Description

GMA Network appeared to be a well-run but slowly declining free-to-air TV company in the Philippines. However, over the past 12 months the business has been transformed, creating an investment opportunity that combines an unusual mix of growth and income, currently valued at 3 x EV/EBIT.

A bit of background 

For a long time the media landscape in the Philippines was dominated by the GMA Network and ABS-CBN duopoly. The former has traditionally been strongest in the North of the country (Luzon) and the latter in the South. Long-running soaps with homegrown TV stars and local news have been a staple for both networks, resulting in strong brand identity and loyal viewership.

Industry earnings had been flat or in slow decline for years due to the rise of internet advertising (the Philippines has 80M Facebook users and some of the highest engagement metrics in the world) and a lack of competitive pressure among consumer product groups in a cartelized market. With revenues oscillating around US$300M a year since 2012, earnings would fluctuate with the country’s election cycles which tend to be fought over the airwaves, predominantly paid for by big donations and endorsement from business groups. For the three years ending in 2019, earnings amounted to about US$70M, following a US$107M record high for the hotly contested presidential election year in 2016.

Despite this uninspiring backdrop, we recognized that management was purposely running the business to maximize free cash flow and distribute it to shareholders (dividend payout ratio has averaged close to 90% over the years).

We also knew that its only free-to-air TV competitor, ABS-CBN, had an increasingly acrimonious relationship with the national government.  That said, we had not anticipated that ABS-CBN’s broadcasting license would not be renewed  in May 2020. Please find some information on ABS-CBN’s loss of its broadcasting license saga, which makes for grim reading about freedom of the press and rule of law in Southeast Asia:

https://en.wikipedia.org/wiki/ABS-CBN_franchise_renewal_controversy

All stars aligning in 2020

While that decision was announced, rolling COVID lockdowns were implemented, leading to more time spent at home watching TV. At the same time, an advertising war ignited between Shopee and Lazada, the two regional e-commerce juggernauts. Lockdown also disrupted production, where costs are mostly variable, translating into lower expenses as the top line jumped.

As a result, GMA’s operating margins shot up from 22% to 37% and EBIT roughly doubled for the first 9 months of 2020. In line with management’s shareholder friendly capital allocation strategy, GMA announced a $1.35 special dividend which was paid in April. Although the share price has rerated, the business is still only valued at 3 x EV/EBIT and  5x P/E (arguably on high current LTM earnings).

GMA Networks’ management has smartly used their current competitive positioning to push a number of initiatives. This includes a second network more focused on news and targeting a  younger audience and digital set top box and mobile digital TV receiver solutions. Other initiatives recently implemented include the relaunch of a movie channel and the sign-up of ABS-CBN’s artists onto its roster. Logically, penetration in the South of the country where they used to be weaker has also benefited and they think that some of the new viewers will remain loyal to GMA Network even if ABS-CBN were able to broadcast again at a later stage.

2021 and 2022

While GMA Network license was renewed in 2018 for another 25 years, we understand that the earliest date by which ABS-CBN could have its broadcasting license reinstated would be in the first half of 2023. This is working on the assumption that a more friendly government would be elected, and that the decision would be fast tracked through the Senate, two big ifs. In the meantime, presidential elections are scheduled for next year, and political advertising revenues should start to roll-in by the second half of 2021.

The company has been trading at an average of 8x EV/EBIT over the past 10 years. Even if we assume that GMA rerates to 5x EV/EBIT while earnings stay at current levels, an investment at present would generate a IRR of ~50% over the next two years, partly through generous dividends.

This calculation does not factor in further earnings increase over that period, which jumped 65% from US$65M to US$107M  in the last presidential elections which took place in 2016. Fixed costs are low, and GMA’s Chairman apparently peppers his executive teams with operation costs containments memos, so we would expect incremental revenues linked to the upcoming elections to efficiently translate to earnings. Alternatively, one could just assume that the presidential elections only shore up earnings to current levels.

Valuation numbers and IRR calculation pencil in 2020 results which were announced last week. I will post a short summary of them in the comments section.

Investing in the Philippines 

The stock can be bought through Philippine Deposit Receipts (GMAP PM) which are relatively liquid. As often is the case in Asia where most interesting companies are controlled by an owner-operator, the float is only 31%. 

The current market capitalization is US$545M but as often happens, liquidity should improve as the market cap comes closer to US$1B. The country’s withholding tax for dividends runs at 15 to 30% depending on tax treaties, which is high for the region.

Risks:

The obvious risk is political. If Duterte’s administration can revoke ABS-CBN broadcasting license, clearly there is a risk that it could happen to GMA when a new administration comes to power or if the company comes in the crosshairs of the current one. It could for instance be slapped with a one-time tax linked to these extraordinary profits.

The usual corporate governance minefield associated with South-East Asia appears to be less of a concern. GMA’s Yale-educated Chairman has a great reputation and an impeccable track record of great corporate governance and effective capital allocation:

https://en.wikipedia.org/wiki/Felipe_Gozon#:~:text=Felipe%20Enrique%20%22Henry%22%20Lapuz%20Gozon,media%20networks%20in%20the%20Philippines.

The Duavit, Jimenez and Gozon families own a total of 68%. Joel Marcelo Jimenez is a Director on the Board and Vice Chairman of the Executive Committee.

Catalyst

Confirmation that GMA Network operational margins will remain abnormally elevated for 2021 and 2022, and that some of this marketing dominance will carry over in 2023 and 2024 even if ABS-CBN’s license is reinstated.