Description

Investment Summary
Grupo Televisa (“Televisa”) is a very well positioned and well-managed company that dominates the media industry of Mexico and other Spanish-speaking areas. Although the company maintains high margins and is growing cash flow at rates well into the double digits, its share price does not reflect such growth and does not account for the quality of the company’s competitive position.


The Business
Grupo Televisa is the largest media conglomerate in Latin America and, by extension, in the Spanish-speaking world. The company’s primary interests are in television production, broadcasting and the international distribution of television programs. Televisa also has interests in direct-to-home satellite, publishing, cable and radio. In 2004, television broadcasting (including pay television and programming exports) accounted for 68% of revenues; Sky Mexico (direct-to-home satellite), 16% of revenues; Publishing, 8% of revenues; Cable Television, 4% of revenues; Radio, 1% of revenues; Ancillary Businesses, 3% of revenues.

History
In 1993, the Mexican government privatized two television channels, and TV Azteca began service to rival Televisa’s four channels. Prior to TV Azteca’s launch, Televisa was an effective monopoly in Mexico. Initially, Televisa worried that the launch of a new operator would damage its monopoly, and TV Azteca did much to foster these fears when it said that it would offer prices on a ratings basis and not under a “French Plan.” (A French advertising plan is a system in which customers pay in advance and hope for the best.) At the expense of Televisa, TV Azteca’s audience share of the advertising market increased to approximately 24% by the beginning of 2000. However, TV Azteca’s robust growth and market share gains didn’t last much longer as Televisa’s new management changed its strategic direction and helped create a very rational duopoly. (Note that Televisa’s market share has remained stable over the past few years at approximately 72%. TV Azteca garners the remaining 28%.)

In 1997, control of the company was passed to Emilio Azcarraga Jean after his father passed away. This began the resurgence of Televisa as a dominant media conglomerate in Mexico. Azcarraga and his team have done a marvelous job of transforming Mexico’s advertising market into a healthy duopoly and expanding the reach of Televisa’s content across distribution platforms and national boundaries. Additionally, management has successfully rationalized Televisa’s cost structure and increased its profitability tremendously, raising EBITDA margins from 26% to 36% over the past five years.

Now that the Mexican advertising landscape is much more stable, the current focus of management is to ensure that its content is the centerpiece of all distribution platforms reaching Spanish-speaking households. Management also wants to take full advantage of its natural links to the U.S.-based Hispanic market and is doing so now primarily through its approximate 11% stake in Univision, which is itself a large purchaser of Televisa’s content.


Investment Considerations
Management
Since Emilio Azcarraga Jean took control of the company in 1997, he has rejuvenated the company’s culture and refocused Televisa as the dominant player in all of Mexican media. In the process, Azcarraga has rationalized Televisa’s cost structure, sold non-core assets and focused the company on its core business of television production, broadcasting and the international distribution of television programs. He is known as being very focused and disciplined, which is a characteristic that was lacking during his father’s tenure but is now driven deep into the company’s operations.

Azcarraga, who owns approximately 13% of the stock, operates the company through a triumvirate of lieutenants: Alphonso de Angoitia, who oversees finance and strategy; Pepe Bastón Patiño, who runs the television broadcasting business; and Bernardo Martínez, who is responsible for all political and government relationships. Note that management as a whole own approximately 26% of the company’s stock.

Management appears to be extremely focused and disciplined and greatly emphasizes the creation of shareholder value. Over the past two years, the company has bought back approximately $440M of stock and paid dividends of approximately $400M.

Industry
Television
Spending on television dominates Mexico’s advertising market, representing approximately 56% of all advertising spending in the country, which is in line with that of other developing countries such as Brazil and Chile, where television represents 58% and 46%, respectively. The largest advertisers in Mexico are the government, which account for approximately 25-33% of ad spending; large international consumer goods companies such as Procter & Gamble, Kimberly Clark and perfume distributors, which account for approximately 30%; food and beverage companies, which account for approximately 20%; and telecom companies, both fixed and mobile, which account for approximately 10%.

Government and retailers appear to spread their ad dollars across media, but other advertisers appear to concentrate heavily on television as the medium of choice. One reason for this is that the Mexican economy is highly centralized, and the country’s main advertisers are large, nationally based companies that seek national reach. Broadcast television is the only medium in Mexico that can easily provide this reach. Thus, it is estimated that the local advertising market, precisely defined as a local company advertising locally, makes up just 5% of the market, and even a generously defined local ad market makes up just 20% of all ad spending. The national ad market represents the remaining 80% of the total advertising market in Mexico.

Importantly, advertising revenues tend to be less economically sensitive in Mexico than in the U.S. This is partly because of the heavy government spending on advertising and also because the big consumer goods companies in Mexico simply tend not to cut advertising in attempt to retain profits when sales decline.

Radio
The radio business is the biggest local advertising medium, while outdoor advertising is the second biggest. Radio advertising captures approximately 20% of total ad spending. Government and supermarket advertisers tend to dominate this segment. It is projected that government drives approximately 60% of the local advertising revenues, and supermarkets drive approximately 30% (rising to approximately 50% in politically quiet years).

Magazine
Mexico’s magazine market is essentially a national market in which advertising is bought centrally. The biggest selling magazines in Mexico are those related to television programs. Small circulation magazines, such as business magazines, carry the higher end advertisers. The top 10 advertisers in this medium come from the following 5 segments: perfume, cosmetics, food, computers/technology and auto companies.

In Mexico, subscription revenues represent only 2% of total publishing revenues. As such, companies cannot sell the reach that magazines offer because the data is hard to prove. (Note that Televisa is working to increase subscriptions as a proportion of total sales.)

Pay-TV
Because there is so much capacity in other media, the Pay-TV advertising market has experienced low absolute revenues (although growth off of the low base has been fairly robust). The primary reason for low total dollars spent in this medium is that only high-income customers can afford Pay-TV, and this demographic is already well serviced by other media channels.

The method of sales in Pay-TV is generally that advertising time is shared between the content companies and the distribution companies (cable television and satellite). In Mexico, content companies hold onto a higher proportion of the advertising time available, and the distribution companies get very little. In this way, the content provider has better control over prices. The distributors benefit indirectly, as they pay a lower price for the program packages than they would under a mixed ad time/cash payment system such as is prevalent in the United States. Since Televisa controls both its content and distribution, this issue is not as meaningful for the company.

Competitive Position
Televisa has a truly enviable competitive position across its major business segments. In effect, Televisa enjoys a superb competitive position akin to being a combination of Time Warner, Comcast, Disney and News Corp., without substantial competition.

The company is the number one television broadcaster in Mexico, owning and operating four of the nine television channels in Mexico City (Channels 2, 4, 5 and 9). With approximately 70% of the audience share, the company maintains a dominant position in this market. (Note that Televisa has maintained its dominant share over the past few years under current management.)

With a total annual circulation of 128 million magazines, Editorial Televisa is the largest publisher and distributor of magazines in the Spanish-speaking world. Televisa's wholly owned distribution network, Distribuidora Intermex, distributes approximately 62% of the magazines circulated in Mexico. Additionally, in its publishing segment, Televisa produces seven of the ten most read magazines in Mexico.

Televisa is also the leader in pay-TV services. The company owns a 60% interest in Innova, which provides direct-to-home satellite television services under the SKY brand name. Innova is the pay-TV market leader in Mexico and the only direct-to-home satellite provider. Furthermore, Televisa owns a 51% interest in Cablevisión, which is the largest cable provider in Mexico City and surrounding areas.

Televisa’s programs are amongst the most watched in Mexico. Over each of the past several years, Televisa’s networks aired approximately 185 of the 200 most watched television programs in all of Mexico. One reason for such high ratings is that Televisa is focused on developing homegrown talent, much like the Hollywood studios of old before actors started leveraging negotiating power. The company successfully trains and cross-promotes its talents through its television, radio and publishing divisions. Televisa operates a school in Mexico City to develop and train actors and technicians, providing instruction free of charge. Once developed into well-known and popular actors/actresses, Televisa does a great job of retaining its talent pool. It’s worth noting that during a recent conversation I had with the company, the director of investor relations mentioned that both Televisa and TV Azteca play nice and do not try to steal each others’ talent pool.

Another dominant competitive advantage of Televisa is that it is under no legal obligation to provide its content to rivals (unlike the laws in the United States). This is a very important point since Televisa is the premier media content creator in all of Mexico, and its ability to keep its proprietary content solely for its own broadcasts gives it a truly wonderful position in the market. Televisa actually exercised its right not to share content with DirecTV in Mexico and practically forced them to shut down their satellite operations and sell their customers to Televisa and others out of bankruptcy.

Price
Televisa’s current share price is attractive. As I write this, the stock is trading at approximately 7.0X 2006 EBITDA and has a FCF yield of approximately 9.5%. At modest growth and margins assumptions, the likely returns of TV at current prices are in the high-teens to 20% with no multiple expansion. If the company continues the strong growth trajectory that it has been able to achieve since new management took over, or if the television business is revalued, returns could likely be higher.


Risks
These are the primary risks that factor into the investment hypothesis:

Economic Downturn
Grupo Televisa's performance is very much correlated with that of the Mexican economy. A downturn in economic activity in Mexico could cause companies to lower advertising budgets, as it is among the first spending items that can be reduced during adverse macroeconomic shifts, even though it might not be as dramatic as in the United States. A downturn in economic indicators in the United States would also likely have a negative effect on Televisa as it would likely impact the valuation of Univision, of which Televisa owns approximately 11%.

Currency Risk
Because the majority of Televisa’s revenues are generated in Mexican Pesos, any devaluation in the currency could adversely affect returns. (Fully hedging the peso costs roughly 200-400 bps per year.)

Mexico Implosion
Mexico is a developing economy and thus does not have the same stability as the United States. The political and economic landscape could markedly deteriorate. Although there aren’t any clear signs of that now, it is worth keeping a close eye on, particularly as the Mexican presidential election approaches in July 2006.

Inability to Renew Licenses
Under Mexican law, Televisa needs concessions from the Secretaria de Comunicaciones y Transportes, or SCT, to broadcast programming over television and radio stations and cable and DTH satellite systems. The expiration dates for the concessions for the company's television stations vary through 2015. If Televisa is unable to renew its concessions for any of its significant stations before they expire, the company's business would be materially affected.


Conclusion
Grupo Televisa has a striking collection of the factors that make it a great company. It has an extremely strong competitive position in an attractive industry, is run by a focused, smart and talented management team, and is currently trading at a price which represents a significant discount to intrinsic value.

Catalyst

Once there is a resolution to the Mexican presidential election, which will be held in July 2006, Televisa's stock will likely rise to a more appropriate valuation because the market will have more certainty around the future policies, particularly with respect to media, of the next regime. (Note that Televisa's management is not concerned with the political outcome because they believe they will still have the backing of Congress regardless of who is elected President. They have also played nice with all candidates currently vying for the Presidency.) In the meantime, EBITDA is still growing at a high rate and management is running the company for long-term shareholder value (exemplified by stock buybacks and large dividends).