After coming under severe pressure from BT with regard to football rights, Sky (LSE: BSY) has responded in two ways. Firstly, it has developed its content and focused on offering customers a more exclusive product, with Sky commissioning various programmes that are not available anywhere else. Its investment in Love Productions last week is further evidence of its commitment to this strategy.
Secondly, Sky is set to acquire Sky Italia and Sky Deutschland to create a bigger, more powerful company that can more easily compete with the likes of BT for sports rights. This could prove to be crucial for Sky, as sports rights remain a key part of its offering and a key differentiator between it and many of its peers.
However, does Sky have the financial firepower to pull off such large deals and can it really conquer Europe?
An interesting aspect of Sky’s finances is the fact that it has a relatively small amount of net assets. Indeed, Sky has just over £1bn of net assets, which means that it currently trades on a price to book value ratio of 14.4, which is very high. The low amount of net assets also means that other ratios are skewed, such as the debt to equity ratio which stands at an insanely high 249%. Going off this measure alone would lead an investor to think that Sky has over-leveraged its balance sheet and should definitely not be pursuing more acquisitions.
However, this doesn’t paint the full picture. A more relevant measure of Sky’s financial standing and, more specifically, of its capacity to service its debts is the interest coverage ratio. This divides operating profit by net interest charges to provide a clear picture of how many times a company could have paid the interest on its debt in the most recent year. For Sky, the ratio stands at 10.2, which is very healthy. Indeed, it shows that Sky, even when interest rates rise, could afford to extend its current level of borrowings and make further acquisitions so as to bolster its competitive position when bidding for sports rights.
Of course, being able to make acquisitions and actually making them are two different things. Certainly, Sky now has vast exposure to Europe, which is a strategy that may take some time to pay off. That’s because the European economy continues to show only anaemic levels of growth and, moreover, it could take time for it to do much more after having failed to recapitalise its banking sector to the same extent as the US and UK have.
However, the long term potential is vast. Sky has purchased high quality assets for what appears to be a very fair price. Further acquisitions could be on the cards, with Sky having the financial muscle to make them happen. A new, bigger Sky could thwart challengers and maintain its dominance not just in the UK, but across Europe, too.
Peter Stephens has no position in any shares mentioned. The Motley Fool recommends British Sky Broadcasting.