British Sky Broadcasting - The sky is the limit

Last week, Rupert Murdoch’s US based Newscorp announced a proposal to purchase the 61% holding in BSkyB (LON:BSY) which they do not own for £7 per share, valuing the company at around £12.6 billion. The "proposal" was swiftly rejected and Sky's independent directors have stated that any offer would need to north of the £8 mark in order to be considered.

Having seen his initial advances rebuffed, it is our view that Murdoch will eventually return with a higher offer. Why? Well, if recent results are anything to go by Sky is an efficiently managed cash generator. So far this financial year, the company has been able to get into more households and implement price rises effectively, therefore boosting revenues, earnings per share and free cash flow.  Such performance, during a downturn, can only be called robust and underscores the defensive or economically resilient nature of "in-home" entertainment.

Sky brings in a huge amount of cash from its subscriptions and with his current level of ownership of Sky at 39%, Rupert Murdoch is well aware of this.  It is likely that Murdoch sees Sky's growth trajectory as more predictable and certain than many other parts of his empire and hence we believe that he will not be denied total control.

However it is not all plain sailing and regulation remains a key issue for Sky shareholders.... on two different fronts.

Whilst the European authorities mandated that Sky should not win total rights to the FA Premiership (upon which their success has been based),and more recently the Office of Fair Trading has ruled that Sky re-sell its sports at wholesale prices to its competitors rather than at a premium. Such a ruling would clearly reduce profits and it is no surprise that Sky is appealing the decision.

Secondly, regulation could scupper the Newscorp takeover. Approval from European regulators could take some time is not guaranteed, explaining why shares have gravitated around the £7 mark. Sky's independent directors may have set and published an £8 target for any deal, but the market evidently remains wary of Newscorp's willingness to pay such an amount as well as possible regulatory hurdles which lie in wait.

Murdoch's interest may have provided a short term boost for the share price however Sky’s growth potential was apparent long before the proposal. 

The recent £160 million purchase of seven channels owned by Virgin Media underlines management’s aim to expand its core business and provide as broad a range of channels as possible. In addition High Definition television is racing ahead at a rate of knots and the group will also launch a 3D television channel later this year.

Should Sky branch out in to the world of mobile telephony, triple play becomes quadruple play and the group's bottom line will expand even if the number of household penetrated remains stable. In reality though Sky will be looking to continue to bolster subscription numbers even further and, with a wide range of price points, this is likely in our view.

Cleary Murdoch is aware of that such developments will be highly earnings accretive and hence this is likely to be the first step in what will be an outright purchase but only on positive terms for Sky shareholders.