Should you buy, hold or sell Nine Entertainment shares?

When people think of Nine Entertainment Co. (ASX:NEC) their first thought is the Channel 9 television station where they watch the news, The Block and rugby league.

The natural extension from there is that Nine must derive its revenue from advertising. While this is true it is not the full picture.

Nine is a diverse media business. In addition to the free to air TV station 9, it owns the on-demand service 9NOW, a number of radio stations including 2GB and 3AW, the video streaming service Stan, all of the old Fairfax print and digital publishing mastheads like The Financial Review, The Sydney Morning Herald and The Age, along with about 55% of real estate advertising business Domain.

When you look at the complete picture, about 63% of revenue comes from advertising, or 75% if you include 100% of the revenue from Domain. Revenue has grown at a compound annual growth rate of 17% over the last 4 years and is forecast to grow a further 14% in this financial year.

Advertising revenue tends to be quite cyclical, fluctuating with movements in economic growth. Further, advertising revenue from the traditional formats of free to air TV, radio and print publications has been gradually declining. The recent declines in Nine's share price may be a reflection of the concerns around the slowing of economic growth.

The portfolio of radio stations were acquired via the purchase of Macquarie Media. Nine acquired the remaining 45% of Macquarie Media that it did not previously own in November 2019 for $114 million. Since then, revenue from radio has fallen from $131 million to $91 million. In recognition of this decline, $61.5 million of the intangible assets were written off.

Nine remain optimistic that radio can turn around and make a more meaningful contribution. In the quarter ended 31 March, radio revenue grew 6% and second-half earnings before interest, tax, depreciation and amortisation (EBITDA) is expected to be higher than the first half. Whilst the optimism may be more like wishful thinking, radio only accounts for 4% of revenue and an EBITDA margin of 9% so it is not a big contributor.

The area of opportunity for Nine lies with digital revenues which have been growing strongly at around 30%. They already account for about two-thirds of the revenue from publishing, about a third of the revenue from TV, including Stan, most of the revenue from Domain and only a sliver of revenue from radio. There is a lot of opportunity for this to grow, even in radio, where streaming is becoming increasingly popular.

In contrast to traditional advertising, the subscriptions side of the business has been growing strongly. This includes Stan as well as the digital side of the publishing business. Subscriptions accounted for 20% of revenue in 2021. It is worth noting that advertising on digital formats has continued growing.

Of course, with any media business, performance is dependent on strength of the content strategy. Both advertising and subscription revenues follow the eyeballs (or ears).

Mike Sneesby took over as CEO in April 2021. He was previously in charge of Stan and so has a strong background in digital and subscription businesses.

Despite the strong revenue growth in recent years, earnings per share (EPS) has trended in the opposite direction, only rebounding in 2021. It declined in 2018, 19 and 20 before rebounding 23% in 2021 and is forecast to grow a further 26% this financial year, but will still be well below the levels achieved in 2017 and 2018.

The declines arose from COVID as well as write-downs of the radio and other business units, reflecting a more subdued outlook for advertising markets. The biggest write-downs occurred in 2020 when the COVID crisis was at its zenith.

Advertising markets were highly exposed to COVID as firms curtailed their advertising budgets. This was magnified as content such as live sport was cancelled taking away a lucrative advertising stream.

The share price has retracted 30% from its highs late last year. Combined with the forecast rebound in EPS the valuation is starting to look quite attractive. The forward PE ratio is 11 which compares with the historical average of 13.6. The forecast dividend yield is 6.4%, fully franked. Return on equity is forecast to grow from the current level of 9.5% to 18%.

Creating content that resonates with the masses can be a bit hit and miss. But, as with investing, a diversified portfolio of shows and formats increases the chances of striking a chord.

Also, the recurring revenue model of subscriptions starts to smooth out the more volatile fluctuations of advertising. Whilst some of the old media formats are in decline, people's appetite to consume content is not. If Nine successfully makes the transition to serving people what they want in the way that they want it, then there is every chance it could become a hit investment.

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