Corporate finance and the media industry

9.11 Corporate finance and the media industry

We often read articles in the media trade press, or in the media or business sections of the broadsheet papers, reporting the share price, current profits,

Strategic management

price earnings ratio etc. of companies in the audiovisual industry. How are we to interpret this information? As employees or potential investors, we may want to understand more about the performance of a particular media company listed on the stock exchange. Financial advisors use the performance of companies listed on the stock exchange as an indicator of the health of a sector as a whole. This may have an impact on the opportunities of even the smallest company to borrow money or negotiate with venture capital. Should a small company grow big enough to offer shares more widely, the price set will be determined by comparison with the performance of those companies listed on the stock exchange. It is therefore important to have an understanding of the market mechanism and the performance of companies beyond the balance sheet and the profit and loss account. These measures have implications for all players in the media industry – employees, freelancers, subcontractors, and those who own companies.

In the past, the small investor was key to a company owner’s ability to raise capital. This role has diminished over the past few decades. The private investor’s percentage of total share holdings declined from approximately 66 per cent in 1957 to 21 per cent in 1989. It is the institutions that have become the important investors on the stock market. This has had a significant effect on the style of investment portfolios as the power shifts from many small investors to key personnel managing investment portfolios for insurance companies, pension funds and financial institutions.

The current status of the media companies listed on the stock exchange is printed each day in the Financial Times (FT). They represent a cross-section of media-related industries, from print, packaging, publishing, photography and entertainment to broadcast television companies and the larger production companies. These companies are used as a benchmark to the health of the media sector as a whole. The performance of companies such as Carlton, Pearson will more specifically provide an indication of the trend in the television industry. There are other sources of financial information that give more details of a company’s performance. These sources can provide data on the performance of the media sector as a whole, or a more defined sub-section of it.

To be able to measure comparative business performance requires an analysis that is independent of the balance sheet numbers. There are several financial tools used to convert balance sheet figures as published by a company, and this is known as ratio analysis. Some of the important ratios are as follows.

Managing in the Media Profitability

The return on capital employed (ROCE) is the key profitability ratio. It is a measure of the profit compared to the capital invested, and is therefore a measure of the capital efficiency of the company.

The ROCE = profit/capital × 100% If a project cost £250 000 and the profit was £40 000, then ROCE = 16 per

cent.

Investment

The price earnings ratio (p/e) ratio is simply the ratio between market price and earnings per share, expressed as:

p/e = market price per share/earnings per share (eps) For example, if the market price of a share is £1 and the eps is £0.50, then

the p/e ratio is 2. To think of this in another way, it will take 2 years to recover the capital investment in this £1 share. It is also a way of knowing the interest payment on the share. In this case it would be 50 per cent; an extremely good return in the current market with bank interest at about 6 per cent.

When examining the performance of a company that is not listed on the stock market or has not provided a listing of the p/e ratio in the year-end accounts, we can establish this figure for ourselves by finding the earnings per share.

The earnings per share (eps) is given by the accounting profit per share after all costs have been deducted. This should not be confused with the actual dividend per share, which is the payment per share voted by the company board. The eps is the amount of money available to the board to offer to the shareholders. It is a measure of the overall profitability of the share base, and is shown by:

eps = net profit/number of shares For a company with a current share issue of three million shares, a net profit

of £0.9 million before dividend payments and a share price of £2: eps = £0.9M/3M = 30 p Using the eps and knowing the market values of the share, the p/e ratio can

then be calculated, given that: p/e ratio = market price per share/earnings per share The p/e ratio is therefore 6.6.

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It would be helpful to establish what the p/e ratio actually means to the market and to the company. The purpose of this ratio is to be able to compare the relative performance of shares with one another without having to consider the absolute value of the share. The range of the p/e ratio is therefore crucial to the analysis of the relative merits of a share within its sector, or between one sector and another.

From these and other ratios, we can interpret the reported accounts of the company. Does the current share price undervalue the company? Do the performance indicators across the sector inspire speculative investors? The current p/e ratio could indicate that the future earnings for the group are expected to be good; it could also mean that the market will expect a good performance in the future and that the share price will continue to rise.

Theoretically, for all companies the choices of what to do with profits are:

1 Issue a bigger dividend up to the maximum eps

2 Invest more. Either could encourage investment. If there was a sudden shift to a larger

dividend that could not be sustained in the future, then the danger is that the share price will fall substantially due to lack of confidence in the future performance of the group and the board’s ability to manage the company.

The answer could be to offer a dividend in line with the investment strategy and allow the ‘efficient market’ to decide and thus regulate the share price.

The dividend yield (DY) shows the shareholder the return on the investment, and is calculated as:

DY = dividend per share/market price per share The capital gearing is the relationship between what the owners of the

company have invested in the company and what the bank or other third party investors have invested. The company will be considered highly geared if there is a high proportion of preference shares and long-term loans (from third parties) compared to the money invested by the shareholders. High gearing, along with high risk, with unknown profits, makes for a very nervous bank manager. This is often typical of the small production company. When two or more people come together to make a film or video production, they are often advised to form a limited liability company; hence many media companies are really a collection of projects organised and managed by the same core team. The smallest company is then a single project, and

Managing in the Media

the rules that apply to the company performance as a whole can be applied to the single project or contract.

preference shares and long-term loans Capital gearing =

shareholders’ fund