QUALIPORT
ITV's Best Kept Secret

By Maynard Paton (TMFMayn)
March 18, 2002

Carburton Street, London -- Commercial television is an attractive 'consumer franchise' industry for long-term investors. The sector is both simple to understand and highly visible, with competitors scarce in number and new entrants few and far between.

Within the industry, Qualiport watch list member Ulster Television (LSE: UTV) is by far the most attractive operator. Unlike Granada (LSE: GAA) and Carlton Communications (LSE: CCM), Ulster isn't pouring millions down an underperforming digital drain. SMG (LSE: SMG), a relatively aggressive media firm that owns two Scottish ITV franchises, is suffering from excessive debt and has recently cut its dividend. The fast growing British Sky Broadcasting (LSE: BSY) is forecast to return to profit the year after next, although the shares (at 774p) trade on a forward price to earnings ratio of 70.

Ulster Television operates the ITV television franchise for Northern Ireland (it having held the license since 1959). With rivals including the Republic of Ireland's RTE and TV3 channels, Ulster operates in ITV's most competitive region. However, it remains the strongest of all ITV broadcasters, with viewing figures well ahead of the ITV average, BBC Northern Ireland and Channel 4 (ITV's nearest commercial rival).

Today's annual results from Ulster highlight the group's solid nature, as well as its progress in non-television areas.

Results

Year ending 31st December        1997    1998    1999    2000    2001 

Turnover (£m)                    34.8    37.2    38.3    40.8    43.0  
Operating profit* (£m)            7.3     8.3    11.9    13.4    13.6 
Exceptional items                   0     2.4    (4.8)   13.3       0 
Pre-tax profit (£m)               8.3    12.5     7.8    27.3    13.4 

Earnings per share* (p)           9.7    10.6    16.0    18.3    18.4 
Dividend per share (p)            5.7     6.3     7.5     8.7     9.2 
Special dividend per share (p)      -       -       -    35.0       -

(* excludes goodwill) 

Overall, Ulster put in a rather flat profit performance for 2001. The purchase of County Media (owner of Cork's predominant radio station), combined with Ulster's Internet businness achieving profitability during the second half, offset the advertising difficulties experienced at the group's core television business.

* Television: Although revenues slumped 6% to £37.6m, a bias towards regional advertising insulated the group from the 13.5% decrease experienced by the overall ITV network. While operating profits fell from £14.3m to £12.4m, operating margins remain at a fantastic 33%.

* Radio: After its £25m purchase in April, County Media chipped in an operating profit of £1.4m. The calendar year saw the radio station generate £1.8m.

* Internet: Following its £4m purchase during March 2000, Direct Net Access reported a full-year operating loss of £0.23m for 2001. However, Northern Ireland's largest Internet Service Provider generated a £0.15m operating profit in the second half as the service expanded into the Irish Republic.

Cash flow & ROE

Ulster's latest results also reaffirm the group's attractive cash flow profile:

Year ending 31st December       1997    1998    1999    2000    2001 

Operating profit* (£m)           7.3     8.3    11.9    13.4    13.6 
Change in working capital (£m)     -     1.3    (2.9)   (2.1)   (2.3) 

Depreciation (£m)                1.3     1.0     1.1     1.3     1.5 
Net capital expenditure (£m)    (0.8)   (1.5)   (2.0)   (1.8)   (0.9) 

Although £2-3m has been absorbed into working capital during recent years, this outflow is counterbalanced by Ulster's very low requirement for fixed assets. Indeed, the company managed to produce an operating profit of £13.5m from fixed assets of just £7.3m in 2001. Over the past five years, net capital expenditure has exceeded the depreciation charge by just 12%.

On the return on equity front, Ulster continues to report attractive figures. Between 1996 and 2001, earnings improved from £4.7m to £9.7m. Over the same time, the equity base (adjusted for goodwill) has expanded from £12.7m to £24.5m. The resulting incremental return on equity comes to a magnificent 43%. Underpinning this performance are two special dividends, a £10.5m payout in 1995 and an £18.4m payout in 2000. More than anything, it is these payments that highlight the cash generative nature of the core television operation.

Summary and valuation

While Ulster is an attractive business, its future encompasses two notable risks:

* Declining market share: As discussed in this article, ITV had a terrible 2001. Ulster stated today that its peak-time viewing share "was 37.3%, well ahead of the ITV network average of 34.8%". However, 2000 saw Ulster having a 41% peak-time share, with ITV as a whole having 37%. So, can ITV recover?

* Acquisitive management: After serving 10 years as Ulster's General Manager, John McCann was appointed Managing Director in October 1999. Helped by Jim Downey (installed as Finance Director in November 2000), McCann has quickly diversified Ulster from its traditional television stronghold. Nearly £30m has been spent on acquisitions over the past two years, with very little to show for it so far.

That said, a welcome note of caution was expressed in today's statement. The group admitted to having considered "a number of possible radio acquisitions in the UK but each time have concluded that the valuation being commanded for appropriate assets could not have enhanced value for our shareholders".

Through a consortium, Ulster has recently applied for its first local radio licence in the UK. But overall, the jury remains out on the acquisitive and expansion talents of boardroom.

In terms of valuation, if you assume the following in 2002...

* Television revenues decline 2%, in line with Ulster's 2002 first quarter performance;
* Television costs remain static;
* Radio generates an operating profit of £2m;
* Internet generates an operating profit of £0.5m;
* Capital expenditure is 12% higher than depreciation;
* Net interest payments of £0.5m result from the current net debt of £10.7m, and;
* Tax is charged at 30%

... then Ulster's prospective free cash flow comes to 17.45p per share. With Ulster shares at 362p, the shares offer a prospective free cash flow yield of 4.8%. Weighing up all the pros and cons, a share price of 235p (equating to a free cash flow yield of 7.5%) would attract the Qualiport.

More: Eyeing Up ITV | Ulster Television Interim Review | Ulster Television discussion board