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Negative report on Sky Italia and Sky Deutschland

Equity analysts at Berenberg Bank have issued a strong “SELL” note for Sky to investors. The bank says that the broadcaster’s acquisitions of Sky Italia and Sky Deutschland, and argued as being able to benefit from Sky’s UK operation, have not worked out, and now offers “limited upside”.

The bank’s note says: “While it is certainly true that the enlarged group can better invest in original content and in developing new technological solutions and applications, it is not the case that Sky has bought two assets which have been underinvested and undermanaged.  The reality is more prosaic: these two companies operate in markets that are very different to the UK, and despite the best efforts of previous management teams operating under the News Corp/Fox umbrella, their financial performance has been disappointing. Management may argue that in Italy, for example, there has been recession, and that the business has been relatively stable given this backdrop, but pay-TV is generally mooted as a defensive business, so this argument is somewhat specious, in our view. Meanwhile, in Germany the business has vastly recovered in terms of subscribers, but profitability recovery has been much slower than expected.”

“Given we do not see the structural differences changing, there is only limited upside, in our view, related to the move to control by Sky itself. These relate to cost savings on duplicated investment, and are a one-time readjustment, in our view. Yet despite these synergies, we have steadily reduced our operating estimates for the profitability of Sky Deutschland and Sky Italia, and we are certainly not alone in this,” says Berenberg.

The bank argues that Sky has regularly missed delivering on its pledges to match football rights price inflation by achieving savings and raising prices.  “Yet a look at what was delivered in 2014 – the first year under the new football deal that was announced in 2012 – shows that, despite management assuring the City that there was no need to change forecasts, in fact it missed that consensus by 11 per cent, with a 9 per cent miss in the subsequent year. Yet the market continues to believe in management’s statement that it will not be negatively impacted by substantially higher than expected cost inflation.”

Berenberg is also concerned that with much of Sky’s programming costs paid for in “strong” US dollars, and a weakness in the GB pound, and that some 70 per cent of its debt is in euros.

The bank is also worried that in barely 18 months from now “we start worrying about” the next English Premier League rights auction, for the 2020 series, and anticipates a high rise in costs.

The bank says bluntly that Sky’s share price is too high (at about 850p) and gives a price target of just 730p.

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