Description

SKY Perfect is the dominant provider of multi-channel Pay TV via satellite in Japan. It is a platform provider that links satellite operators, licensed broadcasters and subscribers. It was founded in 1994; in 2000 it bought the subscribers of Direct TV Japan (from Hughes) to become effectively the only satellite broadcaster in Japan. It currently has 3.4 million subscribers. It does not own or operate any satellites, it rents space from JSAT who owns an equity stake in SKY, likewise the major content providers also own equity stakes (Fuji TV, Nippon TV and Tokyo Broadcasting, as well as an 8% stake held by News Corp). Sony provides the set top boxes and also holds a 10% stake. The company model is not materially different from, Echostar, Direct TV or BSkyB, and should be compared to them. Further information can be found at www.skyperfectv.co.jp.

Positives:

1. Market position: With 3+ million subscribers (just a 6% penetration rate) it dominates satellite broadcasting, an effective monopoly. There is a start-up competitor backed by Nippon TV (which is also a SKY shareholder), which has less than 100,000 subs, and is widely expected to be merged into SKY at some stage. The cable industry in Japan is underdeveloped, fragmented and poorly financed and has just a 30% penetration rate. This has lead to a very low churn rate of 8%, which is a very important statistic in the economics of satellite broadcasting (DISH and GMH run at 20%) also subscriber acquisition costs (SAC) are low at around $225 v’s $500+ for the US companies.

2. Business Model: As a subscription model it does not need to invest in working capital to grow, also since it does not own the satellites it is not capital intensive unlike the cable companies. Its major investments are to secure broadcasting rights.

3. Balance sheet: The company raised 128 billion yen ($1,066m) in its IPO in October 2000. It is expected to end this fiscal year with 90 bn ($750m) of net cash, and to be FCF positive next fiscal year (March year end). This is 42% of the current equity value of 210 bn yen.

4. Management: President (CEO) Unoki spend 27 years at Sony and was president of AIWA for 11years and is well respected. In addition this is a young company and does not have the ingrained practices that are common in Japanese companies.


Negatives:

1. SKY has yet to reach profitability on a sustained basis, as is common in the industry, but it has just reported its first profitable quarter. Management expects to be profitable next year, but increased spending to secure broadcasting rights could put back this timetable. This is a double-edged sword as unique broadcasting rights will drive subscription growth which given the operating leverage is more important in the long run.

2. Average revenue per user (ARPU) has been declining, management thinks it has stemmed the decline, but they have to prove they can drive this figure higher long-term. It is hard to tell how much this figure is impacted by the very week economy. ARPU at $33 is low by international standards, and has potential to increase in the future.


3. While content inflation has become much less of a problem, it still needs to be monitored. It was feared that SKY had paid too much to acquire rights to the World Cup, but they proved by it was a good strategy to drive subscription growth. Subscriber growth has been running at 15% a year, but has slowed down in recent months; management could become more aggressive in their quest for subs at the expense of short-term profitability.

4. Media Ownership Laws: To retain their broadcasting license Japanese media companies can not have more than 20% of their equity held by foreigners. That limit has been reached, foreigners can still buy the equity but you cannot register your ownership with the company. This has the effect of the company not being able to repurchase stock, as well as precluding a takeover by a foreign company.

Valuation

This is a little problematic as the company has yet to reach profitability. There is little to suggest here that this is an inferior Satellite company on an internationaly comparative basis. Critical mass has been reached, market position is strong, churn and SAC are low, and the balance sheet is strong. Among the most common valuation techniques is EV/subscriber; while this may not be the most ideal basis to value a company on it does suggest the company is extremely cheap. Enterprise value is 120 bn yen ($1bn) with a current 3.34m subscribers gives an EV/Sub of just $300. This compares to $1,200 - $1,500 for the U.S. players and over $3000 for the very dominant BSkyB of the UK. (Also Murdoch owned, with no satellite assets). The cable companies that are more capital intensive with worse balance sheets trade between $2,500 and $3,000.
Private market values also suggest SKY is cheap, two offers have been made this year in Europe for second and third place operators at between $800 and $1000 a subscriber.
It should be noted that SKY Perfect just reports as revenues what it retains from subscriber management services and commission fees on content broadcast, it does not report the subscription fees that it remits to the content providers, this is in contrast to DISH, DirecTV and BSkyB who acquire content, and then effectively sell it to their subscribers. You can adjust revenues to account for this difference. Adjusted revenues will be 190 bn yen (reported 72 bn) this year, for an EV/Sales ratio of 63%, this compares to 2.5x for DISH.

Catalyst

1. Realization that the company will be profitable on a Net Income basis for the 2003 fiscal year.

2. SKY Perfect is listed on the ‘Mothers’ section of the Tokyo Stock Exchange; most institutions in Japan cannot buy companies on ‘Mothers’ (it was set up by the TSE at the height of the internet bubble to cater to unprofitable companies, that under the rules of the TSE could not be listed on the first section of the TSE). SKY is seeking an exception to the rule that unprofitable companies cannot be listed on the first section given their importance in the media industry in Japan. This is expected to be granted presently.