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QUALIPORT
By
Scottish Radio Holdings (LSE: SRH) is a bonny wee business. The company has a dominant position in local radio and newspapers, two markets where new, groundbreaking entrants are traditionally few and far between. Although the management's acquisition strategy raises questions, the inherent qualities of the underlying business should rescue long-term shareholders from any boardroom hiccup. The business Scottish Radio is a media group with interests in commercial radio broadcasting and local newspaper publishing. The company's history can be traced back to 1974, when Glasgow-based Radio Clyde was formed. Radio Clyde subsequently merged with Edinburgh counterpart Radio Forth in 1991 to create Scottish Radio. The company branched out into newspaper publishing in 1995 and also moved into (and subsequently out of) outdoor billboard advertising in 1999. As well as continuing to buy other radio stations, the diversifications were also driven by acquisition. Based throughout Scotland and Northern Ireland, Scottish Radio's 15 analogue radio stations all enjoy market-leading positions in their respective transmission areas. The following table highlights the dominance of the company's major stations. Scottish Radio also publishes 40 weekly newspapers in Scotland, Northern Ireland and the Irish Republic. Titles in the Scottish Radio stable include the likes of the Ballymena Times, Tipperary Star and Brechin Advertiser. Over the past seven years, Scottish Radio has spent a net £47.2m on acquiring various papers, the largest being the £24.3m purchase of Kilkenny People two years ago. While the move into newspapers has been without problem, Scottish Radio's venture into outdoor advertising has been an abject failure. Between March 1999 and April 2001, the group spent £61.9m on seven hoarding companies. However, the slump in advertising has (as shown in the company's latest interim results) turned this operation into a loss maker. Scottish Radio sold the poster business earlier this year and the disposal will result in a £22m write off in the next annual accounts. The financials
Here's Scottish Radio's five-year financial record: The results for fiscal 2001 showed underlying operating profits dropping from £18.6m to £14.8m. A deteriorating advertising market saw Radio profits down £1.9m to £11.1m and Outdoor profits £1.7m down to just £0.6m. Acquisitions in the prior year helped underlying Newspaper profits edge £0.4m higher to £5.6m. In terms of continuing operations, for the year ending September 2001, Scottish Radio's split of underlying contributions from Radio and Newspapers was roughly 60:40 in favour of Radio. Even in a relatively tough year, Radio managed to generate a 32% operating margin while Newspapers registered a 25% underlying margin. Such performances are certainly evidence of a media 'franchise' in operation. Although the company overspent on its poster activities, Scottish Radio did not jump heavily onto the Internet bandwagon. The past three financial years has seen Scottish Radio spend a net total of just £1.2m on Internet and digital activities. Cash flow and ROE Scottish Radio's working capital throws up few worries. Around 10% of operating profit is absorbed into stock, debtors and creditors on average each year. For a company that has more than doubled its size over the past five years or so, such cash outflows are relatively minor. There's no problem with undue capital expenditure either. Over the past eight years, net expense on tangible assets has undershot the cumulative depreciation change by 4%. The lack of working capital and fixed assets hasn't translated in to a high incremental return on equity figure though. Since September 1994, Scottish Radio's acquisition spree (6 radio purchases totalling £72.8m, 7 newspaper purchases totalling £47.2m and 7 billboard purchases totalling £61.9m) caused the group's intangible assets to balloon from £6.5m to £109.2m. Over the same seven years, Scottish Radio's asset base (adjusted for goodwill) has swelled from £16.0m to £140.0m while earnings went from £2.8m to £10.2m. The resultant incremental return on equity comes to a miserable 6.0% ((£10.2m - £2.8m)/(£140.0m - £16.0m)). Having spent over £60m for sub-£1m annual profits, the poor reinvestment performance obviously comes from the Outdoor venture. Between 1994 and 1999 (prior to the billboard purchases), the incremental return on equity was 25.5%. With the acquisitive history, getting an accurate grip on the comparative reinvestment performances of the Radio and Newspaper divisions is difficult. Probably the best assessment is by taxing the latest full-year divisional operating profit and dividing it by the divisional net assets employed, which gives reinvestment performances of 27% for Radio and 10% for Newspapers. Valuation and summary
Scottish Radio has many attractive shareholder features. It's a simple, straightforward business with a dominant position in various media markets. High margins plus low current and fixed asset requirements suggest the company can inherently generate high returns on shareholders' equity. The major worry concerning Scottish Radio is the management's liking for corporate activity. The boardroom effectively wasted up to £22m on its billboard business and nearly paid 78 times historic earnings (or £116m) in cash for Border Television during March 2000. Thankfully for shareholders, Capital Radio (LSE: CAP) outbid Scottish Radio and purchased Border for 107(!) times historic earnings. Although not exactly mismanaging a franchise, prospective investors will hope Scottish Radio's boardroom has learnt its lesson.
That said, Scottish Radio's management aren't alone in overpaying for their investments. The past year or two has witnessed SMG (LSE: SMG) buy 29.5% of Scottish Radio and DC Thomson increasing its stake from 4.6% to 10.5%. However, both SMG and Thomson have since seen their holdings slump 60% in value. With a relaxation of media ownership rules in the offing, Scottish Radio's niche position in the overall sector is likely to prompt a predator sooner or later. At 591p per share, Scottish Radio shares stand on a historic price to earnings ratio of 21.1. With earnings a genuine proxy for free cash, the continuing radio and newspaper business generated free cash flow of 31.0p per share during the twelve months ending March 2002. Furthermore, proceeds of £33m from the sale of the Outdoor operation will offset current net debt of £14m, leaving 57p per share cash. All that means the shares offer a prospective free cash flow yield of 5.6% -- no obvious bargain. On balance, the great financial and operational characteristics of commercial radio and local newspapers, plus a possible takeover bonus, offset any doubts over management talent. A share price of 475p, equating to a free cash flow yield of 7.5%, would make an attractive entry price.Station Area Market share of commercial listening
(%)
Radio Clyde Glasgow 52.4
Radio Forth Edinburgh 32.2
Radio Tay Dundee 66.9
Northsound Aberdeen 72.4
Westsound Ayrshire 71.4
Moray Firth Inverness 83.6
Radio Borders The borders 85.2
CFM Carlisle 78.5
Year to September 30th 1997 1998 1999 2000 2001
Turnover (£m) 37.4 43.8 55.1 71.7 79.8
Operating profit (£m) 9.4 12.5 16.8 18.6 13.7
Pre-tax profit (£m) 9.3 12.1 15.7 20.0 14.8
Earnings per share (p) 23.0 29.0 41.1 44.6 27.9
Dividend per share (p) 9.4 11.3 13.6 16.0 17.5
(all figures adjusted for goodwill)
Year to September 30th 1997 1998 1999 2000 2001
Operating profit (£m) 9.4 12.5 16.8 18.6 13.7
Change in working
capital (£m) (1.8) 1.1 (4.3) (1.8) (0.9)
Depreciation (£m) 1.4 1.3 1.7 2.0 2.5
Net capital
expenditure (£m) (0.7) (0.8) (1.1) (2.8) (2.9)