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All eyes on Sky

October 13th will see Sky unveil its first-quarter results. Analysts are looking to the results to show the progress – or lack of it – in particular at its Sky Italia and Sky Deutschland divisions.

Back in July 2014, BSkyB announced it was going to buy its German and Italian sister pay-TV broadcasters. The deal wrapped in November 2014 and saw BSkyB pay £2.45 billion for the Italian operation (including the transfer of a 21 per cent stake in National Geographic to 21st Century Fox) and paid £4.44 billion for the 89.71 per cent stake in Sky Germany it didn’t control.

At the time, CEO Jeremy Darroch said the enlarged company would be targeting the 60 million homes across the three markets that did not subscribe to pay-TV, and that the combined trio would lead to significant synergies of some £200 million, and savings on programming and creativity.

Analysts want to see progress on Churn, and ARPU, and for the results to put some sparkle back into Sky’s share price, which has slumped in the past two years from £11.40 a share (July 31st 2014) to just £8.94 (October 10th 2016) and earlier last week slumped to £8.40.

The analysts are already sharpening their teeth. One bank pointed out that last year’s numbers were artificially boosted by Sky reporting 53 weeks in the year – and “not flagged by management”.  There also a suggestion that Sky’s German operation is not doing well, and that Sky UK’s actual DTH numbers are drifting down.

Sky UK is also now supplying all new customers with its premium grade SkyQ box. This is good for customers, but it is also a savvy accounting move for Sky insofar as it is capitalising all these boxes (and worth an estimated £80 million in a full year).  Sky’s previous HD/HD+ boxes were simply expensed.

Equity analysts at Berenberg Bank explain the move: “This has important ramifications for Sky’s earnings, because while Sky UK has historically expensed directly all its new customer hardware, SkyQ is being capitalised (as is the route associated with the service). Previously, we had modelled in the capex (and depreciation) associated with those customers choosing to trade up to SkyQ, but the bulk of box costs (standard HD+ boxes) had gone through the P&L. With this move, all box costs now move into the cash flow statement.  Therefore, the cost of Sky’s set-top boxes will now be reflected in depreciation costs, rather than above the EBITDA line. This changes the relevance of EBITDA, in our view, as a measure of profitability, at least as it relates to comparison versus historical levels, either in absolute terms, in margin, or when considered from a valuation perspective.”

The bank’s report is blunt: “In our view, the market is taking too benign a view of this issue. Or perhaps it has not really registered it yet. If Sky beats consensus materially as a result of this change, then that would be one thing, but we believe that this is highly unlikely, and that current estimates in the market do not reflect the decision to only issue SkyQ boxes.”  The bank’s recommendation to investors is to “SELL”.

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