Absurdism – The Creative Arts and ITV

A week ago, I attended a production of “The Chairs” at the Almeida theatre, written by Eugene Ionesco, one of the founding fathers of the Theatre of the Absurd movement of the 1950s. The absurdity of the plot and the performance were compounded by the fact that Mr and Mrs Beagles were reluctantly invited up onto stage to take part in some meaningful audience participation, involving moving imaginary chairs around and greeting imaginary guests to a party.

The world of the creative arts and the absurd have collided once again in the last few days at ITV. For full disclosure we hold ITV in the J O Hambro UK Equity Income Fund and our colleagues also do in the J O Hambro UK Dynamic Fund and we see the company as a key long-term holding that we have added to over the last week. Clearly now is not an opportune time to report results given the geo-political background, but on Thursday 2nd March, ITV released their 2021 figures which showed that total advertising revenue had grown by 24% to its highest ever level, despite the continued presence of COVID lockdowns during the year, and that earnings per share were up 40%, slightly ahead of market expectations. Furthermore, they reported that the current year had started strongly, with advertising revenue +15% for Q1 2022. The shares fell 27% on the day.

Obviously investors are concerned that future economic growth and business confidence may be materially impacted by events in Ukraine and this partly explained the share price fall on what was a very weak day for markets. However, the main reason the shares fell was because ITV announced an acceleration in their digital transformation strategy, with the launch of their new streaming platform, ITVx. What is ITVx? Well, firstly it is important to point out that it is not an attempt to compete head on with Netflix. ITVx will consolidate their existing digital platforms, ITV Hub and BritBox onto a new umbrella platform. Whilst this will continue to have a premium subscription offering, predominantly based around BritBox as well as an option to watch other content ad free, the priority of the new platform will be to further expand their free-to-watch/ advertising-funded video on demand (AVOD) offer with more content and the ability to deliver addressable audiences to advertisers, via their Planet V technology. At its simplest this will allow advertisers to deliver targeted and differentiated marketing messages to individuals rather than having to broadcast a single advert/message to the entire audience simultaneously as they currently do via the linear main ITV channels.

This development will entail an incremental cost – around £20m in 2022 as the platform launches - and a further additional £160m in 2023, most of which will be on new content (of which at least 50% will be made internally by ITV Studios). This investment in content is clearly not a “sunk cost” as it will drive revenues in future years as the value of the programmes is monetised across ITV’s various channels. Indeed, speaking to the company this week, it is clear that the main reason for launching this investment programme now is because ITV was short of product or inventory to monetise on its digital platform. In 2021, digital advertising revenues grew by 28% whilst digital viewing grew by 12% - there is more demand for digital product than supply.

In the short term, this additional investment has crystalized earnings downgrades for 2022 and 2023 of 10-20% by most analysts but management have stated that they expect the revenues generated by this additional content and platform to at least match the investment cost by 2026. Our discussions with the company yesterday would suggest this guidance is extremely conservative. In the three days following the results, the stock market reduced the market capitalisation of ITV by around £2bn, or just under 40%. This is despite the fact that the company was already trading on only around 7x consensus 2022 earnings before the announcement, reflecting some concerns about the sustainability of their advertising revenues due to structural viewing changes and also despite the fact that the company have stated that they expect this investment double their digital revenues by 2026.

At the market close on 7th March, ITV was priced at 73.4p – a P/E of 4.8x the 2021 reported results, which showed a renaissance in TV advertising with a record year but still reflected negative COVID impacts on the margin at the studios business because of the extra costs of production; so a normalised COVID-free EPS number would have been meaningfully higher. Furthermore, whilst the investment may have reduced the short-term EPS, it will accelerate the Group’s digital transition and will surely result in a higher terminal value in time. In addition, the Group has a very modest amount of debt (£414m – less than 0.5x Net debt/EBITDA), which creates the firepower and potential to either buy Channel 4, if the UK Government decides to proceed with a privatisation, or to launch a share buyback. Analysts have speculated that an acquisition of C4 could be 30-40% EPS accretive whilst the company could buy back 20%+ of their share capital and still be below their net debt/EBITDA target. Finally, studios businesses globally are valued on 10x EV/EBITDA or more – if a 10x multiple was applied to the ITV’s 2023 Studios EBITDA, by which time, the COVID margin impact would have largely washed through, then it would throw up a value of around £3bn, equivalent to the whole of the market cap of ITV at 73.4p, effectively valuing the rest of ITV ( the media and entertainment division which made c.£600m of EBIT in 2021 ) as worthless.

Of course there are few certainties in investing. But thinking back to last week’s show at the Almeida, I wonder what Eugene Ionesco would make of how the market’s valuing ITV at the moment – in some ways it feels like something from his Theatre of the Absurd.

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