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The set-top box emerges as key in Sky/Vodafone merger, First NZ Capital says

Thursday 16th June 2016

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The set-top box is emerging as a key driver of boosting engagement in pay-TV following the release of more details on the proposed $3.44 billion merger between Sky Network Television and Vodafone New Zealand, analysts say.

The extra detail highlights a clear change in direction for the merged group with a move from satellite delivery to an IP-enabled set-top box, using Vodafone capability as a key way to lift engagement in pay-TV and as the platform for its next generation premium offering, say First New Zealand Capital analysts. The set-top box may also drive the future of its plans for over-the-top (OTT) delivered content.

Earlier this week an independent appraisal report by Grant Samuel said Sky doesn’t have an attractive future as a “pure” standalone pay-TV business in the longer term as it faces increased rivalry and a “fundamental deterioration” in its strategic position.

Sky directors have recommended shareholders vote on July 6 in favour of the deal which will give Vodafone Europe a 51 percent share of the combined group.

Grant Samuel said the deal was fair, a view reiterated by First NZ’s analysts, although they say this will ultimately be tested when they have an integrated model of the business incorporating Vodafone NZ’s telco prospects.

Delivery of a new IP platform will require a significant degree of support and cooperation from the Vodafone Group, most likely centred around its two key fixed/pay-TV markets, Germany and Spain, the analysts say, in order to achieve the full $850 million in estimated synergies from the merger.

The merger’s rationale includes that Sky’s earnings will otherwise continue to decline as it loses subscribers on its dominant satellite-TV service and faces higher content costs because of increased rivalry from internet-based services such as Netflix.

Some of this weakness can be attributed to a “value for money perception” associated with a core technology delivery platform that is coming to the end of its useful life, First NZ said.

The merged group’s intention to invest in a new platform that meets customers expectations around user interface, including search TV everywhere and integration across devices and with the cloud, may see it over time recover some of the premium pay-TV subscribers it has lost, the analysts said. Better innovation has seen BSkyB in the UK hold its core pay-TV levels more than Sky appears to be doing.

But core pay-TV penetration will be challenging to grow from its current levels without major pricing changes and a pay-light option looks attractive with UK experience suggesting it can add subscribers, the analysts said.

The merged companies plan to boost their bundled packages, including moving from a triple play - fixed-line voice, fixed-line broadband, and pay-television services – into a quad play by adding mobile.

The key opportunity for Sky’s pay-TV subscribers is to move them to also taking broadband with the merged group and using content rather than discounting to drive further bundling, the analysts said.

Sky is expected to have between 30,000 to 40,000 subscribers by the end of this financial year to its over-the-top services which include Neon and Fanpass but First NZ said UK experience suggests growing that base will be a long and slow process. “Absent of ‘giving it away’, we’re not yet clear that a move to grow OTT and telco market share by generously bundling telco/OTT content will necessarily be positive,” they said.

The key factors that will drive increased penetration of Sky’s OTT products in the next 12 to 18 months are a new streamlined platform and improvements to the product line-up, including a possible move away from Neon to providing separate access to premium drama and its full line up of movie content.

However the analysts said the more attractive Sky’s product and pricing of OTT, the more risk of cannabilising its existing core pay-TV subscribers.

Sky’s share price is currently trading at $4.99 which compares to First NZ’s 12-month target price of $4.58, including 30 cents per share attributed to likely synergy benefits from the merger.

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