Sky merger veto leaves sport at risk

If Commerce Commission is wrong, impact will also be felt by consumers and Sky shareholders

The Commerce Commission’s decision to reject the proposed merger between Sky Network Television and Vodafone New Zealand is a big blow to both companies.

It means that NZX- listed Sky has to come up with a “plan B”; it needs to devise a new strategy to maintain its financial viability.

In the early 1990s, Sky TV was on the front foot as it took advantage of the deregulation of the television sector but it is now on the back foot as it faces increased competition from a plethora of low- priced internet content providers.

The Sky TV story began in the late 1980s when the domestic television industry was deregulated under the Broadcasting Act 1989. Until then, New Zealand had only two channels, TV1 and TV2. These two channels were staid and lacked content, particularly as far as sports was concerned.

TV3 Network was incorporated in October 1987, in anticipation of the industry deregulation, and went to air in November 1989 as the country’s first commercial television operator.

Sky TV was established by Craig Heatley and Terry Jarvis in November 1987. ESPN became a shareholder in 1988, indicating that sports content would be one of the company’s major offerings, but the US network had to stay below 15 per cent because of the Government’s overseas ownership cap on broadcasting companies.

When Sky TV went to air in May 1990 with three channels ( news, sports and movies), the state- owned TVNZ was the largest shareholder with a 35.2 per cent stake. But Sky TV suffered huge losses in its early years and a US joint venture — Ameritech, Bell Atlantic, Time Warner and TCI — acquired a 51.1 per cent stake after the National Government abolished the 15 per cent overseas ownership cap in May 1991.

This diluted TVNZ’s holding from 35.1 per cent to 17 per cent.

When Sky TV listed on the sharemarket in December 1997, TVNZ’s shareholding was reduced to 12.6 per cent and the state broadcaster sold its remaining shares six months later. The other major post- IPO shareholders were Independent Newspapers with 49.6 per cent, Trevor Farmer ( 12.7 per cent) and the Todd family ( 10.3 per cent). The Heatley/ Jarvis shareholding had fallen to just over 5 per cent.

Independent Newspapers, the NZX- listed newspaper group controlled by Rupert Murdoch, had purchased the US joint venture’s stake.

At the time of listing, Sky TV had five channels — Sky Sport, Sky Movie, Sky News, Orange and Discovery — and 287,790 subscribers.

The pay operator had a golden period after listing as satellite dishes popped up on the roofs of houses all over New Zealand. By June 2005 the number of channels had soared from 5 to 86 and subscriber numbers from 287,790 to 667,270.

However, broadcasting has become more and more competitive and subscriber numbers peaked at 865,055 in June 2014 as Netflix and other content providers entered the New Zealand market.

The company’s financial performance has also stagnated in recent years and this week it announced a net profit after tax of $ 59.5 million for the six months to December 2016, down 32 per cent compared with the same period in the 2015/ 16 year.

Meanwhile, the number of subscribers has declined to 816,135.

The last few profit announcements have clearly signalled that the company’s post- sharemarket listing growth period has stalled.

Meanwhile, Vodafone, which entered the New Zealand market in 1998 when it purchased BellSouth NZ, is also operating in an increasingly competitive environment.

The Explanatory Memorandum for the proposed merger had this to say: “Over the past years Vodafone NZ has experienced a challenging competitive environment that was defined by some of its competitors aggressively pursuing market share, particularly in mobile and in contractbased enterprises services. Increased promotional activities led to a decrease in the average price point for telecommunications services and also affected Vodafone NZ’s revenue.”

Vodafone NZ’s Companies Office accounts indicate that its revenue and profitability also peaked in 2014 although the Explanatory Memorandum forecasts anticipate a small pickup for the 12 months ending March 2017.

The accounts also showed that in the past two financial years Vodafone paid tax of only $ 6.5m on total revenue of $ 3.96b.

The proposed transaction would have resulted in Sky TV purchasing Vodafone NZ from UK- based Vodafone Group for a mix of cash and shares worth $ 3.44b.

This would comprise a cash payment of $ 1.25b and $ 2.19b worth of Sky TV shares, giving the UK communications group a 51 per cent stake in the combined NZX- listed company.

The public version of the Sky TV/ Vodafone submission to the Commerce Commission argued that the proposed merger would not reduce competition for a number of reasons including:

Sky TV does not provide fixed- line or mobile phone services.

Sky TV’s only involvement in fixedline broadband is to refer some of its customers to Vodafone.

Vodafone does not participate in the pay television wholesale market.

Vodafone’s participation in the retail pay television market is largely confined to reselling Sky TV’s pay television services as part of Vodafone’s wider offering.

But the main Sky TV/ Vodafone argument is that the high level of competition and ease of entry into the telecommunications and pay television markets would substantially restrict any attempt by the combined group to increase prices or reduce customer service.

The submission concluded “there is no prospect of a combined Vodafone and Sky TV pursuing any credible foreclosure strategy or otherwise reducing competition”.

The commission’s decision, which was released on Thursday, rejected the merger proposal and Sky TV’s share price plunged 57c or 13.1 per cent.

Commission chair Mark Berry wrote: “The evidence before us suggests that the potential popularity of the merged entity’s offers could result in competitors losing or failing to achieve scale to the point that they would reduce investment or innovation in broadband and mobile markets in the future. In particular, we have concerns that this could impact the competiveness ( sic) of key third players in these markets such as 2degrees and Vocus.”

What evidence does Berry have to assume that Sky TV/ Vodafone will be so successful that its competitors “would reduce investment or innovation in broadband and mobile markets”?

These sectors are highly innovative and competitive at present, in a global as well as a New Zealand context, and it is highly unlikely that the merger of two relatively small New Zealand companies would impact on global innovation and cross- border competition.

As I wrote this column on Thursday night, bloggers were remarking that they were watching the Auckland Blues/ Melbourne Rebels Super 18 game on stream2watch. com. Will this offering disappear if Sky TV and Vodafone merge? Will getyourfixtures. com/ nz, which provides links to live television sports, no longer be available in New Zealand if the two companies merge?

The counterfactual to the commission’s decision is that Sky TV has made a huge contribution to New Zealand in terms of television content and the support of domestic activities, particularly sport from a financial and exposure point of view.

If the broadcaster doesn’t have an effective “plan B” then it may have to reduce its payment, and coverage, of domestic sports. It is highly unlikely that stream2watch. com or getyourfixtures. com/ nz will fill this funding/ coverage gap.

The commission’s crystal ball may or may not be accurate but the important point is that the regulator has no downside if its Sky TV/ Vodafone decision is wrong, whereas the country’s consumers, sporting bodies and Sky TV shareholders may be hugely disadvantaged if the commission’s assessment of future broadcasting and telecommunications trends is incorrect.

Brian Gaynor is an executive director of Milford Asset Management, which holds shares in Sky Network Television on behalf of clients.

Sky TV has made a huge contribution to New Zealand in terms of television content and the support of domestic activities, particularly sport ...