Description

Description – ProSieben (Pro7) is a European media conglomerate, operating commercial television, premium pay channels, radio stations and related print businesses.

• Pro7 operates a leading pan-Euro Free-To-Air (FTA) broadcaster with operations in Germany, Austria, Switzerland, Scandinavia and Eastern Europe. Pro7 garners ~85-90% of revs from TV ads, with the balance from Internet, merchandising, licensing, etc.
• Pro7’s largest region is Germany where they own the #2 (Sat.1) and #3 (Pro7) FTA networks, and 2 cable networks; Over 60% of ProSieben’s revenues are generated in Germany.
• Pro7’s group of internet sites in Germany is the 2^nd most trafficked, and will eventually benefit from growth in internet advertising.
• Pro7 was formed in Oct ’00 by the merger of German TV broadcasters ProSieben Media AG and Sat.1.
  • In Dec ’06 – Lavena Holdings (KKR/Permira consortium) agreed to buy 50.5% from Haim Saban’s German Media Partners, valuing Pro7 at ~€5.9B. Lavena paid €28.71/sh for Pro7 common, and €22.40 for Pro7 preference shares (‘PSM GR’; no voting rights).
  • In Jun ’07 – Pro7 acq’d SBS Broadcasting for €3.3B; SBS is a broadcaster focused Scandinavia, Benelux and Eastern Europe.
  • In Dec ’07 – Lavena Holdings acq’d an additional 12% stake from Axel Springer for ~€509mm (€19.40/sh) – bringing its total ownership to 62.7% (100% voting interest); Lavena also holds a significant portion of the HoldCo debt.

Industry – The free TV industry in Germany is a duopoly between RTL Group and ProSiebenSat.1 – combined they have >60% audience share and >80% advertising share.  TV advertising in Germany has still not fully recovered from its decline post-2000 when it peaked at €4.7B, and currently is back at levels not seen since 1998.

• Germany tends to be a better market than most for free TV broadcasters.  Audience fragmentation is not a big risk; pay TV penetration is already very high as almost all German households already subscribe to cable and satellite.
• ~55% of German TV HHs have cable and 41% have satellite.  The average analog cable HH receives about 35 channels and the average satellite HH receives more than 40 channels. 
• DVRs and digital penetration are currently ~10% of German HHs – the majority of cable plant is not fully upgraded and the incremental digital programming is not very abundant; there is more English content than German content available.
• German TV continues to gain share from newspapers as print media continues to be the largest medium in Germany as measure by ad expenditures.

High level thesis – Pro7 is a cheap, highly-leveraged broadcaster benefiting from the early cyclical ad recovery, German macro recovery, cost-cutting and deleveraging via thru FCF generation and the pot’l disposal of non-core assets. The combination of the FCF ramp with a reduction in leverage during a recovery should result in 30-60% upside in the next 12 months. My 12-18 month price target is €18-20/sh.

• It operates in an industry with significant barriers to entry and a duopoly market structure.
• Current valuation of ~8x cons ‘11E EBITDA (~7.2x my numbers) is >25% discount to the FTA broadcaster average of 11-13x, as well as its own historical average of 10x EBITDA.
  
• Current share price is >50% discount to Lavena’s purchase price for a controlling stake in 2007.

Quality of company from secular perspective based on market position, management and secular issues.

• Management: In Dec ‘08, Pro7 hired a new CEO who put a stop to discounting by replacing the head of ad sales, and signaled to media buyers, advertisers, and competitor RTL that pricing was going up.
  • Pro7 embarked on an aggressive cost-cutting program in ‘09 that achieved savings of >€220mm. I expect management to make another round of cost cuts in 2010 of ~€50mm.
  • Both RTL and PSM will begin raising rates and curtailing discounting, eventually leading to growth in German TV advertising as the economy improves.
• Macro: Germany emerged from the recession in Q2 09. The German economy is in a far better state than other European economies, as well the US. Unemployment stands ~7.5% vs. over 10% in France, UK, US, and ~20% for Spain. Unlike most of these countries, Germany did not see a housing bubble. Business confidence rose to an 18-month high in Jan ’10, while the government increased its 2010 growth forecast to 1.4% from 1.2% earlier this year.
• Edge: This is a two-player market. The key to getting edge here is talking to media buyers responsible for purchasing on both Pro7 and RTL. These include, but are not limited to, the following: Omnicom, Carat, Adidas, Daimler, CBS International, RTL Group, MPG Germany, Pilot and OMD. 
  • Pro7’s market dominance of 14-29 year olds (~1/3 audience share)
  • RTL vs. Pro7 – market position, strength and weaknesses, level of budget sequentially, Y/Y, etc.
  • Outlook for German TV ad spending
  • German economy/macro outlook

Catalysts including analyst days, conferences, roadshows, potential upgrades / downgrades, sellside previews, lockups, earnings releases, customer wins/losses, etc.

• Q2 results: Expect a solid Q2 quarter. In Q1, management was more upbeat than I expected raising the lower end of the 2010 guidance range from -2% to flat. CEO even indicated that the top end (+2%) may move up to 3% or even 4%. I expect German TV NAR to turn +VE: +1-2% vs. -5% cons; -11% comp. Expect +ve management commentary on German, Dutch pricing power. Expect sequential improvement in German TV NAR and International TV NAR decline. Also expect +ve commentary on no capital raise, on the new sales model, and on asset disposals.
• Deleveraging: Ongoing. PSM GR is heavily levered at ~3.8x ‘10 EBITDA, but the company has no maturities until 2014/2015 and should generate more than €700mm of cumulative FCF over the next three years, reducing leverage to ~3.3x EBITDA by YE11, and ~2.8x by YE12. Each ~€100mm paydown = ~€0.50/sh.
• Asset disposals: PSM GR has targeted a handful of non-core assets that it could look to sell to paydown some of its debt, including their recent announcement of the sale of C More, some pay TV assets in select markets, its radio division ‘Veronica’ and potentially SBS’ print businesses.
  • Management’s view on timing: "current market multiples are coming back and the potential market to sell will be there in 2010 – non-core assets like Veronica are clearly on the sell list".
  • Pro7 is looking at potentially selling its breaking news channel - N24. N24 is loss-making and management is willing to sell for 'acceptable terms'. A decision expected by the end of Q1 2010. Financials no longer disclosed, but based historical and press spec – looks like they could get ~€150mm – translating into €0.70/sh on the stock.
• Better advertising: Media buyers are getting more optimistic about 2010. Market dynamics will SIGNIFICANTLY improve next year – CEO is "optimistic that Pro7 will be able to put through price increases in Holland and Germany" Still need to see if that translates in NAR growth but management sounds optimistic "all players in the market will be committed to increase prices...there is more activity in Q4, some late money in the market. Too early to make a forecast but more optimism in Q4."  Saying too early to forecast 2010, it will be +VE.
• Resumption of dividends: I believe there is a decent likelihood Pro7 will announce resumption of a small dividend in 2010.
• Cost savings: Expect savings of €200mm for ’09 (€193mm thru Q3). I believe Pro7 will exceed ’09 cost-savings target, and introduce ’10 cost-saving target (expect ~€50mm).
• Debt restructuring: Majority owners KKR and Permira have publicly stated they are prepared to support Pro7 with add’l shareholder loans, and is continuously looking to optimize capital structure.

Setup – What I really like about this story is a considerable rebound in Germany isn’t needed for the stock to work, unlike its peers. If Pro7 delivers decent revenue growth on a back of modest NAR growth (+2-3% in ’10; +4-5% in ’11), and management can control costs tightly while protecting FCF, I believe sentiment will improve, deleveraging will progress and the valuation gap will narrow

• Until the recent market swoon, Pro7 had traded at 52-week highs, and is up over 500% from its yearly lows set on 3/10/09 of €0.88. Given its financial gearing, the stock is very volatile and should be actively traded. I anticipate very strong Q2 results and 2010 commentary. In fact, I believe Pro7 may be one of the few broadcasters to emerge from the downturn with stable ad market share, improved audience share and potentially higher EBITDA margins in its core German TV business.
• Valuation: PSM GR trades ~8x cons ’10 EBITDA and ~9x ’10 P/E – this represents a discounted multiple on trough results. Comparables trade in excess of 10x EBITDA.
• Analyst ratings: 8 Buys / 7 Holds / 7 Sells with avg PT = €14.53.

Risk / Reward – Risk is down to 7x ’10 EBITDA (~€7.50/sh) with 12-month target of 8-9x ’11 EBITDA for a range of €18-20/sh, or >50% upside. If PSM GR were to trade inline with Euro FTA peers @ 10x EBITDA, its target price would be €23/sh. Pro7 is a highly operationally and financially geared company – there is upside risk to these targets on higher cost savings, faster rebound in German NAR, re-initiation of a dividend, disposal of non-core assets, faster debt paydown, etc. PSM GR is a volatile stock and requires a more active trading strategy. After making 52-week highs earlier this month, the stock has swooned with the market. I would look to build a starter position between ~€11-12/sh and add on weakness.

Catalyst

• Deleveraging
• Asset disposals
• Advertising rebound
• Resumption of dividends
• Cost savings
• Debt restructuring