We love writing about industries with structural concerns, we have done it before and we’ll do it again. But we don’t like investing in them.
Consolidation in a sector often brings share price appreciation but also masks the more worrying long-term reason why it had to occur in the first place. Some consolidation enables companies to marry technologies or geographies to expand the opportunities in a growth market. Those we like.
There was an example this week with international stock Atlassian vending one of its technologies into a competitor’s business and then taking an investment in order to create a better outcome in a fast-growing space. But others occur because companies are getting desperate for growth, or have already run out of growth and cost cutting or taking out a similarly flagging opponent is the only solution remaining. These we don’t like. There may be short-term earnings benefits but long term it’s back to the normal long decline.
We experienced it first-hand with PMP Limited (ASX:PMP). It merged with one of its major competitors whilst another competitor mopped up the other major player in the printing industry to create an effective duopoly at the top of town. With synergies and then a more sensible pricing outcome mooted there was an expectation of a few years of profit growth and strong dividends. It looked dirt cheap. Sadly the printing market’s rate of decline turned out just too great to lessen the competitive tension and the merger benefits not enough to offset the continuing decline. So the outcome was less than expected and shareholders ended up exposed to a company and sector going nowhere. The share price still hasn’t recovered. Fortunately we sold out long ago.
This week’s much discussed takeover of Fairfax (ASX:FXJ) by Nine Entertainment (ASX:NEC) is the latest instalment in this type of scenario. News is buying Fairfax because it has to. Both the newspaper industry and the television industry are in decline. Fairfax has some assets like radio stations and Domain (property website) which will benefit from the ownership of a larger group, but most of has been seriously deteriorating for years. Fairfax needs to sell because it has exhausted itself cutting costs. Seven Group’s media assets, which has obviously missed out here, has no media growth and very little available to help it avoid a slow demise.
The short-term synergies are lucrative. But most of it is cost-outs. Revenue synergies are there but, like PMP, they will simply be offsetting structural decline. TV and newspaper revenues will continue to fall in the face of competition from the digital world. We are well aware Nine and Fairfax have invested in digital but those assets are still dwarfed by the old media assets. Linking this back to our earlier comments regarding PMP, it is interesting to note that Fairfax did a deal two weeks ago with News Corp to print each other’s newspapers out of a selection of each other’s printing facilities and close the remaining assets no longer required. Short term gains, but really it tells more of the declining state the media sector is in.
It can affect newish companies too. We’ve been watching with interest the share prices of Facebook, Netflix and Twitter fall of late. They are single use assets which have experienced extreme top line growth on a global basis. The growth is so extreme that the brands have become ubiquitous in a relatively short time. That means the majority of users who are going to be interested in then have already tuned in. So then what?
They have to think about other ways to monetise their position. That’s not easy. Consumers are familiar with the main product and become comfortable and complacent. And if there is something better out there they will jump across to that. It’s the nature of media these days. Netflix has done such a good job it’s hard to know where it can add better value. Facebook is used by everyone so younger people have been leaning away from it (not to mention its controversies). Twitter is just becoming old-hat. They may have to start consolidating more to hide the pressures they are facing.
At least Fairfax and Nine enjoyed decades of growth. It doesn’t seem to be the case with the new lot.
