If we were to travel back in time five years knowing all the changes that were to sweep through the entertainment business, would we think that Sky’s business would be up, down, or flat by 2016? 1 in 4 UK households currently subscribe to Netflix. Even the most optimistic forecast would probably conclude that Sky’s growth would have flattened by now…but it hasn’t.
Revenue grew 5% in the first nine months YoY, in-line with the past few years. Profit has been shrinking but Sky announced progress today with 12% growth. Shares are down 4%, this is hard to understand. Maybe analysts were expecting more profit growth but today’s results look good against the past few years. This doesn’t look like a business struggling to cope with a new world.
The economics of the media business help: customers are very sticky. Sky’s triple-play package (phone, TV, broadband) has extended this stickiness into new categories. In addition, Sky has no serious competition for the rights to most sporting events or the first window for movies. How much is this position worth?
The forward EPS multiple, based on analyst consensus, is ~16x suggesting investors attach significant value to this position. Given how resilient Sky has been, I am inclined to agree. The German and Italian businesses have room to improve profitability too.
Even if we take all this for granted, it is hard to ignore the change sweeping the industry. Most analysts diagnose the threat simply as Netflix, Sky’s CEO has done so this morning, but the truth is more complicated: the threat is a dramatic reduction in distribution costs.
Ten years ago, it was difficult to gain access to your TV. The technology was complex, you needed a big distributor like Sky. Even though Sky was often negotiating with huge producers, they realised that they needed Sky at least as much as Sky needed them.
Today, the industry is very different. Most TVs can be accessed from the internet. Distributors are still creating platforms for producers but the tech is comparatively simple. The cost of creating that platform is, therefore, down significantly. For example, Netflix’s SGA costs are about half of Sky UK, despite the former serving over 6x the subscribers. Given Sky’s large share of the UK market, the result is less money for producers and higher prices for consumers. In the long-run, it is hard to see how this could be sustainable.
Will Sky disappear overnight? No,…
