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“If there is an offer of P100 billion, I will sign with my eyes closed,” GMA Network Inc. chairman Felipe Gozon reportedly told a press briefing last May in response to queries on buyout offers to the controlling shareholders of the media company. This amount would be “enough” for the company’s three major shareholders and the minority owners that bought in the stock exchange, he further stated.
More recently, reports have it that Mediaquest Holdings Inc., the media arm of the Beneficial Trust Fund of Philippine Long Distance Telephone Co., both led by Manuel V. Pangilinan have made an offer worth P52.5 billion in terms of enterprise value, which is the sum of the market values of common and preferred shares as well as debt. GMA7 has no debt but has 7.5 million preferred shares with par value of P0.20 each, all of which are owned by the three families that comprise the controlling bloc in the company.
(Editor's Note: Pangilinan is also chairman of TV5, for which InterAksyon.com is the online news portal.)
A very wide ocean separates the two valuations, obviously, but the tide towards a deal appears to be flowing towards the much lower boundary. Why? Surely, the normal course of any haggling would be to split the difference, which would settle the GMA7 matter at around P76 billion, right?
Acquiring an entire company lock-stock-and-barrel can be a bit more complicated than purchasing a pre-owned automobile. When a company buys another company, it can be a major multi-billion-peso investment decision that is made under great uncertainty. A lot of information and factors go into the decision, including the growth prospects of the company and the industry it operates in, its cash flows, the prevailing cost of money, the extra benefits or synergies that can be generated from the deal, the choice of accounting, as well as tax and legal effects, and so on. In the final analysis, the rule is this: the target company should be acquired if its overall future cash flows exceeds the purchase price, i.e., it generates a positive net present value to the shareholders of the acquiring firm. That is very difficult to do in most cases.
The market, as well as GMA7’s underwriters during its initial public offering, apparently had it mostly wrong. This is apparent when one looks at GMA7’s post-IPO share price performance prior to the current takeover excitement in the market.
GMA7 was first offered to the public at P8.50 per share in July 2007. Except for at the start of February this year, GMA7 has consistently traded below its IPO price. Even at the recent close of P10.30 per share, the stock has returned a measly 3.9 percent per annum, on a compounded basis, versus the overall local market’s annual return of 8.3 percent over the same period.
At the IPO price, the company was valued at roughly P41 billion (including the preferreds), at which the three controlling families happily sold P6.2 billion of their own holdings. This accounted for 80 percent of the IPO proceeds of P7.76 billion. The company currently has a market value of P34.6 billion.
The company’s principal shareholders are the three families led respectively by Gilberto M. Duavit, Felipe L. Gozon, and Menardo R. Jimenez. Each family, post-IPO, holds 28.35 percent, 24.21 percent and 28.29 percent, respectively, of the company’s share capital, including preferred shares. Altogether, the three families own 80 percent of GMA7.
The preferred shares are convertible at the option of the shareholders at the ratio of five preferred shares to one common share, based on par value, according to the company’s disclosures. However, the board “may specify other terms and conditions, qualifications, restrictions and privileges of the preferred shares or series/classes thereof, insofar as such terms, conditions, qualifications, restrictions and privileges are not inconsistent with the articles of incorporation and any applicable law or regulation.” According to media reports, the preferred shares have greater voting power and are convertible at the rate of one preferred to one common. For valuation purposes, therefore, the preferred shares may be treated like a common share.
The next question to ask would be: what accounts for the underperformance of not only GMA7 but also of its main rival, ABS-CBN Broadcasting?
A number of things. One is the maturity of the so-called “old media” industry where both companies belong. When an industry reaches maturity or old age, its average sales growth approaches the growth rate of the economy and may even go below it. The country’s gross domestic product, in current value terms, grows an average 10 to 12 percent. GMA7’s top-line growth, in comparison, has averaged less than 5 percent and, during election years, does not exceed 10 percent.
More tellingly, in the first quarter of this year, GMA7 net revenues declined 5 percent, while the country’s GDP grew over 6 percent, in real terms. Its corresponding net income plunged 27 percent.
Not only is the “old media” neck of the woods at its elderly growth pace, the competitive struggles within this industry has become rough and tumble. As GMA7 stated in its annual disclosure: “The company currently competes for audiences and advertising revenues directly with other broadcast stations, radio stations, newspapers, magazines, cable television, and outdoor advertising within their respective markets.” The revitalization of TV5, a direct competitor helmed by would-be buyer Pangilinan, effectively intensified the industry infighting for a piece of a stagnant-growth or shrinking advertising revenue pie.
Why would anyone buy into this unattractive industry and company? Happily for GMA7 shareholders, there are a number of positive things going for their company. These include a leading position in the industry, clean books with no debt whatsoever, and no need for heavy capital expenditures, which means zero retention of earnings that are wholly paid to shareholders each year. Taken all together, these factors mean one thing: lots of cash flow.
The company consistently throws off approximately P2.2 billion in free cash flow each year. Free cash flow, which is much-beloved by would-be takeover artists, refers to the cash flow that remains after the company has set aside the necessary funds for operating working capital, capital expenditures, and debt payments. The cash flow that remains is “free” to be deployed by management as they wish.
This free cash flow, then, needs to be valued using the discounted cash flow techniques employed by equity analysts. Using the long 25-year bond rate as part of the discounting rate and a high equity risk premium of 8.9 percent, the company’s free cash flows would be valued at P24 billion, much less than the current value of the firm and well below the Pangilinan offer price of P52 billion.
This is where some financial engineering comes in. Since GMA7 carries no debt, the cost of its capital rests solely on the cost of equity, which is the more expensive kind due to its additional risks. One potential source of synergy is to be able to lower the cost of borrowing for the combined companies. In the case of GMA7, if its new owners were to restructure its capital to 60:40 in favor of debt (borrowing at prime rate at 5.5 percent), then the overall cost of capital would fall to around 9 percent from the previous 14.5 percent. The resulting value of GMA7 would then become P54 billion, or about P16 per share (issued shares of 3.364 billion).
So, P50 to P55 billion it is.
But that is only the start. Pangilinan will need to shell out this amount but, afterwards, has to create synergistic values that surpass it. Otherwise, he and his shareholders would be better off doing nothing, staying at home and just watching the telly.
The potential sources of these synergies, aside from the unused borrowing capacity, would include marketing gains from a wide distribution network, a strategic beachhead in the new media as a result of this broader network, cost reductions due to economies of scale and complementary resources, and lower cost of capital for the group.
Take for example one source of synergy: economies of scale and complementary resources. It may be seen that while revenues have been weak and even sliding, the talent fees paid by the industry have been rising strongly due to the stiff competition for the limited number of bankable talents in the industry. With control of two channels, Pangilinan would have gained the upper hand in negotiating for talent fees.
In the end, Pangilinan has steadfastly adhered to his long-time strategy based on his belief in technology, media and telecommunications convergence, which foretells that one day everyone would be getting their news and information, be entertained, watch shows and movies, call, talk and send messages to people, and a host other things from one device. TMT convergence is seen to create new product categories, new markets, and even change the structure of existing industries. This convergence trend, according to experts, is being driven by these underlying trends: the proliferation of digital data, widespread connectivity, and continuous advances in technology.
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