The price is right: ITV’s valuation case

The trading update is the latest twist in an underwhelming plot. Even before Covid-19 hit, ITV’s advertising revenue had begun to stagnate and the media and entertainment division was struggling to grow its profits. Meanwhile, the broadcaster’s reach – defined as the proportion of people aged four and above who watched at least 15 minutes of ITV a week – had fallen from 60 per cent in 2016 to 48 per cent in 2021, with younger viewers proving particularly elusive. 

It’s not just ITV that is suffering. The communications regulator Ofcom has identified a trend of “long-term decline” among all traditional broadcasters, including the BBC, Channel 4 and Channel 5.

No wonder ITV shares have halved in the past five years. 

It is possible, however, that investors are being too squeamish about the broadcaster’s prospects - not to mention the content of its shows. (This year’s I’m a Celebrity…, featuring former health secretary Matt Hancock, has roped in 10mn viewers). It is important to remember, for example, that ITV’s advertising revenues were 11 per cent higher than pre-pandemic levels in the 2021 calendar year, and the first half of 2022 also started well. So while ad sales suffered in the latest quarter, they are only down 2 per cent so far this year. 

Meanwhile, group-wide turnover is up6 per cent. This growth has been driven by ITV’s often-overlooked studios division, which accounts for almost half of company sales. ITV Studios produces television programmes for global streaming platforms and international broadcasters, as well as for its own entertainment division. Counterintuitively, it also makes shows for other UK broadcasters. The most recent series of BBC hit Line of Duty, for instance, was made by an ITV Studios subsidiary.

Together, these programmes form a valuable library of intellectual property, and the division has reported robust revenue and profit growth. While there was a bit of a blip during the pandemic, management said it is now on track to exceed 2019 levels by the end of 2022. 

ITVX: Better late than never 

The big criticisms of ITV are that it has been too slow to change and hasn’t deployed its programmes to full effect. While the likes of Netflix (US:NFLX) and Amazon (US:AMZN) were busy creating slick streaming platforms, ITV largely stuck with the increasingly unpopular ‘linear’ television format. There is ITV Hub, of course, but – as anyone partial to a Poirot or Midsomer Murders will know – the platform is glitchy and difficult to use. 

This may be about to change, however. Having begun rolling out branding this month, the broadcaster officially launches a new streaming service called ITVX on 8 December, in a bid to grow digital revenues to £750mn by 2026. Viewers will be able to watch ITVX with adverts for free or pay a subscription and avoid the interruptions. 

Many commentators (and investors) have argued that this should have happened a decade ago – and certainly four years ago, when Carolyn McCall took over as chief executive. Others have baulked at the amount of money being pumped into new programmes: total content investment will be around £1.23bn in 2022 before rising to £1.35bn in 2023 and is expected to remain at that level going forward. This compares with £1.09mn in 2019.

At the same time, senior Berenberg analyst Sarah Simon notes that ITV spending is a “drop in the ocean compared to what the streamers are spending on content” and warned that Netflix and Amazon could lure advertisers away from ITV.

Ultimately, however, it’s better late than never and it's important not to underestimate the power of local programming. While US content is incredibly popular, the desire for shows that have been written and shot in the UK seems unlikely to fade, and a world where we only consume American US blockbusters seems very unlikely. 

Simon Adler, a value equity fund manager at Schroders, believes that ITV is a “very powerful” medium for advertisers to build their brands. “There’s no other place where you can reach five million people, live, in the UK,” he told us. “It is a very important business for marketing to UK customers.”  

Sum-of-the-parts discount 

There is a more compelling argument in ITV’s favour, however: it’s cheap. So cheap, in fact, that some analysts argue that it’s now worth less than the sum of its parts. “The conglomerate discount is now so acute at ITV that you don’t just get the broadcast business for free – you actually get it at a negative value,” argued Thomas Singlehurst, head of European media equity research at Citigroup, in a recent presentation.

This argument rests on the idea that content producers are more secure and attractive - and thus more valuable – than cyclical broadcast businesses, and that ITV Studios is trading at an unfair discount. Singlehurst uses the example of FL Entertainment (NL:FLE), a France-based entertainment company listed in Amsterdam whose distribution hits include Peaky Blinders and the Masterchef format, saying it provides a “clear reference value for ITV Studios”.

FL Entertainment’s enterprise value (EV) – shorthand for a company’s market capitalisation plus any debt and minus any cash – is currently 13.8 times the group’s operating profit. Using this as a benchmark, and based on forecast operating profits for ITV Studios of around £259mn in 2022, the division has a theoretical EV of around £3.57bn. After subtracting the relevant debt, and making a few other adjustments, Singlehurst arrives at an equity value of £2.95bn for the production business. Divide this by the number of shares in issue, and you arrive at 74p per share for the studios business – equal to the current value of the entire ITV group.

Time for a re-think  

The big question for ITV is how to unlock this value. In October, the Financial Times reported that management was actively reviewing the future of the studios business, including the possibility of a partial sale. This is not as straightforward as it sounds, however. While it would certainly free up cash to fund share buybacks, it’s not clear why a third-party would want a minority stake in the studios business, as it would only secure limited control. Selling a bigger stake is probably more realistic but also comes with risks, given how much of ITV’s strength lies in its integrated producer-broadcaster model.  

Citigroup has suggested that ITV might consider merging the studios business with a third party, much like when Pearson (PSON) folded its Penguin publishing business into Random House. While this might lead third-party investors to re-appraise the valuation, it would not free up any capital for ITV itself. Still, the bank believes such a deal has the potential to create significant value “via increased economies of scale” and by signalling that the business is less dependent on “ad-funded linear TV”.

What will actually happen is far from certain. However, ITV appointed a new chair earlier this year and change seems to be in the air. The group’s lowly price-to-earnings ratio of 6.3, therefore, could be ripe for an upgrade. In the meantime, management has committed to a dividend of at least 5p for the full year, giving a dividend yield of about 7 per cent.

Shareholders who are willing to take chance might do well to follow Hancock’s lead and linger in the jungle a little longer yet.