptions.
Whilst I've been a very satisfied Sky customer for almost 20 years I'd be reluctant to buy their shares at this price and prefer to remain as a consumer rather than becoming an investor.
More from Tony Luckett:
