Nicholas Grove: I'm Nick Grove for Morningstar, and today, I'm joined by Brian Han, who is here to discuss the implications of a potential relaxation in Australia's media ownership laws.
Brian, thanks for your time today.
Brian Han: Good morning, Nick.
Grove: Brian, in your report you state that the government's attempt to relax media ownership laws is neither historic nor significant and is building towards a Groundhog Day in Australian traditional media. Why do you describe it as such?
Han: Nick, contrary to what media may have you believe, we actually had media reform almost exactly 10 years ago. At that time, we had the foreign ownership restrictions on Australian media assets abolished. We had the cross media restrictions partly relaxed. That brought out a spate of M&A activities in the sector, all of which led to significant value destruction for all the acquirers. And now we have a situation that is very eerily similar to what happened then with M&A interest bubbling under the surface ahead of potential deregulation, hence the reference to Groundhog Day.
Grove: Brian, could you just briefly elaborate on the "audience reach rule" and the speculation surrounding Seven West Media and Prime should that rule be abolished and also the "cross media rule" and the speculation surrounding Nine and Fairfax?
Han: Sure, Nick. The audience reach rule is one of those archaic rules in Australian media where it says a TV network signal cannot reach more than 75 per cent of the country's population. This is essentially the reason why a TV network, one TV network operates a TV station in metropolitan areas and a totally different company operates another TV network in regional areas even though both of them essentially telecast the same signal. So if that audience reach rule gets abolished then it's only natural that Seven West Media actually look at taking over Prime Media because Prime Media at the end of the day is nothing but a re-transmitter of Channel Seven signals in regional areas.
As for the cross media restriction, the rule says that in a defined market a company cannot own newspaper, radio and TV in that same market. They can own two out of those three but not all three. If that rule gets abolished, I can see a situation where Nine Entertainment will be very interested in merging with Fairfax Media and the rationale would be to combine the resources, the editorial resources, and monetize content over multiple platforms.
For example, let's say, you break a story. One journalist or one little journalist team breaks a story and then carries it in The Sydney Morning Herald in the morning. It gets talked over the 2UE radio station throughout the day and then you do an analysis on it on A Current Affair on Channel 9 at night. So, one story, monetized over three platforms, three bites at the advertising pie and that would be the rationale.
Grove: Brian, in your report you talk about negative virtuous cycles and how these are impacting free-to-air TV and newspapers. Can you just briefly explain what these cycles mean?
Han: Sure. It all starts with the audience. So, we know that audiences are falling for TV and newspapers because there are so many alternatives out there because of digital. Now, when audiences are falling then advertising dollars are falling. After all, if you're an advertiser why would you advertise on a platform where there are no audiences? So, advertising dollars are falling and then profitability is falling and these TV networks and newspapers have less money to spend on content. Because of the falling content quality, more audiences fall, and hence the virtuous negative cycle.
Grove: Brian, you say while a commercial radio has shown remarkable resilience in the digital age, this doesn't necessarily mean that it's immune from disruptive forces. Why do you believe this to be the case?
Han: I worry that digital technology and all these social networking phenomena will ultimately fragment the radio medium and compromise this mass audience business model. And when that happens, that will not only put downward pressure on advertising revenues but it will also put upward pressure on costs because, for example, if you listen to Kiss FM because you like Kyle & Jackie O, what stops them from setting up an internet streaming radio station and getting all the advertising dollars themselves or worse still, use that as a bargaining leverage the next time the contract come up for renewal. That's the kind of concern that I have with radio longer term.
Grove: Finally, Brian, how should investors approach the Australian media sector given the way that technological winds are blowing and what are some of your preferred stock picks?
Han: Nick, the short answer is, I think investors should approach the sector very, very carefully and they certainly shouldn't play this M&A game and this game of picking who might be the M&A targets because ever since the mid-90s the two companies that have been often touted as takeover targets, Fairfax Media and Prime Media, they are still the two longest-standing independent companies out there. But having said that, I think there is value to everything, even in a challenged sector like media and on that valuation basis, we do like News Corporation and not only does it have a valuation attractiveness to it, but it also has a strong balance sheet, strong free cash generating power and a stable of very underappreciated non-newspaper assets.
Grove: Brian, thanks very much for your time today.
Han: Thank you, Nick.
Grove: I'm Nick Grove for Morningstar. Thanks for watching.