British Sky Broadcasting - Bid dramas

The News Corporation bid for British Sky Broadcasting (LON:BSY) has so far been a very colourful affair and this is before the real haggling over price has kicked in. The culture secretary Jeremy Hunt has given the transaction the green light and stockholders are now keen to push Rupert Murdoch to pay up.

The decision was transferred to culture secretary Jeremy Hunt after undercover journalists at Vince Cable’s constituency meeting obtained damaging statements from the MP. One of these was that he had ‘declared war’ on Rupert Murdoch which was subsequently heavily publicised Mr Cable was therefore unable to continue to oversee the News Corporation bid for Sky as legal challenges could be made on the fairness of his ruling.

News Corp’s initial indicated offer was for £7 a share for the 61% of the group which it doesn’t own already. However, this was turned down by Sky and with strong results recently and good prospects shareholders are looking for a price north of £8. The negotiating hereon in will be fierce and full of bluffs and counter bluffs.

In our view, Rupert Murdoch is eager to get his hands on Sky and the strong performance of the company will ensure shareholders make him pay up. After a decade of investment Sky is now reaping the rewards with strong profits growth. As such a share price of between £8.50 and £10 is not out of the question which leaves further upside versus the current stock price.

The recent interim results for the six months to the end of December 2010 illustrate how Sky has matured into a profits engine. Revenue was up 15% on a year ago while adjusted operating profit rose 26% to £520m... the group’s operating margin rose 140 basis points to 16.3%. As such adjusted basic earnings per share increased by 32% to 20p and the group felt able to increase the pidend by 11%.

Sky has already put in place much of its infrastructure and so further customer growth, and the sale of more products to existing customers, translates into strong profits growth. With regard to new customers, the group topped the 10m mark in the three months to the end of December after 140,000 net new additions in Q2 (three months to the end of December).

Improved content has attracted new subscribers to Sky but it is increased sales to existing subscribers which is providing much of the growth as only 24% (up from 6% over the prior year) of customers take all three services: telephony, broadband and TV. Thus net additional product growth in Q2 was 1.064m with HD TV subscribers rising 68% year on year to 3.5m and broadband additions showed the fastest growth for ten quarters.

Overall Sky is in great shape and set for strong profits growth going forward. It should be noted that the regulatory situation with News Corp’s offer isn’t entirely cleared up yet as competitors could seek to challenge Mr Hunt’s decision. However the subscription model is robust and Sky’s position has arguably improved versus competitors through strong product innovation. In its current form Sky looks well placed to perform.

This article was produced by Senior Research Analyst, Andrew Latto.