It is a fact of corporate life that company management will occasionally decide to significantly change the strategic direction of the business they run and, whenever this happens, it is a fact of investment life that sometimes you will agree the decision is in the best interests of the business and its shareholders – and sometimes you will not.
For many years, satellite broadcaster BSkyB has focused almost exclusively on growing organically within the UK, but evidently the powers that be have now decided this is the time to expand its horizons. To that end, BSkyB has said it is to pursue growth in Europe through the acquisition of both 100% of Sky Italia and a controlling stake in Sky Deutschland. The stakes are to be acquired from BSkyB’s own controlling shareholder, 21st Century Fox.
To the eyes of The Value Perspective, the most striking aspect of the proposed deal – aside of course from the fact it represents such a marked departure from the very successful strategy BSkyB has pursued over the past decade or two – is the combined near-£5bn price tag the company is paying for two businesses that are at relatively early stages in their development.
While both Sky Deutschland and Sky Italia have been in existence for a few years now, they are still relatively young businesses and neither is particularly profitable or cash-generative in its own right. Perhaps the most positive way to describe their current situation is they are just about at that stage where their own cashflows can sustain the investments they need to make in order to continue growing.
Here on The Value Perspective, our concern would be that in stumping up some £5bn in cash for two businesses – and remember this only buys it 57% of the German company – that currently make no profits, BSkyB’s valuations of Sky Deutschland and Sky Italia appear to take for granted a meaningful amount of their future profit growth.
As ever, when a business pays a rich price for something, there is less room for manoeuvre – less margin for safety, so to speak – in salvaging an acceptable return from that investment should things not work out as it has planned (or hoped).
It is only fair we observe it may turn out that, by doing these two deals, BSkyB has played a blinder and the company ends up with one or more hugely valuable assets that make the price being paid today appear a bargain. This is obviously what the company’s management hopes – maybe even expects – will happen and it has a reasonable track record of delivering good financial results for shareholders.
The trouble is, if we were to take the returns from, say, 100 deals done on valuations in this ballpark over time, we suspect that – far more often than not – they would not look great. In short, whether for individual investors or corporate acquirers, buying assets on a rich valuation stacks the odds against your making a good return and, over time, you will have to be very skilful – or very lucky – for this to not catch you out.
As value investors, we are always looking to stack the odds in our favour where we can and so the valuation of this deal – in combination with the way BSkyB is gearing up its balance sheet to do it – explains why The Value Perspective has pressed the ‘off’ button on its metaphorical remote control.