“Show me the money!” improved capital allocation to drive returns
* Multiples high, but better capital allocation creates selective value
After 4.5 years of outperformance, the sector is down 3% ytd relative to the
European market driven partly by I/B/E/S consensus earnings revisions
(-11% for 2014 and -8% for 2015). 1Q14 earnings were lacklustre and
indications for 2Q14 show a slower growth trajectory for an advertising
recovery than expected. Despite a relatively high NTM P/E of 17.3x for the
sector, we still see selective value opportunities as repaired balance sheets
and more disciplined capital allocation should drive improvement in
structural outlooks and returns.
* M&A centre stage in pay TV, but limited elsewhere
In this report, we look more closely at capital deployment as a driver of
future growth and returns. We forecast €15bn of acquisitions in the next
five years, up from €10 bn in the last five, but see the focus as bolt-on
rather than transformational given: (1) integration risks in subsectors with
high personnel costs such as agencies and publishers; (2) ownership
restrictions in free TV; (3) market concentration in several TV and publishing
markets; and (4) blocking economic and voting stakes. We see consolidation
as most likely in European pay TV with BSkyB looking to acquire assets in
Italy and Germany and Mediaset exploring options for its pay TV unit.
* Greater cash returns to increasingly become a focus
With strong FCF conversion and a lack of major M&A opportunities, we
expect cash returns to increasingly become a focus. We forecast buybacks
to double in 2014-18 vs. the last five years and dividends to increase 83%
with overall cash returned as percentage of FCF rising from 46% to 57%.
Of the subsectors, we expect broadcasters to return the most cash.
* Key beneficiaries from uses of cash
We retain a 50% M&A weight in our valuation for SkyD (Buy) and add a
33% weight for Havas, which we upgrade to Buy. We expect greater capital
returns from ProSieben and DMGT (both CL Buy), Publicis (Buy), Vivendi
(NR) and Reed Elsevier (Neutral). We estimate more defensive capital
allocation at Pearson and Lagardere which we downgrade to Sell. Our top
picks remain stocks with several strategic options such as portfolio realignment
(DMGT, Mediaset), capital returns (ProSieben), restructuring
(Solocal) and cost savings (Mediaset).