The headline-grabbing performance of media conglomerates Johnnic Communications (Johncom) and Naspers seem to indicate that the media industry’s return to financial health is well underway. The numbers show that overall Johncom is not as profitable as Naspers, but as Johncom CEO Connie Molusi points out, there are huge differences in the underlying business mix, which affect margins. In addition, the groups don’t disclose financial information on the same basis, which makes comparisons difficult.
Johncom’s results were staggering. Headline earnings for the six months ended September 2004 rocketed 727% to R124m (R15m). Even better for shareholders, annualised return on equity was a shareholder value-creating 15,1%. Revenue was up a remarkable 52%, although this falls to a still-creditable 12% increase if the first-time consolidation of M-Net/ Supersport is taken into account. (This follows the increase in Johncom’s equity stake in the pay television operation to 38,6% following its delisting from the JSE Securities Exchange).
Johncom’s overall improvement in profitability is clearly shown in the jump in its operating margin to 7,8% from 0,5%. If you strip out pay television, which traditionally has better margins than most of Johncom’s core operations, operating margins still improved to 4,6%. The group is now reaping the benefits of the corporate restructuring undertaken in the previous year, the new management focus, and the current consumer boom. Johncom felt the benefit of the latter through increased advertising revenues in both its own print media operations and Caxton, disclosed separately as an associate.
Although this financial performance is exceptional in terms of the rate of growth, Peter Armitage, Nedcor Securities’ media analyst, argues that comparisons with competitors do not flatter the group. In cinema, Armitage believes that Nu Metro is loss-making, although this is not separately disclosed, and performs significantly worse than Primedia’s Ster Kinekor. He says that the core operations “performed reasonably”, but the newspaper and magazine divisions performed worse than those belonging to Naspers.
Johncom is now reaping the benefits of the corporate restructuring undertaken in the previous year, the new management focus, and the current consumer boom.
Armitage believes that the turnaround in Johncom’s print media operations is sustainable. In the next six months it should benefit from a first-time contribution from Sunday World as well as accounting for the Sowetan for the full period. Despite this, Armitage says that Johncom is unlikely to reach Naspers levels of profitability “as it lacks critical mass”. That said, Johncom should show “strong” financial results, partly because it’s coming off a low base.
Against the assessment, Molusi argues that strictly speaking the two conglomerates are incomparable. He points out that Naspers does not account for its printing business separately, and that margins for printing operations are significantly higher than they are for newspapers. “Since volume and profit growth for print media should translate into growth for the operators of printing presses,” says Molusi, “the Naspers media division should outperform Johncom.”
Challenging Armitage’s belief that Johncom will struggle to meet Naspers profitability levels because the latter has critical mass, Molusi points out that Johncom’s media division outperformed Naspers in both turnover and profit growth, with operating growth before tax and depreciation for Johncom’s media operations at 63%, against 50% for Naspers. “Given that the Naspers figure includes its printing business with higher margins, this suggests that Johncom’s newspapers performed significantly better than Naspers newspapers and are more profitable. Much of that is probably due to the Sunday Times, which has the best operating margins in the country and one of the best in the world. The Sunday Times operating margins are closer to radio margins than newspaper margins.”
Armitage believes that Johncom’s key issues for the next year are strategic. To start with, its black empowerment status has been dealt a body blow by parent Johnnic’s announcement that it will unbundle its 62,5% shareholding in Johncom this month (February 2005). The Johncom board has to take “full responsibility for ensuring that an appropriate black empowerment shareholding is achieved in the short term”, as it believes an empowerment partner is “critical to ensure long-term value creation”.
The second strategic question that needs to be addressed, according to Armitage, is to develop a “strategy that makes sense” for the core operations. Armitage calculates that Caxton and M-Net/Supersport each contribute around 35% of Johncom’s value. Its core operating activities only account for the balancing 30% – and it’s these that management controls.
Molusi’s response is unequivocal: “Market criticism, which Armitage shares, is often that Johncom’s most profitable assets are its associated companies, Caxton and M-Net, which it does not control. In fact, Johncom owns a little less than 40% of Caxton. Caxton’s contribution to Johncom’s profits is 40%, which is in line with the market’s perception of Caxton’s 30% value in the Johncom share price. That also suggests that the rest of the operation’s performance justifies Johncom’s price-earnings ratio.
“Johncom’s price-earnings ratio at 13 times is slightly cheaper than Naspers at 15. Both groups are a ‘hold’, indicating that the market feels them both fairly and fully valued at their current share price. A big contribution to Naspers profits is subscriber television, which generated operating profit growth of 48%. Stripping out Johncom’s associated share in the Naspers television business, the Johncom group operating profit was still up 106%. This compares favourably with the 66% operating profit growth of Naspers.”
Armitage characterises the Naspers interim results for the six months to September 2004 as “truly excellent”, despite some confusion as to why the group’s management was downbeat at the beginning of the new financial year. Core headline earnings per share were up 103%, although management highlights the exceptional R345-million “dilution profit” from the successful June listing of Chinese internet provider Tencent in June. Nonetheless, the core operations performed well. Armitage highlights four positive surprises in the result, which, he believes, creates a platform for a higher level of future sustainable earnings. Three of these were: the unexpected turnaround in the Greek pay television operation, MWeb SA’s R27-million operating profit, and a 50% increase in South African pay television’s operating profit despite an effective rand/dollar exchange rate of R12,21:US$1 for an operation where 18% of its cost base is dollar-denominated. (The latter is the result of M-Net covering its forex commitments forward for two years). The final positive surprise was print media operation Media24 showing a 66% increase in operating profit. Says Armitage: “This is a typical case of an increase in advertising (+27%) flowing straight through to the bottom line”. Having said that, it’s possible that Media24 is “overachieving” in profit terms, relative to management expectations, and so further large improvements in the division’s operating margin are unlikely.
Naspers spokesman Mark Sorour comments that print media “rides economic cycles”, but questions whether the growth rates in adspend reflected in this result can be sustained. He highlights the consumer boom as key, saying that retailers’ confidence about lower inflation and strong volume sales growth feeds through to more advertising. He doesn’t expect any new print competition to emerge in the next year, “although there is always a chance”.
Sorour says that the South African magazine industry is highly overtraded, “but Naspers has a substantial position in this market and is likely to launch two to three new magazines in the next year. This sector will continue to evolve.” In newspapers, the Daily Sun and Son continue to grow.
Sorour says the group’s mooted BEE deal is dependent on the finalisation of the ICT sector charter.
Intriguingly, Armitage argues that Naspers is not a punt on the consumer boom. He forecasts 95% and 69% growth in core headline earnings per share in financial 2005 and 2006 respectively, irrespective of the state of the South African consumer. The key reason is that M-Net will reap the benefits of the rand’s strength, however the currency performs. In addition, he believes this result has addressed many of the risk perceptions surrounding the Naspers long-term growth prospects. He too prefers Naspers to Johncom.
Kirsty Laschinger, a former JP Morgan business analyst, is a freelance journalist and regular contributor to Finance Week.
Reasons to be Upbeat
According to some of the world’s leading media agencies, 2005 will bring the third year of consecutive growth in global advertising spend after a slump at the beginning of the decade caused by the demise of dot.com advertising. While overall growth is expected to be slower than 2004 – which saw a US$3-billion boost to media companies’ revenues off a combination of the Olympics, the US presidential elections and the Euro 2004 football tournament – the underlying factors contributing to the turnaround are still very much in evidence.
Sir Martin Sorrell, chief executive of the British advertising services giant WPP, told the BBC last December that he expected the company’s earnings per share to grow by at least 10% in 2005. Growth forecasts out of two of the world’s leading ad buyers, Universal McCann and ZenithOptimedia, range between 5% and 6% respectively, with the former pegging overall ad expenditure at a total US$553.4-billion for the year.
Proof that South Africa follows global trends is provided by last year’s figures out of Nielsen Media Research, as well as the healthy results and share prices of the listed media companies. The first six months of 2004 saw a 20% growth in local advertising spend over the same period in 2003. “This is mainly due to gains across all major media,” explained Nielsen Media Research, “spearheaded by a 38% (R1.2-billion) increase in spend by the top 10 companies, growing confidence in the local economy and healthy competition in most commercial sectors.”
It is expected that growth for the first half of 2005 will be slightly lower, as last April’s elections saw a 61% increase in spend by the government and R27.5-million spent by the ANC. Nevertheless, the global and local fundamentals should justify and perhaps even strengthen the renewed confidence in media stocks, where performance across the board has been excellent – outside of Naspers and Johncom (see main story), at the time of going to print HCI is trading at R28.00 a share off a 12-month low of R9.00, Primedia at R12.20 off a low of R6.12, AME at R10.50 off a low of R3.11, and Caxton at R20.00 off a low of R16.20.
As for sector predictions, it is expected that once again the internet will be the fastest-growing medium. Having been the cause of the global slump in 2001 and 2002, it has the most ground to make up – and is fast doing exactly that. According to Universal McCann, the amount spent on internet advertising globally is forecast to rise 25% in 2005. It should be even higher in South Africa, where the medium’s share of total spend is still way behind the world average.
Kevin Bloom