TVNZ Scoping Study

Tony Ryall State Owned Enterprises

Scoping Report onTELEVISION NEW ZEALAND LIMITED

May 1998

Cabinet agreed on 3 november 1997 to investigate the Crown's ownership interests in TVNZ. This report was commissioned by Treasury following the 3 november 1997 Cabinet decision.

The report was prepared by a consortium led by Ord Minnett.

The report was completed in May 1998.

Note

Cabinet agreed on 3 November 1997 to investigate the crown's ownership interests in TVNZ.

This report was commissioned by treasury following the 3 November 1997 cabinet decision. The report was prepared by a consortium led by ord minnett. The report was completed in may 1998.

Note that parts of the document have been deleted or summarised by the government in accordance with sections 9(2)(b)(ii), 9(2)(ba)(i), 9(2)(i) and 9(2)(j) of the official information act, which allows for commercially sensitive information to be withheld where this outweighs the public interest in making the information available.

Where text has been summarised it is contained in square brackets. Where text has been deleted, "[text deleted]" has been inserted.

1.0 Executive Summary

1.1 Introduction

TVNZ

TVNZ is New Zealand's leading television broadcaster. In the first three months of 1998, 65% to 70% of viewers watched one of TVNZ's three channels, a very high proportion compared to industry norms worldwide.

TVNZ is a fully commercial broadcaster. Advertising commenced within weeks of the first television broadcasts in this country and has been the principal source of revenue for over 20 years. TVNZ was established as a State Owned Enterprise in 1988 and has been profit-motivated, and profitable, since then.

TVNZ's subsidiary, BCL, is New Zealand's main television transmission service provider. Virtually all of the terrestrial broadcasting of TVNZ, TV3 and SKY channels is from BCL's transmitter towers.

[Text deleted] Shareholders' funds as at 31 December 1997 were $245.5 million.

Scoping Report

Ord Minnett was appointed by Treasury in February 1998 to undertake a review of the Crown's ownership interests in TVNZ, including an assessment of the risks associated with ownership, different possible ownership structures and sale methods, and the valuation impacts and other issues associated with each option. The terms of reference for this scoping review are contained in Appendix I.

In preparing this report, Ord Minnett has been assisted by the New Zealand Institute of Economic Research (Inc.) (on regulatory and public policy issues) and by Andersen Consulting (on television industry and technology matters).

Ord Minnett is grateful for the generous assistance provided by the senior executives of TVNZ during the preparation of this report.

1.2 Operating Issues

Access to Programme Content

Acquiring popular programming to fill the schedules of its three channels is a key element of TVNZ's business. TVNZ purchases 68% of its programme hours from overseas sources. Some of the balance is acquired from independent New Zealand producers. Competition between programme purchasers has increased significantly in recent years. All of TVNZ's competitors now have an ownership association with a major global television network that provides them with better access to programme content than is available to TVNZ. Competition is expected to continue to increase with the arrival of new broadcasters and the proliferation of channels. TVNZ believes that the inability to secure appropriate programme content is one of the greatest risks it faces.

Programme Change

TVNZ continuously changes its programme schedules to account for changing viewer preferences, the activity of competitors and other changes in market conditions. TV ONE is well known for its high proportion of news, current affairs and sports programmes. Changes are expected to occur in these areas.

Live sports programmes are very important to pay TV operators. They generate far more subscription income for them than advertising revenue for free-to-air broadcasters such as TVNZ. TVNZ lost the rights to show live rugby to SKY in 1996 and has just withdrawn from bidding for rights to show live cricket. TVNZ's purchases of rights for replacement sporting events, such as the Rugby World Cup, Olympic and Commonwealth Games, were at very high prices that TVNZ now considers unprofitable. TVNZ does not expect to maintain its current level of sports rights expenditure, and this will change the extent and nature of its sports programme content.

TVNZ's in-house production of news and current affairs represents a significant cost that TVNZ intends to reduce (see below). As a consequence, the extent and nature of TV ONE's news and current affairs programme is likely to change over time.

Financial Performance

TVNZ's net profit after tax fell by 50% in 1997, largely as a result of lower ratings, a depressed advertising market, and the write-off of programme inventory and the restructuring and repositioning of the company. TVNZ's television division profitability is below that of comparable Australasian broadcasters. TVNZ intends to significantly improve its earnings over the next three years.

CLEAR

TVNZ owns 25% of the shares in CLEAR. CLEAR is involved in areas of telecommunications that are not related to TVNZ's core business.[Text deleted]

1.3 Television Industry Developments

Digital Transmission

Digital transmission is a method of broadcasting television that permits the delivery of more channels on the same radio frequency bandwidth than the analogue transmission method currently used for all of New Zealand's television programmes. Digital transmission can also provide other benefits and enhancements. Implications for TVNZ include:

  • a proliferation of new television channels, resulting in greater market fragmentation and probably a decline in the ratings of the existing main channels;
  • an increase in demand for programme content; and
  • the need for digital set top boxes in viewers' homes to receive the new signals. Ownership of set top boxes provides influence over the channel choices available to viewers. SKY, as a pay TV operator, is expected to have a leading role in the installation and hence ownership of set top boxes, placing it in a strong competitive position.

In addition to the risks above, digital transmission provides TVNZ with a number of new business opportunities (see "Pay TV and New Media" below).

Satellite Transmission

BCL has been New Zealand's main provider of television broadcast transmission services since broadcasting commenced. It has a network of 460 hilltop sites that would be very difficult for a competitor to duplicate. However, satellite is an alternative distribution platform to BCL's hilltop sites, and digital satellite transmission costs are competitive. SKY has commenced satellite transmission and plans to introduce digital services, initially with 10 channels, in late 1998. BCL no longer has a monopoly position in television transmission.

Pay TV and New Media

The advertising-funded, free-to-air television market is widely thought to be mature and relatively stable, whereas pay TV, internet services, interactive television and other new media activities are expected to experience significant growth. TVNZ anticipates that [Text deleted] new media revenue will be similar to free-to-air advertising income by 2005. To maintain a significant position in the New Zealand media industry, TVNZ will need to participate in these new media activities. TVNZ [Text deleted] is [Text deleted] investigating other new media opportunities.

Spectrum Licences

TVNZ has some unused UHF spectrum licences that would permit it to provide digital transmission of its existing free-to-air channels in most areas. It does not have sufficient licences for all of its [Text deleted] new media plans and intends to acquire further licences.

SKY

TVNZ has commenced discussions with SKY regarding the introduction of set top boxes capable of supporting all television broadcasters. These discussions might lead to co-operation in access to STBs, [Text deleted], new media and BCL transmission activities. TVNZ has a 12.6% shareholding in SKY, which had a market value of $127 million at 8 April 1998, and Board representation. [Text deleted]


1.4 Ownership Issues

Business Risk

In our view, the Crown's investment in TVNZ is subject to greater risk than investments in most "average" commercial enterprises for the following reasons:

  • TVNZ's revenue varies with audience ratings while costs are, in the short term, primarily fixed;
  • competition is increasing. SKY's subscriber base is growing strongly and a new free-to-air broadcaster is due to commence operations in September 1998. Digital transmission will result in a proliferation of competing channels and make satellite transmission a cost effective alternative to BCL;
  • BCL must select and implement a digital transmission strategy;
  • TVNZ is concerned about its ability to acquire adequate programming content; and
  • TVNZ intends to participate in [Text deleted] new media opportunities, the results of which are difficult to forecast.

Separation of BCL

Continued ownership of BCL is valuable to TVNZ during the transition to digital broadcasting for the following reasons:

  • [Text deleted] Until TVNZ's digital strategy is determined in detail and BCL's new digital transmission revenues from TVNZ are known, we do not believe it is possible to sell BCL at full value; and
  • in effect, continued ownership of BCL provides TVNZ with an option over BCL's digital transmission capacity, removing potential difficulties and uncertainties, giving greater control and reducing risks in relation to the transition to digital transmission.

BCL's importance to TVNZ following the full development of its digital strategy is currently uncertain and should, in our view, be determined at the time. We also believe that:

  • many of the likely buyers of TVNZ will prefer that TVNZ retain BCL, so that if any part of TVNZ is sold in the near term, the sale price of the combined TVNZ and BCL will be at least as great as, and probably more than, the sum of the sale prices of the parts if sold separately; and
  • if TVNZ is not sold in the near term, the separation of BCL would reduce the value of the balance of TVNZ if were to be sold later.

Separation of TV ONE and TV2

TV ONE and TV2 are currently operated as a single, integrated business. The two channels share common facilities and operate in a complimentary manner. TV ONE's programmes are intended to appeal to viewers who may not watch TV2, and vice versa.

As part of our review of sale options available to the Crown, we have considered the implications of the separation of TV ONE and TV2 under two different structures. Under the "Contract" structure a new Crown entity would retain TV ONE's frequency licences, brand name and trademarks. It would contract the operation of the TV ONE channel to TVNZ for a limited period with a specification as to programme format. TVNZ would then be sold. If the TV ONE programme format specification is no more restrictive than that currently applying to TVNZ, we judge that the loss in total value to the Crown (compared to sale of TVNZ intact) would be relatively modest [Text deleted]. More restrictive programme format specifications would increase the loss substantially.

The arrangement above preserves the benefits of complimentary channel operation. More drastic or fundamental separation structures will result in far greater loss of value to the Crown. The second separation structure we have examined ("Dissection") would involve the creation of an independent stand alone television station to broadcast TV ONE.

TVNZ [Text deleted] estimate[s the][Text deleted] the loss of earnings from such a separation (assuming that TV ONE does not change its programmes to counter competition and becomes a non-commercial, unprofitable public service broadcaster) [to be around half the present value of TVNZ in Crown ownership].[Text deleted].

We have estimated the loss from Dissection, assuming that TV ONE remains a commercial channel and competes with TV2 and TV3, to be approximately [a quarter of the present value of TVNZ in Crown ownership] [Text deleted] in simple DCF terms. However, when the loss of sale premium is included, the total valuation impact from Dissection rises to approximately [half of the present value of TVNZ in Crown ownership] [Text deleted].

In our Dissection scenario TV ONE's programme format is likely to change substantially, probably reducing the amount of news, sport and "quality" British drama and moving towards a "middle of the road" TV2/TV3 - style format.

Comparison of Ownership Options

 

Sale of TVNZ Intact

TV ONE

Contract Structure;

Sell Balance

TV ONE

Dissection Structure;

Sell Balance

Status Quo

Continued Crown

Ownership

Maximise Value

+ +

+

x x

x x

 

Cleanest sale option

Minor value loss from Contract structure

Significant value loss from operational split

Sale value higher than retention value

Minimise Crown's Ongoing Business Risk

+

+

x

x x

Retain Direct Crown Influence over TV ONE

x

+

+ +

+ +

+ Beneficial to the Crown

x Adverse for the Crown

If TVNZ were to be sold intact constraints could be imposed on the future programme content of TV ONE in order to achieve some of the benefits of retention. Radio New Zealand has a charter that specifies, in general terms, Radio New Zealand's broadcasting objectives. A similar charter could be devised for TV ONE. Such a charter would impair sale price, to an extent determined by the charter terms. Our judgement is that terms similar to current SOE Act and Statement of Corporate Intent constraints would result in a price discount marginally less than Contract separation.

Valuations

Section 9.0 describes the basis on which we have valued TVNZ and the difficulties and uncertainties involved. Our conclusions can be summarised as follows:

Valuation Summary

[Text deleted]

For reasons explained in Section 1.5, we do not believe that a 100% IPO of TVNZ is advisable at present and therefore the IPO valuation in the table above is provided mainly for comparative purposes. The high trade sale value reflects the premium industry buyers are likely to pay to achieve strategic benefits and economies of scale. The value obtainable on a combination partial trade sale/partial IPO will depend on the particular basis of the arrangement, but could be close to the value achieved in a straight trade sale.

Equity Partner

TVNZ believes that it needs a strategic equity partner (i.e. a global media industry participant to take an equity interest in TVNZ) in order to:

  • secure the supply of programme content;
  • provide expertise in [Text deleted][digital] TV and new media developments;
  • provide technological expertise; and
  • provide capital and spread business risk.

The concerns underlying TVNZ's views have been mentioned previously in this section. Equity partnerships are common within the media industry, in New Zealand (where all of TVNZ's major competitors have such associations) and overseas. In our view an appropriate strategic equity partner would add substantial value to TVNZ, and this partly explains the significant difference between the value to the Crown from retaining TVNZ and the potential trade sale price.

Equity partnership could be arranged at different levels within TVNZ. The partner could hold an equity interest in TVNZ itself, in one of its subsidiaries or in a newly formed joint venture. However we believe it is preferable for the Crown to capture the value of these strategic partner benefits via a competitive sales process for ownership of TVNZ itself. Partnership arrangements at lower levels within TVNZ could provide many of the benefits sought by TVNZ, but have the following disadvantages:

  • any joint venture with a particular, selected partner could not be arranged in a competitive sale process. As a result, it would be difficult to ensure that full value is obtained for the equity interest that is sold;
  • buyers in any subsequent sale of TVNZ will discount its value if full control of all of its operations cannot be acquired;
  • some potential buyers will be deterred if the nature of the equity partnership or the identity of the equity partner is not compatible with their own operations, or if they believe the incumbent has an advantage in the bidding process for TVNZ; and
  • such arrangements effectively introduce the Crown to several of the risks of a partial selldown of TVNZ (e.g. possible conflicts with the partner and the possible perception of an implied Crown guarantee) without delivering any of the immediate benefits of a Crown selldown (cash proceeds and reduced ongoing business risk).

1.5 Sale Issues

Public Service Broadcasting

TVNZ is a fully commercial broadcaster and has been since it was established as a State Owned Enterprise in 1988. It is not a public service broadcaster as are the BBC, ABC and the US Public Broadcasting Service. Its profit motivation, and therefore its approach to public service broadcasting issues, is not expected to change if it were to be sold.

When the New Zealand television industry was reformed in 1988, separate, independent bodies and structures were established to deliver non-commercial public service broadcasting benefits. It is the function of the Broadcasting Standards Authority and NZ On Air to ensure that there is:

  • universal coverage;
  • appropriate broadcasting standards;
  • promotion of national identity;
  • support for the democratic process; and
  • supplementary minority interest programming.

The operations of the Broadcasting Standards Authority, NZ On Air and related public service broadcasting delivery mechanism are independent of TVNZ and would be unaffected by changes in TVNZ's ownership.

Concerns have been expressed about minority interest programming, in that:

  • NZ On Air has limited funding; and
  • TV ONE's brand positioning, which lends itself to the material NZ On Air often wants to be shown, may change.

We have seen no evidence that this is a material difficulty or that any difficulty would be exacerbated by the sale of TVNZ. NZ On Air's public service broadcasting arrangements are designed to deal with both public and privately owned television broadcasters.

Much of the public debate about ownership of TVNZ does not relate to true public service broadcasting issues of social welfare and public good. Rather, many members of the public are concerned to preserve popular entertainment which suits their personal tastes. They believe that, particularly as they pay licence fees, the Government should represent their interests to ensure that TVNZ has a programme schedule acceptable to them. In fact, the proportion of the licence fee NZ On Air passes on to TVNZ represents less than 5% of its income, and the Government does not currently influence TVNZ's programme schedule. In any event, it is difficult to see how the Government could make better choices than TVNZ in regard to popular entertainment programming. TVNZ's commercial objectives motivate it to provide programmes which are as popular as possible. We see no reason why any element of private sector ownership of TVNZ should materially change these objectives.

Te Reo Maori

The Crown has an obligation under the Treaty of Waitangi to actively protect and promote Maori language through television broadcasting. The Government has approved, in principle, a policy for Maori language broadcasting that appears to be capable of meeting the Crown's Treaty obligations. The policy involves the creation of a new, independent Maori language television channel and the continued "mainstreaming" activities of Te Mangai Paho. Ownership of TVNZ by the Crown is not necessary to put the policy in to effect. However, further development of the policy, including further consultation with Maori, would be necessary before any significant restructuring of TVNZ's ownership could take place.

Other Potential Impediments

We believe there are no other significant impediments to the sale of TVNZ or to relatively simple ownership restructurings. More complex rearrangements, such as a Dissection separation of TV ONE and TV2, would require further investigation.

Comparison of Sales Methods

In our view, a trade sale of TVNZ would maximise sale proceeds, minimise completion risk, minimise the level of residual risk to the Crown, shorten the sale timetable and minimise sale costs compared to an IPO. In any event, the recent financial performance of TVNZ and its current market position will affect its attractiveness to sharemarket investors. As previously noted, TVNZ's net profit fell by 50% in 1997, its audience ratings have declined in recent years and it faces a number of uncertainties regarding media industry developments. The equity market may not be able to look beyond these difficulties to the future in the way that trade buyers will, and in our view an IPO of TVNZ would not be advisable in the immediate future.

If the Government wished to achieve wide public ownership and capture most of the valuation benefits of a trade sale it could combine an IPO with a trade sale. Of the available combination sale approaches, a 100% trade sale with a requirement that the buyer float a portion of TVNZ within a specified timeframe may be most attractive. This structure, which was used in the sale of Telecom and Air New Zealand Limited, would overcome current, temporary IPO difficulties.

Summary of Principal Features of Sale Methodologies

     

Combination

Assumed Objectives

Trade Sale

IPO

Partial Trade Sale with Crown IPO

100% Trade Sale with IPO Selldown

Maximise competition and value.

+ +

x

+
Premium for strategic stake but still incur IPO discount.

+
Potentially maximises value except to extent bidders discount offers due to IPO risk.

Public participation

x

+

+

+

Minimise completion risk.

+

x
Depends on market conditions at issue launch.

x
Depends on market conditions at issue launch.

+ .

Minimise residual risk.

+

x
Promoter risk.

x
Promoter risk.

+

Avoid ongoing exposure to TVNZ business risk.

+

+

x
Exposure until IPO completed.

+

Avoid disclosure of commercially sensitive information.

x

+

x

x

Sale timetable (for execution phase).

3 Months.

4 Months.

5+ Months.

3 Months. IPO in two to three years.

Crown transaction costs.

Low.

High.

High.

Low.

+ Beneficial to the Crown

x Adverse for the Crown

On balance, the two sale methods which appear to best satisfy the Crown's objectives are the straight trade sale of TVNZ, or the combination of a trade sale with the requirement that the buyer sell down via an IPO within, say, three years.

Sale Now vs. Later

We mention above the potential difficulties of undertaking an IPO in the immediate future. In respect of a trade sale or combination trade sale with delayed IPO selldown, our view is that there are no commercial reasons for delay because:

  • the need to obtain a strategic equity partner for TVNZ is immediate;
  • although TVNZ's earnings have the potential to be significantly higher in the future, we believe experienced trade buyers (who we expect to be the parties most interested in buying TVNZ) are able to judge reasonably accurately the earnings potential of TVNZ. (The merger and acquisition pricing details in Appendix II.4 are evidence that trade buyers recognise and are prepared to pay for future earnings growth potential); and
  • the television industry is undergoing significant change, and TVNZ has substantial digital transmission, [Text deleted] and new media opportunities. TVNZ must take steps in the immediate future to take advantage of these opportunities. In our opinion, while these steps may maximise value to the Crown as owners, they may not suit the circumstances of all potential buyers. As TVNZ develops its strategies it may close off some options which would otherwise be valued more highly by some buyers.

Partial vs. Full Sale

Retention of a part of TVNZ might maintain some of the Crown's direct influence or control. However other arrangements, such as a Radio New Zealand-style charter and Contract or Dissection separation of TV ONE, are also capable of providing any necessary influence. In our view, such direct and precisely designed mechanisms are likely to be more efficient than retaining a partial ownership interest. In addition, retention of an interest continues the Crown's exposure to business risk and the possible perception of an implicit guarantee over TVNZ.

Retention of a part of TVNZ might allow the Crown to participate in future TVNZ value growth. However, as noted above, we would expect trade buyers to accurately value full future potential. There are also potential "clawback" mechanisms that can return future value growth to the Crown without exposing it to the risks attaching to continued investment in TVNZ (although the imposition of a clawback mechanism is likely to result in an offsetting discount to the initial sale price). On a risk adjusted basis, we do not believe that a partial selldown maximises value compared to a 100% sale under any of the possible sale methods.

Sale Implementation

If the Crown decides to sell TVNZ while retaining TV One, or decides that it is appropriate to prepare for a possible sale, then the preparation phase would consist of:

  • Crown decisions on some fundamental choices regarding sale structures and methods (i.e. how TV ONE might effectively be retained, by imposition of a charter, through public participation, retention of a partial shareholding or imposition of foreign ownership restrictions);
  • refining the sale structure to the next level of detail once the Crown has narrowed the field of focus by making as many of the decisions above as possible. The details to be developed could include the precise terms of Contract or charter arrangements, retail investor incentives in an IPO or the design of a sales process which gave bidders the choice between options on which the Crown seeks market valuation feedback; and
  • general preparation of TVNZ for sale (e.g. due diligence), definitive progress on Maori language television arrangements and any new legislation or regulations required to facilitate a sale in the form envisaged by the Crown.

More complex restructuring arrangements, such as Dissection separation of TV ONE, will extend the time required for the preparation phase.

Once sale preparations have been completed to a general state of readiness, the execution phase can be initiated at almost any time. The likely time required for execution would be three months for a trade sale, four months for an IPO, and five months for a combination trade sale with IPO following immediately thereafter.

2.0 Business Description

2.1 History

Television was introduced to New Zealand by the Broadcasting Service, a department of government. The first station was established in Auckland in 1961. Other independently operated, government-owned stations were later formed in Wellington, Christchurch and Dunedin. All were subsequently networked and eventually became TV ONE. Colour television was introduced in 1973 and the second channel (now known as TV2) commenced transmission in 1975. The government's television operations were separated from its other broadcasting activities to form TVNZ on 1 December 1988.

Television in New Zealand was initially funded from general taxation and television licence fees. Advertising commenced within weeks of the first television broadcast and has been the principal source of revenue for over 20 years. TVNZ has been fully commercial since its establishment in 1988.

The first privately owned free-to-air channel, TV3, commenced broadcasting in November 1989, ending TVNZ's monopoly. The first pay TV operator, SKY, began broadcasting in May 1990.

2.2 Business Overview

Summary Description of Business Divisions

TVNZ operates two main business divisions (television and distribution) and a support services group. It also has substantial investments in SKY and CLEAR. The principal activities of each of the business divisions are described below.

Television (including Production)

TVNZ's television division operates in the retail television broadcasting, programme procurement and local programme production markets. Its activities include:

  • broadcasting television signals;
  • selling television advertising services;
  • commissioning, producing and purchasing video and film material for broadcast and/or sale locally and overseas;
  • providing production support facilities internally; and
  • providing film, video and sound production facilities to domestic and international clients.

The division's channels are TV ONE, TV2 and MTV.

Distribution

TVNZ's distribution division is involved in:

  • operating and maintaining domestic and international linking services;
  • operating, maintaining and developing transmission facilities and services;
  • providing datacasting services; and
  • providing consulting services (including design and build services) to parties operating in the linking and transmission services industry in New Zealand, Australia, Asia and other countries.

BCL, a wholly owned subsidiary of TVNZ, is the principal operating company of the distribution division.

Support Services

This group provides the normal range of support services including legal, business development, finance, accounting, audit, planning, personnel and company secretarial services.

The remainder of this section focuses largely on the television division. Further details of BCL and the distribution division appear in Sections 4.2 and 4.5. TVNZ also has significant investments in CLEAR and SKY. Details of these investments appear in Sections 4.3 and 4.4.

2.3 New Zealand Television Market

TVNZ retained a monopoly over television broadcasting until 1988 when extensive deregulation allowed the entry of competitors in both free-to-air and pay TV. New Zealand is now a highly deregulated market with a number of international media entities having local interests. The table below and Section 2.6 contain details of the involvement of multinational organisations in New Zealand television.

Depending upon their geographical location, New Zealand viewers may elect to receive television services delivered via terrestrial (VHF/UHF), satellite or cable broadcast platforms.

TVNZ, TV3 and SKY currently offer a total of ten terrestrial based channels. Prime is due to commence broadcasting one near-nationwide channel in August 1998. BCL provides all New Zealand terrestrial broadcast transmission and a large proportion of local linking and maintenance services. SKY also broadcasts two channels by analogue DTH on the Optus B2 satellite. SKY proposes to upgrade this service to 30 digital channels on three transponders from late 1998 to mid 1999. Saturn provides a cable service in parts of Wellington via fully owned infrastructure. Telecom has also installed cable in areas of Wellington and Auckland but has now ceased expanding its network and is investigating the services it might provide using ADSL (asynchronous digital subscriber line) technology on its "copper pair" telephone lines.

New Zealand Television Industry

Operator

Delivery

Main revenue

Homes passed

Channels

Ratings (1)

Ownership

TVNZ

VHF/UHF

Advertising

100%

TV One,

TV2, MTV

65%

Government

             

TV3

VHF

Advertising

96%

TV3, TV4

29%

CanWest

             

Sky

 

UHF

Satellite

Subscription

Subscription

73%

100%

5 channels

2 channels

6%

<1%

INL/News Corp

             

New Regional

UHF

Advertising

89%

 

0%

Prime

             

First Media

Cable

Subscription

65,000

 

<1%

Telecom

             

Saturn

Cable

Subscription

40,000

 

<1%

UIH

(1)Source: AC Nielson, channel share of 18 to 49 year old viewers, 6.00pm to 10.30pm, January to March 1998


2.4 TVNZ Market Position

Competition

TVNZ has been the dominant television broadcaster in New Zealand since its inception. However, competition has increased with the arrival of TV3 (1989), Sky (1990), Saturn (1996), TV4 (1997) and Prime (1998). In response, TVNZ is promoting its television channels as distinctive brands occupying targeted market positions.

TV ONE

The TV ONE brand is focussed towards an older, wealthier demographic between 25 and 54 years old with a programming mix of news, current affairs and sport complementing mainly British-sourced drama, comedies and documentaries. TV ONE, because of its history and programming content, is seen by many New Zealand viewers as the core identity of the overall TVNZ offering. TVNZ believes that TV ONE appeals to a very broad audience encompassing most types of viewer.

TV2

The TV2 brand is marketed primarily to household shoppers with high disposable incomes in the 18 to 49 age group. TVNZ is currently moving the focus of TV2 to the 18 to 39 age group. TV2 programming consists of popular drama, comedy and lighter content, with much content sourced from the USA. TV2 has a strong female bias and low local content.

TVNZ arranges the TV ONE and TV2 brands and programmes of so that they are complementary. It aims to have TV2's programmes appeal to those who may not watch TV ONE and vice versa.

MTV

MTV replaced the Horizon Pacific Television regional stations as part of the TVNZ channel offering in 1997. It is a music channel with an established international brand and clearly defined target audience under 25 years old. It has yet to achieve a significant audience rating.

TV3 and TV4

CanWest has adopted a high margin/low cost strategy for TV3 and TV4, consistent with its approach in other countries. TV3's brand has a similar focus to TV2 and is directed towards a 25 to 49 age group audience. TV4 has a target audience of 18 to 29 years old.

SKY

SKY broadcasts five channels including Sky Sport, HBO (movies), Sky News, Orange (US nostalgia) and Discovery (documentaries). Discovery channel programming is shared with live racing supplied by the TAB. SKY is now affecting free-to-air channel ratings due to its recent rise in market penetration following the acquisition of rights to broadcast rugby. As a subscription-based service, SKY sees low advertising as a significant marketing feature and does not aggressively compete for advertising revenue (other than during major sporting events).

Other Channels

Cable TV operators First Media (i.e. Telecom) and Saturn have made little impact on the television market, with approximately 1,500 and 3,000 subscribers respectively. Prime, an Australian broadcaster affiliated to the Seven Network, is due to commence broadcasting a near-nationwide free-to-air channel in late 1998.

TVNZ Audience Ratings

The recent increase in fragmentation of the New Zealand market is mirrored by the fall in TVNZ's ratings over the same period. In the first three months of 1998, TVNZ achieved a total peak time audience share of approximately 65% in the 18 to 49 age group of most importance to advertisers, representing a decline from an 80% share in 1993.

Even with a 65% audience rating, TVNZ has a very high market share compared to overseas broadcasters. Further background to TVNZ's ratings position appears later in this subsection.

Great New Zealand Television

TVNZ accepts some reduction in ratings as an inevitable consequence of an increasingly fragmented market. In very few countries does a single broadcaster have a 65% market share. Recognising the need to protect its core free-to-air television business, TVNZ has identified new strategies to strengthen its brand and consolidate its market position.

An integral part of this approach was the launch in July 1997 of GNZTV. A key component of GNZTV is the reorganisation of the management of the television division with a formal split between the channels involving separate [marketing] management responsibilities, budgets and brand development. It ensures that there is greater focus on gross margin management and on customers. It is targeted to also improve financial performance by reducing costs and increasing yields and revenues. (The separation of the channels is a management device to focus responsibilities and accountabilities. It does not involve physical separation. The two channels still use common equipment and assets. A number of key functions, such as programme procurement and advertising sales, are still undertaken jointly for both channels).

Further details of TVNZ's response to market fragmentation are contained in Section 5.0.

Local Content

TVNZ sees local content as an important channel differentiation as both TV3 and SKY offer limited local programming. In addition, TVNZ's local programmes achieve high ratings. High costs, particularly for sports events, have recently led TVNZ to modify its commitment to local production (see Section 2.6). TVNZ still dominates local programming, particularly on TV ONE.

Rating Details

In New Zealand audience share is usually measured by viewer ratings provided by the AC Nielson/AGB McNair organisation which maintains the only people meter panel recognised by the advertising industry. This comprises 440 households selected to be representative of New Zealand's population. The people meter is a monitor mounted on the television remote control unit in each of these households that separately records the channel selection of each member of the household. A channel must be watched for a minimum of eight minutes per quarter hour to be registered. The channel selection is electronically downloaded to AGB McNair on a real-time basis. The demographics and buying behaviour of this panel are also updated by periodic survey.

Whilst TVNZ on a combined basis still has a very strong audience share this has steadily declined over the last five years. In the last few months the ratings of TV ONE have improved and those of TV3 have declined.

As shown in the table below, the market demographics targeted by TV ONE are less attractive to advertisers. The table shows the age group targets of a major advertising agency which handles the accounts of a substantial number of the largest national television advertisers.

In aggregate 69% of the agency's advertisers target the 15 to 39 age group, 92% the 15 to 49 age group and 78% the 25 to 54 age group. The chart clearly demonstrates the complementary nature of TV ONE and TV2, with TV2 having higher ratings in age groups up to 35 and TV ONE strongly preferred by the over 35 age group.

In Australia the free-to-air networks are closer in their demographic appeal. Seven Network and Nine Network compete directly for the mass market. The audience focus of Nine Network is similar to that of TV ONE with a rating of 38.7% for all age groups and a skew towards older viewers demonstrated by its 40.7% rating in the 18 and over age group.

Seven Network has a market focus similar to that of TV2 being relatively strong across all age groups with a particular strength in the household buyers with children demographic.

Ten Network has consciously targeted a younger audience, achieving ratings of 31.2% in the 16 to 39 age group in 1997 compared with its prime-time ratings of 25.6% for all viewers. It has achieved this by both its programme mix and also its counter-programme scheduling against the other channels.

The USA has an industry structure that developed as a result of stringent ownership and coverage restrictions. In 1996 the Federal Communications Commission amended its regulations to eliminate multiple ownership rules on the number of television stations a broadcaster may own or control nation-wide. Local ownership restrictions remain unchanged at one station per market. Permitted national audience reach was also raised from 25% to 35%. As a result of the historically high level of industry regulation and the greater market penetration of cable television the USA television industry is much more fragmented than that of New Zealand or Australia. The major networks depend on affiliates to provide audience reach.

The three traditional free-to-air broadcasters, NBC, CBS and ABC, all pursue very similar audiences concentrating particularly on the 18 to 49 age group. Fox, as the new network entrant has taken a similar approach to the Ten Network in Australia targeting the 16 to 39 age group with shows such as "The Simpsons". Due to the fragmented nature of the US market the networks have an average aggregate audience share of 50% to 55% with top individual programmes having ratings of 18% to 20%.

In conclusion, whilst ratings have declined since the introduction of competition, TVNZ's two channels have both performed well in respect of audience share compared with other major free-to-air broadcasters in overseas markets. TV ONE has a stronger hold on its target audience, although the demographics of this audience are less attractive to advertisers than the demographics of TV2 and TV3's core audience. At 65% to 70%, the combined ratings of TVNZ are equal to, and possibly greater than, those of any other broadcaster in a developed television market. TVNZ's extremely strong market position and the ability to offer combined advertising packages is a powerful marketing tool.

Future Market Position

TVNZ is exposed to new market threats (and opportunities) from digital transmission and other industry developments. Digital transmission will accelerate fragmentation in the television market and allow video programming to be enhanced with interactive multimedia content. SKY is scheduled to progressively launch a package of 30 digital channels starting in late 1998 and will require new programming to fill this capacity. The movement into a mass multi-channel environment will increase pressure on TVNZ audience share, may raise programming prices and may remove TVNZ's access to some of its core programming. These issues are covered in more detail in Sections 4.1 and 5.0.

2.5 Revenue Sources

Introduction

TVNZ, as a commercial free-to-air television broadcaster, derives the majority of its revenue from advertising. Other major income sources include carriage revenue derived by BCL and the rest of the distribution division, funding from NZ On Air for non-commercial activities and miscellaneous revenue from production and merchandising activities. The introduction of digital broadcasting will provide opportunities to generate new revenue from activities in new media, depending on the strategic approach taken by TVNZ.

TVNZ Revenue Sources

 

Years ended 31 December

(in $ millions)

1995

1996

1997

       

Net advertising revenue

288.5

292.9

270.1

External distribution division income

56.2

76.8

98.0

Public funding

25.8

23.5

21.2

Other revenue

57.0

64.8

62.1

       

Total external income

427.5

458.0

451.4

Source: TVNZ management accounts

Advertising Revenue

Television broadcasters derive advertising revenue from the insertion of video commercials both during and between television programmes. In 1997, the entire New Zealand television industry generated total gross advertising revenue from commercial airtime of $478 million, a decline from $491 million in 1996. The advertising market has been affected over recent years by low growth in the New Zealand economy and a resurgence in alternative advertising media including print, radio and direct marketing. In contrast, television advertising revenues in Australia have experienced growth of 12% to 15% over the previous year.

TVNZ's net advertising revenue in 1997 was $270 million, a 7.5% decline from $292 million in 1996. The fall is attributed to both the overall contraction in the New Zealand advertising market, the closure of Horizon Pacific Television and the drop in TVNZ ratings. TVNZ aims to improve its earnings by [Text deleted] improving advertising yield management (for example, selling more premium slots in the short-term market). At 20%, standard agency commissions are high by international standards, although rebates provided by agencies to advertisers reduce the effective rate substantially. [Text deleted]

Television advertising revenues correlate strongly with ratings for 18 to 49 age group audiences. This group of viewers is seen as the most important by advertisers. However, advertising for some particular products is directed at different age groups, audiences with other characteristics (for example, those known as "household shoppers") or is best shown in connection with particular types of programme content.

TVNZ derives 89% of its advertising revenue from advertising agencies, with the remainder made by direct sales to advertisers. The majority of advertising is by nationwide campaigns shown throughout New Zealand. 12% is regional advertising that is shown in particular, limited areas. New Zealand and Australian companies place 98% and 2% of advertising respectively.

TVNZ's six main advertising agency customers provide around 50% of its advertising revenue as follows: Saatchi and Saatchi (14%); Colenso Communications (13%); Ogilvy and Mather (8%); Bates NZ (8%); William Roberts Advertising (8%); and McCann-Erickson (7%). TVNZ's main individual television advertisers are Unilever (5%), NZ Government (4%), Telecom NZ (3%) and Lion Nathan (2%).

Approximately 70% of advertising space is pre-sold under Volume Incentive Discount (VID) contracts. These require agencies to buy an agreed minimum volume over a 12-month period but allow individual slots to be purchased as required. There has been a recent industry trend away from long-term contracts towards a short-term market where rates dynamically reflect demand and ratings. TVNZ believes that the short term market can increase overall revenue by minimising long-term discounts and that the short-term market introduces more volatility but not necessarily more risk. At present, total available television advertising space (from all broadcasters) exceeds demand.

TVNZ's competitors and now TVNZ offer bundled packages across multiple media, including radio and print. All broadcasters compensate advertisers for lower than expected ratings by providing additional free slots. These arrangements are proving popular with agencies that are seeking more flexible approaches in an increasingly fragmented market.

Distribution Division

TVNZ's distribution division engages in four main areas of business:

  • broadcast transmission and co-siting services (approximately 40% of the division's revenue);
  • distribution linking services (approximately 30% of the division's revenue);
  • consulting and contracting services (approximately 17% of the division's revenue); and
  • network maintenance services (approximately 13% of the division's revenue).

[Text deleted] [Major customers, ][Text deleted] [o]ther [than TVNZ,] [Text deleted] include TV3, SKY and the Australian National Transmission Agency (see Section 4.5).

The distribution division generates the majority of its income by utilising its established national distribution infrastructure to provide independent linking and transmission services to terrestrial broadcasters. In an analogue environment, the challenging commercial and environmental barriers facing a new entrant seeking to duplicate BCL's extensive network of hilltop sites assist in protecting its traditional terrestrial business. BCL has also secured the pre-eminent tower locations in each major urban area.

[Text deleted]

Public Funding

NZ On Air and Te Mangai Paho provide funding to TVNZ to support the broadcasting of programmes and the provision of services that are believed to have non-commercial public welfare benefits. Sections 6.5 and 7.1 provide more details of the roles and constitution of the two organisations.

TVNZ Public Funding

(in $ thousands)

1995

1996

1997

NZ On Air

     

- production funding

16,624

15,514

13,916

- other

6,168

3,241

2,823

Te Mangai Paho funding

2,965

4,764

4,443

Total public funding

25,757

23,519

21,182

Source: TVNZ management accounts

The "other" category of NZ On Air funding includes approximately $1.8 million per year for extending transmission coverage to areas where broadcasting would be otherwise uneconomic. NZ On Air funding is provided from the broadcasting fee. It is not expected that the fee will be increased in the foreseeable future. Te Mangai Paho funding supports Maori language programming. Section 7.1 describes the government's proposals for the future of Maori broadcasting.

Other revenue

[Text deleted]

2.6 Programme Costs and Availability

Introduction

TVNZ must acquire programming to fill the schedules of its three free-to-air channels. Programming is the key element in both free-to-air and pay TV businesses. It defines the core identity of each television channel and determines their popularity with audiences. Programme selection by TVNZ is responsive to audience preferences identified from ratings statistics. TVNZ purchases the majority of its programming from international content distributors, with the remainder produced in-house or purchased from local production houses. TVNZ also has a library of archived video content.

Programming may be classified into news and current affairs, sport, movies, lifestyle programmes, series, documentaries and general entertainment. Fragmentation in the New Zealand market has greatly increased competition for programming in all sectors. This has the effect of raising prices and also threatens TVNZ's access to, and involvement in, traditional core programme types such as sport, movies and series. TVNZ has more control over the costs of local content and in many cases these costs have fallen.

TVNZ Programme Utilisation Expense


[Text deleted]

Overseas content

TVNZ acquires 68% of its programme hours from international content distributors, of which 60% is purchased under long term output agreements and 40% is purchased on the spot market. Output agreements are typically three to five year contracts that guarantee TVNZ access to international programming for use on its free-to-air channels, usually on an exclusive basis. In return TVNZ is obliged to purchase minimum amounts (either in volume or dollar terms) of programming each year from the distributor.

When entering output agreements TVNZ knows the general nature or intended content of the programmes to be produced in the short term. TVNZ does not know the content of the majority of the programmes it will be committed to acquire in the later years of the agreement. All programme prices are established at the inception of the agreement. TVNZ faces the risk of the later programmes proving to be unpopular, but is prepared to commit to them in order to secure availability.

TVNZ's main output agreements are with Warners, Polygram, Columbia and CBS in the USA and the BBC and BRITE in the UK. TVNZ also has strong relationships with Australian free-to-air networks Nine Network and Seven Network and with independent production houses such as Southern Star.

TV3 is thought to have output agreements with Disney, Universal and NBC. SKY obtains programme content from ESPN, CNN, HBO, Discovery, BSkyB and Fox.

TVNZ assigns purchased programmes to TV ONE or TV2 based on programme compatibility with each channel's brand. The majority of British programming from BBC and BRITE is presented on TV ONE. TV2 uses a large proportion of American material.

TVNZ Output Agreements (General Terms Only)

[Text deleted]

[TVNZ faces an increasing threat that globalisation of television networks will restrict its access to programme content.] [Text deleted]

[Both its major competitors, TV3 and Sky, are now part of global organisations with growing programme purchasing power.] [Text deleted]

The television industry world-wide is witnessing the formation of global media conglomerates through acquisition and alliances. These international groups have the geographical and commercial leverage to negotiate programming contracts on a regional basis. TVNZ, as an independent broadcaster operating solely in a small market, faces the threat that core programming content will be lost to a competitor with a major international alliance. As programming contracts are renegotiated every three years, TVNZ could see its programming position deteriorate over a relatively short period.

TVNZ is the only television broadcaster in New Zealand without an ownership relationship with an international operator. TVNZ has identified the need for an alliance with a major global network. Section 5.10 considers this issue in further detail.

Local Content

TVNZ views local content as a major component of both its programme line-up and channel identity, particularly for TV One. Many locally produced series achieve consistently high ratings. However, TVNZ no longer believes it is viable or necessary for it to produce drama and other complex series and now concentrates on local product with long run formats and predictable rating patterns. It has sold an 80% interest in its Natural History Unit and 100% of South Pacific Pictures Limited. The ownership of Avalon Studios in Lower Hutt (the largest studio complex in the Southern Hemisphere is also under review).

TVNZ has retained facilities to produce news and current affairs programmes (such as One Network News, Holmes and 60 Minutes), outside sports broadcasts and programmes such as Maggie's Garden Show (i.e. other than complex series and drama). [Text deleted]Local programming offers TVNZ the advantage of perpetual rights and is available for inclusion as a permanent asset in the TVNZ library archive.

News and Current Affairs

TVNZ presents approximately 20 hours of news and current affairs per week, all on TV ONE. [Text deleted] TVNZ has extensive local news production facilities as well as exclusive and non-exclusive access to a range of local and international news services. Major contract commitments include the BBC, Nine Network, CNN, WIN and CBS. New Zealand viewers believe high quality news and current affairs programmes are a key feature and attraction of TV ONE.

TVNZ employs over 250 staff in news and current affairs, with 170 in Auckland and the remainder located in offices throughout New Zealand and also in London and Sydney.

In-house production of news is expensive for TVNZ, although costs do not greatly exceed overall average costs per hour of programme content purchased under output agreements. The cost of news, current affairs and sport (see below) partly explains the lower EBIT margins of TV ONE. TVNZ has previously addressed this issue by increasing news programme output to spread overhead costs (for example, by producing low marginal cost morning news programmes). This approach is now being supplemented with the cost reduction plan described in Section 5.2.

Sport

TVNZ presents an average of 12 hours of sport per week mostly on TV ONE. In 1997 sport provided $14.4 million in advertising revenue at a cost of $24.5 million for a contribution loss of $10.1 million. TVNZ suggests that sport is not inherently expensive to produce, but that the high cost of sport is mainly attributed to increases in the purchase price of licensing rights.

[Text deleted]

Sport contributes significantly to the core identity of TV ONE and helps to explain its relatively high cost base. TVNZ has accepted that sporting rights will become increasingly expensive to acquire in the future. Live sports programmes for significant events are a key subscription driver for pay TV operators, generating them far more subscription income than is available from advertising revenue for free-to-air channels. With the absence of anti-siphoning laws in New Zealand, TVNZ is not guaranteed access to mainstream sport at a viable price in the future. The loss of mainstream sport would be a significant change in brand focus for TV ONE. TVNZ considers the loss of rights to some major sporting codes is inevitable in an environment of increasing costs.

2.7 Other Costs

Non-programme Expense Analysis

[Text deleted]

Principal elements of non-programme expenses are set out below:

Non-programme Expense Elements

 

Years ended 31 December

(in $ thousands)

1995

1996

1997

       

Labour (excluding that charged to productions and other projects)

72,940

74,708

68,678

Depreciation

21,666

25,244

28,444

Other costs

86,733

98,145

113,229

       

Total non-programme expense

181,339

198,097

210,351

Source: TVNZ management accounts

[Text deleted]

TVNZ's non-programme expenses are substantial and complex. Detailed benchmarking is beyond the scope of this review. Set out below are selected data which are not necessarily directly comparable.

Other Broadcasters' Non-Programme Costs

 

Amount

% of revenue

     

Seven Network and affiliates

A$202.7 million

23.2

Nine Network and affiliates

A$326.4 million

33.5

Ten Network and affiliates

A$172.3 million

27.5

Source: Australian Broadcasting Authority; commercial television service revenue, expenditure and profitability in multi-station markets for the year ended 30 June 1997

     

TVNZ (year ended 31 December 1997)

NZ$210.4 million

46.6

Source: TVNZ Management Accounts

   

TVNZ's operations and cost structure differs from the major Australian networks. It provides transmission services for other local broadcasters and has significant production facilities which provide services to both TVNZ and external producers. New Zealand programme schedules contain a higher proportion of news and current affairs programmes that are produced in-house and give rise to higher indirect overhead costs. The Australian networks are significantly larger in scale. Their total broadcasting revenue ranged from 1.6 to 2.5 times that of TVNZ.

TV3's non-programme costs are not known. In the year ended 31 March 1997, total expenditure, including programme costs, was $74.4 million (TVNZ's total expenditure in 1997 was $367.3 million). TVNZ has compared its staff numbers with those of TV3 as at February 1997. TV3 had 301 employees. TVNZ had 791 in equivalent departments (for example, excluding BCL and Avalon). In total, TVNZ had 1739 employees at the time. It has approximately 1,500 employees at present. There are significant differences between the two networks' operations. TVNZ produced nearly twice as much news and three times as much sport. It also achieved an audience rating nearly three times that of TV3 at the time of the comparison.

Distribution Cost Analysis

[Text deleted]

2.8 Corporate Structure

This section details TVNZ's current company structure and the interrelationships between TVNZ's various businesses.

All of the companies in the TVNZ Group:

  • are incorporated in New Zealand (except where specifically noted) under the Companies Act 1993; and
  • have a balance date of 31 December.

Capital Structure

TVNZ had 140 million fully paid $1.00 ordinary shares on issue as at 31 December 1997. These shares are held equally by the Minister of Finance and the Minister for State-Owned Enterprises on behalf of the Crown. Total shareholders' funds were $245.5 million at 31 December 1997.

TVNZ has no options, convertible notes, preference shares or other equity or quasi-equity securities on issue. Section 2.10 provides details of TVNZ's debt funding.

Rationale for Corporate Structure

TVNZ's current corporate structure has only recently been put in place following the launch of GNZTV in 1997.

GNZTV was a broad review of TVNZ's core television business. It was intended to put in place new structures, strategies and skills to ensure that TVNZ is aligned to the market and its customers. The key outcomes of the project were:

  • the establishment of each channel as a complementary separate profit centre with dedicated staff;
  • that key teams such as news, sport and sales work across all three channel teams;
  • the introduction of a key marketing capability and increasing the profile of marketing to a more appropriate level;
  • for TVNZ to contribute to the growth of a "production village" from which it will increasingly source its local programming;
  • the strengthening of TVNZ's overseas programme acquisition process by instituting refined negotiation and efficient product control procedures; and
  • a focus on reducing costs and improving revenue generation.

Relationship between the Business Groups

TVNZ operates a transfer pricing system for the provision of services between business groups, although formal contracts only exist between incorporated companies within the TVNZ group.

The main areas where transfer pricing arrangements exist are set out below.

Broadcast Communications Limited. TVNZ Television purchases services from BCL on the same commercial terms as third parties purchasing similar services from BCL. The intent of this arrangement is to ensure a "level playing field" between TVNZ and its competitors. We understand that as part of TVNZ's current strategy for improving the profitability of the television division it intends to renegotiate the contracts between BCL and TVNZ (see Section 5.2).

Avalon Studios. TVNZ currently purchases services from Avalon Studios on an "arm's length" commercial basis. However, as part of the process of preparing Avalon for sale the arrangements between TVNZ and Avalon are being reviewed.

TVNZ Natural History. TVNZ has recently sold an 80% shareholding in TVNZ Natural History to Twentieth Century Fox (a wholly owned subsidiary of News Corp). As a consequence the arrangements between TVNZ and TVNZ Natural History are now on fully commercial terms.


2.9 Assets

Fixed Assets

The following table summarises TVNZ's fixed asset position.

TVNZ Fixed Assets

 

As at 31 December


(in $ millions)


Cost

1996

Accum.

Depn.

Book Value


Cost

1997

Accum.

Depn.

Book Value

Freehold land

29.3

-

29.3

16.7

-

16.7

Freehold buildings

83.8

15.8

68.0

81.8

18.0

63.8

Leasehold improvements

7.0

4.2

2.8

6.2

4.8

1.4

Transmitters, masts and aerials

109.8

36.0

73.8

126.4

44.3

82.1

Studio equipment

71.3

48.8

22.5

72.4

50.7

21.7

Other plant and equipment

12.9

6.2

6.7

14.1

7.9

6.2

Information systems

26.1

14.5

11.6

30.1

19.1

11.0

Motor vehicles

4.2

2.0

2.2

4.9

2.3

2.6

Fixed assets work in progress

26.5

-

26.5

11.2

-

11.2

             

Total fixed assets

370.9

127.5

243.4

363.8

147.1

216.7

Source: TVNZ book values

Land and Buildings

TVNZ inherited much of its property from the Broadcasting Corporation at the time TVNZ was incorporated as an SOE. Since its incorporation in 1988 TVNZ has been steadily reducing the number of properties it owns and leases. This process is being accelerated following the recent group restructuring and the closure of HPTV.

This section summarises TVNZ's property portfolio including details of the properties' current use, government valuations and TVNZ's intention for the properties.

TVNZ Auckland and Hamilton

[Text deleted]

The details of the properties owned by TVNZ are as follows.

[Text deleted]

TVNZ Wellington/Lower Hutt

[Text deleted]

TVNZ Christchurch

[Text deleted]

TVNZ Dunedin

[Text deleted]

BCL

[Text deleted]

Other Property

[Text deleted]

Fixed Asset Policy

Whilst each business area is responsible for maintaining its fixed asset register, TVNZ has a policy covering the recording and maintenance of these registers. The general principles of TVNZ's fixed asset policy are set out below.

Asset Review

All divisions are required to complete a stocktake of all significant assets every two years. Significant assets are those that make up 80% of the total fixed assets for that business area.

Specific classes of asset are not required to be sighted as part of the two yearly audit. These are:

  • transmitters - these are able to be checked with reference to transmission outputs;
  • motor vehicles - these must be identified by a check against the vehicle management database; and
  • land and buildings - these are not required to be identified.

Minor "attractive" assets are required to be counted yearly. These include:

  • televisions and videos in offices;
  • televisions and videos in employee homes (via letter of certification);
  • computers, monitors and printers; and
  • office fridges.

Return on Assets

All asset acquisitions are required to produce a return in excess of the Company's current Hurdle Rates of Return (which range from 15.5% to 18.6%). However, certain exceptions to this rule exist including the purchase of:

  • replacement assets where the assets are essential to the maintenance of TVNZ's existing business base;
  • strategic assets; and
  • assets required to improve the quality of a product or service where such improvement will improve TVNZ's competitive position.

Asset Valuation

All fixed assets, except land and buildings, are recorded at cost less depreciation unless there is a permanent impairment in the value of the asset.

Cost includes costs incurred in the acquisition of the asset and other directly attributable costs incurred to bring the asset to the location and condition for its intended use.

TVNZ depreciates all tangible assets on a straight-line basis, except freehold land. The economic lives used to determine depreciation rates for specific classes of assets are set out in the table below.

Economic Lives

Asset Class

Estimated Useful Life (years)

Freehold buildings

40

Leasehold improvements

3

Transmitters, masts and aerials

10 to 20

Studio equipment

5

Other plant and equipment

5 to 10

Information systems

3 to 5

Motor vehicles

6 to 10

Delegations

Annual fixed asset expenditure programmes are prepared for each business area and consolidated into divisional plans. These plans are submitted to the Chief Financial Officer and Board of TVNZ for approval as part of the annual Business Plan. Once approved, the General Managers and/or Financial Controllers of each division have the authority to commit TVNZ to purchase the relevant assets within their respective delegated authorities.

All fixed asset expenditure outside the approved Business Plan must be submitted to the Chief Financial Officer for consideration. Those proposals supported by the Chief Financial Officer must then be approved by either the Chief Executive or the Board of TVNZ.

Investments

As at 31 December 1997 the book value of TVNZ's investments were as follows:

TVNZ Investments

[Text deleted]

Current Assets

As at 31 December 1997, TVNZ had current assets totalling $128 million. These are made up as follows:

Current Assets

(in $ millions)

As at 31 December 1997

Cash

2.5

Trade debtors (1)

49.2

Stock

2.4

WIP

2.4

Programmes not transmitted (including programme prepayments)

52.7

Prepayments (excluding programming rights)

5.4

Fixed assets intended for sale

13.4

   

Total current assets

128.0

(1) After provision for doubtful debts

In addition to the current programme rights and prepayments, TVNZ had $24.6 million of non-current programme rights and inventories. Of the $77.3 million total, TVNZ has $60.9 million of overseas television stock.

Intangibles

At 31 December 1997 TVNZ had $16.7 million of licences and intangibles. TVNZ's amortisation policies are as follows:

  • Frequency Licences - purchase cost is amortised on a straight-line basis over the period of the licences;

  • Research and Development - research costs are expensed in the period incurred. Development costs are capitalised where there is a clear future benefit. Capitalised development costs are amortised straight-line over the period of the expected future benefits;

  • Brands - the cost of acquiring brands is amortised over the period available for the use of the brand;

  • Goodwill - is amortised over five years commencing from the date of acquisition;

  • Programmes Produced by TVNZ and Commissioned from Independent Production Houses (complete and in production) - programmes not broadcast at balance date are valued at cost (including a proportion of production-related overheads) less amounts written off. Programme values are written off within a three year period. Generally 100% of the value is expensed when the programme is first broadcast. A minimum of 67% is expensed over the first 18 months; and

  • Rights Acquired to Screen Overseas Television/Film Productions - programmes not broadcast at balance date are valued at cost less amounts written off. Programme rights are systematically expensed over the broadcast licence period. A minimum of 67% is expensed when a programme is first broadcast.

2.10 Liabilities

Funding Facilities

TVNZ has $210 million of committed funding facilities as summarised in the following table.

TVNZ Funding Facilities

(in $ millions)

As at 31 December 1997

   

Promissory Note

 

National

46.0

ANZ

42.0

ASB

36.0

BNZ

21.0

Westpac

15.0

   
 

160.0

Overdraft

 

BNZ

2.0

Money Market

 

BNZ

48.0

   

Total

210.0

[Text deleted]

Foreign Exchange and Interest Rate Agreements

[Text deleted]

TVNZ Interest Rate Swaps

[Text deleted]

TVNZ Interest Rate Options

[Text deleted]

Trade Creditors & Provisions

As at 31 December 1997, TVNZ had trade creditors and accruals of $57.6 million. These were made up as follows:

TVNZ Trade Creditors

(in $ millions)

As at 31 December 1997

   

Operating payables

48.3

Payments received in advance

3.7

GST creditor

2.1

Fixed asset and other payables

3.5

   

Total

57.7

[Text deleted]

TVNZ Provisions

[Text deleted]

2.11 Human Resources

TVNZ currently employs approximately 1,500 staff.

TVNZ Staff Numbers

(in full-time equivalents)

December 1996

December 1997

Television

664

542

Production

607

532

Distribution

317

301

Group

152

116

     

Total

1,740

1,491

Of the 1,491 full-time equivalents employed by TVNZ, 391.0 are full-time regular payroll, 980.2 are other hours regular payroll and 120.1 are "irregular payroll".

Television Division Staff Numbers

(in full-time equivalents)

December 1996

December 1997

Programmes, sales, marketing, finance and enterprises

218

215

News & current affairs

242

272

Sport

31

21

Maori programmes

13

34

eTV

4

0

HPTV

155

0

     

Total

663

542

Of the 542 full-time equivalents employed by the television division, 198.4 are full-time regular payroll, 320.3 are other hours regular payroll and 23.1 are "irregular payroll".

Production Division Staff Numbers

(in full-time equivalents)

December 1996

December 1997

     

Production

51

33

TV archive

29

27

Avalon

264

215

Natural History

47

0

South Pacific Pictures

14

14

Operations

164

199

Moving Pictures

38

44

     

Total

607

532

Of the 533 full-time equivalents employed by the production division, 142.6 are full-time regular payroll, 321.1 are other hours regular payroll and 68.8 are "irregular payroll".

Distribution Division

(in full-time equivalents)

December 1996

December 1997

     

BCL New Zealand

244

223

BCL Australia

42

44

Satellite & Pacific Services

20

23

Engineering

11

11

     

Total

317

301

Of the 301 full-time equivalents employed by the distribution division, 35.0 are full-time regular payroll, 251.5 are other hours regular payroll and 14.2 are "irregular payroll".

"Group" Staff Numbers

(in full-time equivalents)

December 1996

December 1997

Corporate services

54

49

Finance and accounting

37

25

Human resources and cr&eacut;che

18

15

Administration services

43

27

     

Total

152

116

Of the 116 full-time equivalents employed by "Group" or TVNZ head office, 15 are full-time regular payroll, 251.5 are other hours regular payroll and 14.1 are "irregular payroll".

Board and Senior Management

The board of TVNZ comprises Rosanne Meo (Chairman), David Irving, Wayne Brown, Rick Christie, Robin Somerville, Whaimutu Dewes and Richard Walls.

At the time of preparation of this report, the senior management structure of TVNZ is under review and is expected to be finalised by mid May.

Employment Agreements

This section briefly summarises the key elements of TVNZ's collective and individual employment contracts.

Collective Employment Contracts

TVNZ has three collective employment contracts ("CECs") which cover approximately 990 employees. Two of the CECs expired on 31 October 1997 and a new agreement has not yet been negotiated. The third CEC expires in January 1999. The terms of the expired CECs are deemed to continue in force through an employee's individual employment contract ("IEC"). The terms of the CEC may be altered or waived by the terms of an IEC provided the terms are no less favourable than those in the CEC.

The employees' representative in respect of the CEC is the New Zealand Public Service Association.

Most employees' salaries are set in their IECs but the CEC contains provisions covering minimum salaries for certain position types. These are as follows:

CEC Minimum Salaries

 

Minimum Salary

Position

Annual Rate

Hourly Rate

     

Receptionist, mail clerk

$17,000

$8.15

Secretary, rigger

$18,000

$8.63

Vision operator, floor manager, TV librarian, teletext sub editor

$20,000

$9.59

Camera operator, sound operator, editor, promotions director, presentation director, technical director

$22,000

$10.55

Journalist, technical producer, engineer

$24,000

$11.51

Producer

$26,000

$12.46

The collective employment contract covers the basic terms of employment including:

  • hours of work;
  • annual, sick, parental, statutory and other leave provisions;
  • remuneration including salary setting and reviews;
  • reimbursing allowances;
  • terms and conditions for part time and casual employees;
  • warning and dismissal procedures;
  • personal grievance, harassment and disputes procedures;
  • employee representation, freedom of association and other employee right provisions; and
  • redundancy provisions.

[Text deleted]

Individual Employment Contracts

Approximately 350 of TVNZ's employees are on IECs. These IECs are a mixture of fixed term and non-fixed term contracts.

TVNZ currently has approximately 50 fixed term contracts mostly with "talent" and certain senior executives.

  • TVNZ has not had a consistent policy on IECs so the terms and nature of the IECs vary across employees. TVNZ is currently implementing a process for standardising and simplifying its IECs. [Text deleted]

Remuneration

[Text deleted]

Labour Costs

[Text deleted]

The following table shows the number of salaried employees in each salary band [from above $100,000.]

Analysis of Payroll

 

Employee

Cumulative

Salary Bands

Numbers

Total

100,001 - 120,000

51

960

120,001 - 140,000

21

981

140,001 - 160,000

22

1003

160,001 - 180,000

5

1008

180,001 - 200,000

5

1013

200,001 - 220,000

4

1017

220,001 - 240,000

1

1018

240,001 - 260,000

3

1021

260,001 - 280,000

1

1022

280,001 - 300,000

2

1024

320,001 - 340,000

1

1025

360,001 - 380,000

1

1026

400,001 - 420,000

1

1027

440,001 - 460,000

1

1028

620,001 - 640,000

1

1029

Of the 1,029 salaried employees 68% are paid less than $60,000 per annum and 95% are paid less than $140,000 per annum. Less than 1% of TVNZ's employees are paid in excess of $280,000 per annum.

TVNZ provides its employees with a number of non-salary benefits such as home television and video equipment, clothing allowances, cars and superannuation. The cost of these benefits is included in TVNZ's payroll cost in its accounts.

[Text deleted]

Superannuation

TVNZ employees participate in the following superannuation schemes.

TVNZ Superannuation Scheme Participation

 

BCL

Other

Total

National Provident Fund schemes

 

   

- National

6

23

29

- Standard *

1

2

3

- Revised *

19

33

52

- Defined *

-

2

2

Government Superannuation Fund *

4

5

9

AMP Society

-

5

5

TVNZ scheme

-

52

52

BCL scheme

48

-

48

 

78

122

200

* Defined benefit schemes

No company contributions are made to the TVNZ and BCL schemes. Company contributions to the defined benefit schemes range up to 13.6% of employee's salaries, but are generally around 11.0%. Total company contributions to defined benefit schemes are currently approximately $404,000 per year. All other schemes are defined contribution schemes. Appendix III considers the implications of restructuring on the superannuation schemes.

2.12 Taxation

The Inland Revenue Department is currently investigating TVNZ's tax returns and disagrees with several aspects of TVNZ's tax calculations. The investigation commenced in June 1994. The Department originally identified 50 areas of concern but now accepts TVNZ's treatment in respect of 43. Seven items remain outstanding.

The Inland Revenue Department claims that TVNZ owes extra tax of approximately $6.5 million in respect of permanent differences. In addition, the Department contends that TVNZ should pay $3.2 million earlier than TVNZ anticipated in respect of timing differences.

TVNZ believes that these matters will eventually be resolved with no further tax to pay. It has not provided for any additional liability in its 31 December 1997 accounts, and its auditors have concurred with this approach.

3.0 Financial Summary

3.1 Historical Financial Performance

TVNZ Financial Performance

 

Years ended 31 December

(in $ millions)

1993

1994

1995

1996

1997

           

Net advertising revenue

261.4

278.5

288.5

292.9

270.1

External distribution division

revenue

n/a

n/a

56.2

76.8

98.0

NZ On Air & TMP funding

n/a

n/a

25.8

23.5

21.2

Other production funding &

programme sales

n/a

n/a

22.7

20.7

24.3

Other income

n/a

n/a

34.3

44.1

37.8

           

Total income

371.7

391.4

427.5

458.0

451.4

           

Programme costs

         

Local

n/a

112.5

115.9

116.2

110.1

Overseas

n/a

47.2

49.1

41.9

46.9

Other costs

n/a

159.3

181.4

198.8

210.4

           

EBIT

55.2

72.4

81.1

101.1

84.0

           

Interest expense

6.2

8.2

14.2

13.8

13.2

Non recurring items/(losses)

0.0

8.5

(3.3)

0.8

(36.1)

           
 

49.0

72.7

63.6

88.1

34.7

           

Taxation

16.4

21.8

20.5

27.5

4.7

           

Net profit after tax

32.6

50.9

43.1

60.6

30.0

Source: TVNZ Audited Accounts and Management Reports

Section 2.5 provides further details of TVNZ's income. Section 2.6 contains details of programme costs. Section 2.7 contains details of other costs. Section 3.5 examines EBIT performance. Section 3.2 provides details of the performance of each division. [Text deleted]

Analysis of 1997 Non Recurring Items

[Text deleted]

3.2Divisional Performance

Television Division Financial Performance

[Text deleted]

Production Division Financial Performance

[Text deleted]

Distribution Division Financial Performance

[Text deleted]

3.3Historical Financial Position

TVNZ Balance Sheet

 

As at 31 December

(in $ millions)

1993

1994

1995

1996

1997

           

Cash

0.6

0.8

0.9

2.0

2.5

Receivables and prepayments

49.6

74.3

82.4

69.1

70.3

Programme rights & inventories

57.0

40.1

40.7

48.7

41.8

Other current assets

-

-

-

-

13.4

           

Total current assets

107.2

115.2

124.0

119.8

128.0

           

Fixed assets

196.2

213.8

236.7

243.4

216.7

Investments

56.5

72.9

53.1

59.4

60.6

Non current programme rights

-

26.3

27.5

32.8

24.6

Licences and intangibles

0.7

2.7

25.8

25.8

16.7

           

Total non-current assets

253.4

315.7

343.1

361.4

318.6

           

Future income tax benefit

5.8

3.6

0.9

-

10.9

           

Total assets

366.4

434.5

468.0

481.2

457.5

           

Bank overdraft

-

0.6

0.7

0.3

0.2

Creditors and payables

54.2

49.7

66.0

66.4

57.6

Dividends provision

12.7

20.6

15.2

26.4

11.0

Other provisions

12.4

10.5

12.2

10.1

21.5

           

Total current liabilities

79.3

81.4

94.1

103.2

90.3

           

Term loans

76.9

127.7

135.6

139.8

121.7

Deferred tax

-

-

-

1.7

-

Shareholders' funds

210.2

225.4

238.3

236.5

245.5

           

Total funds employed

366.4

434.5

468.0

481.2

457.5

           

Programme right commitments

112.3

150.5

96.6

273.4

253.4

Source: TVNZ Audited accounts and management reports

Section 2.9 contains details of TVNZ's assets. Section 2.10 provides further details of current liabilities and term loans.

3.4 Historical Cash Flows

TVNZ Statement of Cash Flows

 

Years ended 31 December

(in $ millions)

1993

1994

1995

1996

1997

           

Cash flows from operating activities

         

Receipts from customers

369.2

374.7

396.2

464.7

445.3

Interest and dividends received

0.1

0.3

3.5

3.1

4.0

Payments to suppliers and employees

(284.1)

(308.1)

(311.6)

(347.4)

(361.4)

Interest paid

(6.5)

(7.9)

(13.8)

(13.8)

(13.4)

Taxes paid

(18.9)

(20.5)

(18.5)

(23.0)

(14.9)

           
 

59.8

38.5

55.8

83.6

59.6

           

Cash flows to investing activities

         

Sale (purchase) of Fixed Assets

(29.4)

(39.2)

(24.5)

(27.0)

(27.4)

Sale (purchase) of Investments

(14.1)

(20.5)

19.7

(6.3)

10.6

Sale of business unit

-

-

-

-

12.2

Purchase of other non-current assets

-

-

(16.5)

-

-

Intangibles

(0.3)

(2.1)

(6.9)

(1.6)

-

           
 

(43.8)

(61.8)

(28.2)

(34.9)

(4.6)

           

Cash flows to financing activities

         

Dividends paid

(12.2)

(27.7)

(35.6)

(51.2)

(36.4)

Drawdowns of loans

(4.9)

50.7

7.9

4.2

(18.1)

           
 

(17.1)

23.0

(27.7)

(47.0)

(54.5)

           

Net increase/decrease in cash held

(1.1)

(0.3)

(0.1)

1.7

0.5

Source: TVNZ audited accounts and management reports


3.5 Performance Assessment

In evaluating the performance of TVNZ we have considered:

  • audience share;
  • share of advertising to share of audience;
  • EBIT margin (EBIT as a percentage of revenue); and
  • cost efficiency.

Audience Share

Section 2.4 describes TVNZ's audience ratings. In the three months to 31 March 1998 68% of all 18 to 49 year old viewers watched a TVNZ channel. Very few television broadcasters in the OECD have an audience share greater than that of TVNZ.

Share of Advertising to Audience

The ratio of advertising market share to audience share indicates the efficiency and effectiveness of a broadcasters' sales and marketing.

Ratio of Advertising to Audience Share

(in %)

1994

1995

1996

1997

         

TV ONE

99.1

89.2

101.7

102.7

TV2

99.0

106.5

98.4

105.4

TVNZ total

99.1

100.0

101.9

102.5

         

TV3/TV4

103.5

100.0

94.6

94.4

Seven Network

95.2

97.1

94.1

97.6

Nine Network

110.6

105.2

107.6

102.5

Ten Network

91.6

96.2

97.1

99.7

Source:Ord Minnett research, ABA Statistics, TVNZ management reports

Basis:For New Zealand, FTA advertising market share to annual 18 to 49 year old, 6.00pm to 10.30pm audience share. For Australia, commercial station revenue share to audience share

The analysis above incorporates some estimation and is not a precise comparison of channel performance. However, it indicates that TVNZ's share of advertising revenue has improved and is now better than that of TV3 (relative to audience ratings).

EBIT Margin

The ratio of earnings before interest and tax ("EBIT") to revenue provides a basis for the comparison of operating efficiency between television broadcasters.

TV3 accounts

ABA statistics for networks including affiliate stations

The statistics above are not directly comparable due to differences between the activities of the broadcasters. The Australian market has different regulatory and economic features. TVNZ undertakes, through BCL, a higher proportion of transmission and telecommunications activity. TVNZ also has a higher market share.

The decline in TVNZ's EBIT margin in 1997 was largely due to a decline in its ratings and a depressed advertising market.

TVNZ has undertaken a similar study of its EBIT margin and has determined that its current performance is unsatisfactory. Section 5.2 describes the corrective action TVNZ is undertaking.

Cost Efficiency

Section 2.7 describes TVNZ's non-programming costs and compares them with those of other broadcasters.

4.0 Current Strategic Issues

4.1 Digital Transmission

Technology

Digital transmission is a cheaper and more efficient method of broadcasting television. It is expected that digital transmission will accommodate four to six channels on the same UHF bandwidth as that currently used for one analogue channel. Alternatively, digital transmission can be used to transmit one high definition television ("HDTV") channel on the same bandwidth. In addition, digital transmission can utilise bandwidth between existing analogue channels due to its better interference characteristics. Digital transmission also provides enhancements such as improved picture quality and extended support for internet services and interactive television.

Fragmentation

A principal consequence of digital transmission for TVNZ is likely to be greater fragmentation of the television market and the further reduction of the audience share of TV ONE and TV2.

TVNZ is currently investigating the steps it might take to counter the implications and take advantage of the benefits of digital transmission. Several options are available, including the digital transmission of TVNZ's existing free-to-air channels and the establishment of [Text deleted][additional] digital [Text deleted] TV channels. Adoption of these options will have significant financial implications. Section 5.0 describes TVNZ's television division digital strategy.

Transmission

Digital signals can be sent from BCL's high-site transmitter towers (digital terrestrial transmission or "DTT") or by satellite (direct to home or "DTH"). Advantages of DTT include the ability to broadcast programmes and advertising tailor-made for particular regional areas. The advantages of satellite include total coverage of New Zealand from a single transmitter.

Digital satellite television has been available internationally since 1995. SKY intends to introduce a digital DTH service in New Zealand in September 1998. It has acquired long term leases on three Optus transponders with capacity for 40 to 50 digital video channels.

BCL believes that DTT is a viable approach to television broadcasting in New Zealand. Section 5.4 describes BCL's digital strategy.

Set Top Boxes

Viewers must install a digital set top box ("STB") between their antenna and television set to receive digitally transmitted television signals. TVNZ is likely to select an STB that is similar to that used by SKY. The initial cost to SKY for digital STBs is approximately $650, but a continuation of existing trends should see a progressive fall in STB costs over time and an increase in STB functionality. It is anticipated that future digital television sets will incorporate STB circuitry and remove the need for a separate device. Section 5.6 considers TVNZ's approach to the introduction of STBs.

4.2 Separation of BCL

BCL is a TVNZ subsidiary within the distribution division. It owns and operates 460 transmitter towers and the linking network between them.

Distribution Division Financial Analysis

[Text deleted]

The distribution division includes Satellite and Pacific Services Limited ("SAPS"), Engineering and an Australian business which principally deals with the NTA contract referred to in Section 4.5. SAPS operates a satellite link to the United Kingdom which is used to obtain programmes from British producers (amongst other things). SAPS also transmits television programmes to the Pacific Islands. The Engineering unit provides engineering services to all of TVNZ.

TVNZ has investigated the merits of the separation and sale of BCL. It commissioned a scoping report from Southpac Corporation Limited and McKerlie Consulting Limited to identify, consider and report on the strategic, operational and financial issues associated with the potential divestment of BCL by TVNZ. [Text deleted]

The Board of TVNZ has concluded that TVNZ should not separate and sell BCL in the immediate future before TVNZ's digital strategy is in place. TVNZ believes ownership of BCL is necessary:

  • for TVNZ to influence the process of determining STB design, thereby ensuring that pay TV operators are not favoured to the disadvantage of free-to-air broadcasters;
  • to ensure that the television division is able to participate in developing opportunities [Text deleted];
  • [Text deleted]; and
  • to ensure the balance of TVNZ is attractive to potential purchasers.

The value or significance of the added influence over STB design that ownership of BCL provides is difficult to gauge. We are not able to reliably test TVNZ's estimate of the additional EBIT that [Text deleted] new business opportunities will provide the television division. (Sections 5.0 and 8.1 describe the various outcomes possible from TVNZ's future digital broadcasting strategy and the difficulty in forecasting financial outcomes). It is also not certain that another owner of BCL would prevent TVNZ using the facilities necessary to obtain any additional EBIT. Ownership of BCL does, however, remove potential difficulties in this regard. In effect, it provides TVNZ with an option over BCL's digital transmission capacity, giving TVNZ greater control and reducing its risks during the transition to digital transmission. [Text deleted] TVNZ considers it important, not only for TVNZ but also for the whole free-to-air television industry, that access be available to competitively priced DTT broadcasting facilities.

In our view, uncertainty relating to digital transmission would significantly impair the sale price of BCL if it were offered for sale of now. While TVNZ could commit to some form of digital transmission now or in the near future, it will be some time before long term contracts for transmission services between the television division and BCL can be signed. As noted elsewhere, TVNZ has not decided on all aspects of its future free-to-air [Text deleted] or new media strategies. STB arrangements are also uncertain. We envisage that it will be some months before TVNZ and BCL could sign a contract for future digital transmission services. [Text deleted] In the absence of a long term digital transmission contract with TVNZ, we believe potential buyers would significantly discount the value of BCL.

Considering the effect of the sale of BCL on the attractiveness of TVNZ to other buyers, we note that most overseas television broadcasters have their own transmission facilities. TV3's reliance on a competitor for transmission is unusual. Overseas sales of transmission networks (in the United Kingdom and as proposed in Australia) have been by non-commercial or less commercial public service broadcasters. We expect the likely buyers of TVNZ to prefer that TVNZ retain BCL. If BCL were sold separately, we expect them to discount the value of the residual parts of TVNZ [Text deleted]. We also believe that buyers of TVNZ will value BCL, as a part of TVNZ, at least as highly as the price achieved in a separate BCL sale.

[Text deleted]

4.3 CLEAR

Description

TVNZ owns 25% of the shares in CLEAR. [Text deleted]

CLEAR is New Zealand's second largest telecommunications company. The majority of its revenues are generated from toll by-pass operations. It currently has a domestic and international toll market share of approximately 18%. CLEAR has very limited local loop assets and no mobile telephone operations.

CLEAR Financial Performance

[Text deleted]

CLEAR Financial Position

[Text deleted]

CLEAR Forecast EBIT

[Text deleted]

BCL Relationship

[Text deleted]

Renegotiation of the CLEAR Contracts

[Text deleted]

Sale of the CLEAR Shares

[Text deleted]

4.4 SKY

Description

TVNZ owns 12.6% of the shares in SKY. At 8 April 1998 the holding had a market value of $127 million.

SKY is New Zealand's largest pay television broadcaster. It was formed in 1987 and commenced transmission in May 1990. It currently broadcasts on five channels to approximately 305,000 subscribers.

SKY owns UHF analogue frequency licences for four nation-wide channels and has the right to broadcast for approximately 128 hours per week on a fifth channel whose frequency licence is owned by the Totalisator Agency Board. SKY's programmes are broadcast by BCL to an area in which 73% of New Zealand's households are located. 28% of those households are SKY subscribers.

SKY has leased three satellite-based transponders owned and operated by Optus Communications Limited. Each transponder has the capacity to carry up to two analogue channels or up to 15 separate channels using digital compression technology. The first transponder commenced analogue transmission in April 1997. The remaining two are scheduled to become available in May 1998 and June 1999. SKY proposes to offer a nation-wide digital DBS service with up to 20 channels in the second half of 1998. SKY is estimated to have approximately 12,000 analogue DBS subscribers.

For the months of March and April 1997, AGB McNair Dataline estimated that within homes subscribing to the SKY network, SKY channels accounted for 29% of the total viewing during the hours between 6.00 a.m. to midnight. TV ONE, TV2 and TV3 accounted for 26%, 23% and 19% of total viewing respectively.

SKY carries a limited amount of advertising on its programmes. [Text deleted]

Financial Information

SKY Financial Performance

 

Year ended

31 March

Nine months ended

Years ended 31 December

(in $ millions)

1993

31 Dec. 1993

1994

1995

1996

1997

             

Revenues:

           

Subscriptions

31.6

38.1

72.3

102.3

127.0

149.7

Other

3.1

4.1

7.6

6.4

17.7

27.1

 

 

 

 

 

 

 

Total revenues

34.7

42.2

79.9

108.7

144.7

176.8

             

Operating expenses:

           

Cost of services:

           

Programming

18.4

19.9

35.1

42.5

61.6

76.8

Subscriber management

3.1

2.8

4.8

4.6

5.6

7.2

Transmission

7.2

5.6

9.5

10.8

13.6

15.3

Selling, general and admin.

14.4

12.0

16.8

18.0

22.1

31.2

Depreciation and amortisation

11.8

12.4

22.8

29.4

45.8 (1)

30.9

 

 

 

 

 

 

 

Total operating expenses

54.9

52.7

89.0

105.3

148.7

161.4

 

 

 

 

 

 

 

Operating profit (loss)

(20.2)

(10.5)

(9.1)

3.4

(4.0)

15.4

Interest expense

4.2

5.0

9.6

13.2

16.6

14.9

 

 

 

 

 

 

 

Net profit (loss) before tax

(24.4)

(15.5)

(18.7)

(9.8)

(20.6)

0.5

Tax expense

0.0

0.0

0.0

0.0

0.0

0.0

 

 

 

 

 

 

 

Net income (loss)

(24.4)

(15.5)

(18.7)

(9.8)

(20.6)

0.5

Source:SKY prospectus and annual accounts

(1)Includes additional depreciation of $10.6 million on analogue and UHF transmission equipment


SKY Financial Position

 

As at

31 March

As at 31 December

(in $ millions)

1993

1993

1994

1995

1996

1997

             

Fixed assets

59.9

75.2

102.5

113.1

105.7

154.6

Total assets

76.3

97.4

130.0

148.5

158.2

214.4

Total tangible assets

69.4

87.0

116.2

129.2

128.0

173.4

Debt due within one year

39.0

1.3

4.0

11.1

29.6

2.2

Long-term debt and lease obligations

19.9

86.0

123.8

135.7

138.8

81.6

Total liabilities

84.8

121.4

172.8

201.1

231.3

160.1

Shareholders' equity

(8.5)

(24.0)

(42.8)

(52.6)

(73.1)

54.3

Source: SKY prospectus and annual accounts

SKY Cash Flow Data

 

Year ended

31 March

Nine months ended 31 Dec

Years ended 31 December

(in $ millions)

1993

1993

1994

1995

1996

1997

             

Cash flow from operating activities

(8.2)

(2.1)

13.6

30.6

26.2

37.5

Cash flow from investing activities

(21.0)

(25.7)

(52.2)

(40.1)

(41.1)

(61.4)

Cash flow from financing activities

30.3

28.7

37.8

13.8

17.1

18.0

EBITDA

(8.4)

1.9

13.7

32.7

41.9

46.4

Capital expenditure

21.1

25.8

52.2

39.0

41.5

58.7

Source:SKY prospectus and annual accounts

SKY Subscriber Details

 

As at

31 March

As at 31 December

 

1993

1993

1994

1995

1996

1997

Total number of households

in New Zealand

1,272,000

1,287,200

1,307,000

1,326,800

1,346,600

1,346,600

Number of households within reach of the SKY UHF network

668,100

679,700

855,900

906,000

986,500

986,500

Percent of households within reach of the SKY UHF network

52.5%

52.8%

65.5%

68.3%

73.3%

73.3%

Subscribers - UHF:

           

Residential

81,038

116,448

163,695

191,061

238,908

269,891

Commercial

776

1,003

1,478

1,648

2,490

2,708

             

Total UHF

81,814

117,451

165,173

192,709

241,398

272,599

             

Subscribers - DBS (satellite)

           

Residential

-

-

-

-

-

11,729

Commercial

-

-

-

-

-

453

             

Total DBS

-

-

-

-

-

12,182

             

Total Subscribers

81,814

117,451

165,173

192,709

241,398

284,781

             

Percent of households within reach subscribing to the SKY network:

           

UHF

12.1%

17.1%

19.1%

21.1%

24.2%

28.2%

DBS

-

-

-

-

-

0.9%

Churn rate (1)

25.8%

25.8%

28.7%

40.1%

33.8%

28.9%

Average monthly revenue per

residential subscriber (2)

$38.48

$38.48

$40.15

$45.29

$46.26

$45.76

Source:SKY prospectus and annual accounts

(1)"Churn" refers to the percentage of residential subscribers over the twelve-month period ended on the date shown that terminated their subscriptions, net of existing subscribers who transferred their service to new residences during that period.

(2)Exclusive of goods and services tax payable by subscribers.

SKY has never paid a dividend and is not expected to do so in the foreseeable future.

Shareholders

[Text deleted] The market price of SKY shares at 15 April 1998 was $2.75.

[Text deleted]

SKY offered 57.5 million of its shares to executives, directors and the public in November 1997 and is now listed on the New Zealand Stock Exchange. Its current ownership is as follows.

Shareholder

Number of shares

Percentage of total

     

INL

147,093,977

40.2%

Heatley Jarvis Investments Limited

52,117,840

14.2%

TVNZ

46,098,956

12.6%

Todd Corporation Limited

28,936,862

7.9%

Tappenden Construction Limited

24,698,150

6.8%

SKY executives and directors

1,700,000

0.5%

Members of the public

64,975,000

17.8%

     

Total

365,620,785

100.0%

In connection with the public offering referred to above TVNZ has agreed not to sell any SKY shares for 180 days from 9 December 1997. Under the terms of SKY's Constitution, TVNZ is entitled to appoint one director. TVNZ's Chairman is a director of SKY.

TVNZ Shareholding

TVNZ originally invested in SKY to participate in a part of the television industry that was expected to develop and expand. The financial rewards from the investment were intended to partially offset any corresponding decline in the mature free-to-air business. It was also anticipated that SKY would profitably utilise TVNZ's resources and skills, and that SKY would be more willing and able to do so with TVNZ's support as shareholder. TVNZ's strategy has been successful to date. BCL transmits SKY's programmes; there are other business dealings between the two companies; previous sales of SKY shares have been at a profit; and the unrealised gain on TVNZ's remaining holding is substantial.

SKY continues to have significant growth potential. The pay TV industry is expected to continue to expand and SKY's connection with INL and News Corp might be beneficial with the advent of digital satellite broadcasting representing a significant opportunity for SKY.

Now that SKY is listed on the stock exchange the value of its growth prospects (and the implications of the related risks) should be reasonably accurately reflected in its share price. If appropriate, TVNZ could realise virtually all of the value of SKY's potential (other than strategic benefits particular to TVNZ) through sale of its shares on the stock exchange.

[Text deleted] The potential for such strategic benefits may be evidenced by the frequency of common ownership of pay and free-to-air television broadcasters in overseas markets. Although business dealings between SKY and TVNZ are on an arms-length basis, TVNZ's SKY shareholding and appointed director can be expected to foster a strong working relationship and facilitate joint action between the companies.

More significantly, the introduction of digital transmission and the determination of STB design are critical issues for TVNZ that will involve discussions, negotiations and, probably, joint action between TVNZ and SKY. [Text deleted]

If any sale or restructuring of the ownership of TVNZ is contemplated, consideration needs to be given to whether the SKY investment should be sold separately or together with the rest of TVNZ's business. As SKY is listed on the stock exchange and the market for its shares is liquid, we see no reason why any buyer of TVNZ should undervalue the SKY shares that TVNZ owns. In fact, some buyers of TVNZ may recognise a material strategic value in the SKY shareholding (as does TVNZ) and therefore pay more than the stock exchange price. In light of these factors, we believe that the SKY shareholding should remain with TVNZ in the event of any sale.

4.5 National Transmission Agency

The National Transmission Agency ("NTA") is responsible for planning, constructing, operating and maintaining the Australian Federal Government's network of broadcasting facilities. At 30 June 1997 it had 547 sites on which 1717 transmitters were located. Its primary role is to provide transmission facilities for the Australian Broadcasting Corporation and the Special Broadcasting Service. It also provides services for community radio and television broadcasters and for radio communications operators.

[Text deleted]

[TVNZ, as part of a][Text deleted] consortium, lodged an expression of interest regarding NTA in February 1998 and has been accepted in the short list of final bidders. Unconditional final tenders are due to be submitted by 14 July 1998.

At 30 June 1997 NTA's transmission assets had a depreciated replacement cost value of A$407.1 million. For the year ended 30 June 1997 NTA's revenue was A$103.9 million and its operating loss (before tax and interest) was $26.4 million. Revenue from Australian Broadcasting Corporation and Special Broadcasting Service transmission services is to be increased by approximately A$13.5 million per year after sale.

TVNZ's prime motive is to secure its existing NTA contracts and obtain additional work [Text deleted].

TVNZ is continuing to investigate NTA and intends to consider its final offer at its May Board meeting. TVNZ is under no obligation to lodge a bid.

In our view, the potential purchase of NTA by the TVNZ consortium has little or no bearing on the investigation of the separation of BCL described in Section 4.2. In respect of the Crown's consideration of its ownership of TVNZ, the NTA investment is an example of the expansion opportunities that TVNZ will need to consider in order to capitalise on its strengths and continue to develop as its core, traditional business has limited growth prospects. [Text deleted]

5.0 Future Operating Strategies

5.1 Introduction

The Board and management of TVNZ have recently extensively reviewed the company's future operating strategy and are devising plans for several areas of development. The remainder of this section describes the status of TVNZ's investigations into the following principal issues:

  • EBIT improvement;
  • digital transmission of free-to-air channels;
  • conversion of BCL to digital transmission;
  • acquisition of spectrum;
  • STB design;
  • STB subsidies;
  • [Text deleted] new media;
  • [Text deleted] CLEAR contracts;
  • sale of CLEAR shares; and
  • strategic equity partners.

5.2 EBIT Improvement

TVNZ has compared its television division performance with four commercial television broadcasters: TV3 and, from Australia, Channels Seven, Nine and Ten. In terms of the ratio of EBIT to revenue, TVNZ believes its performance in the three years ended 31 December 1996 compared well. Performance deteriorated in 1997 primarily due to increased competition and a depressed advertising market. Section 3.0 sets out this and other financial performance comparisons in more detail.

TVNZ aims to improve television division EBIT margin from 21.2% to 30.0% (i.e. from $51.5 million after adverse foreign exchange rate movements to approximately $97.8 million) over the next three years. [TVNZ's strategies include][Text deleted]:

  • [Text deleted]revenue yield management[Text deleted];
  • improve gross margins[Text deleted];
  • reduce losses on sport[Text deleted];
  • lower transmission costs[Text deleted]; and
  • lower overhead costs[Text deleted].

In total, TVNZ's television division EBIT improvement strategy appears to be challenging. It represents a reversal of recent trends. [Text deleted]. Overall, we believe that TVNZ's EBIT target is ambitious. The Board of TVNZ has indicated that it is committed to achieving this plan.

5.3 Digital Transmission of Free-to-Air Channels

Digital transmission is expected by virtually all industry participants to become the dominant television broadcasting medium in New Zealand with the phasing out of analogue transmission over the next 10 to 15 years. To preserve its market position and long term prospects, TVNZ will need to arrange for the digital broadcasting of its core free-to-air channels.

For its free-to-air channels TVNZ is investigating:

  • DTT broadcasting from BCL's [Text deleted] main transmitter sites to 79% of New Zealand's population, thereby allowing for regional advertising; and
  • DTH broadcasting of a national programme to cover the remaining 21%.

A significant proportion of TVNZ's programme material and production processes are already in a digital format suitable for digital transmission. The additional capital cost of modifying production equipment, control rooms and other television division facilities to allow for digital transmission is relatively small.

Sections 5.4 and 5.5 consider issues relating to the conversion of BCL's transmission equipment and the availability of frequency spectrum for DTT broadcasting.

It is not yet known how TVNZ will arrange DTH broadcasting. TVNZ is discussing DTH arrangements with SKY, which is expected to have spare capacity on its three satellite transponders. These are capable of broadcasting 40 to 50 digital channels. Of greater significance in determining DTH arrangements is the installation of STBs. SKY is in the process of arranging STBs for its own DTH channels. Section 5.6 contains further details of the issues relating to STBs.

The financial arrangements that might be made with SKY concerning DTH broadcasting are unknown. However, the "base case" financial projections set out in Section 8.0 assume that some form of digital broadcasting for the core free-to-air channels will be arranged by TVNZ. Details of the approach to modelling the related uncertain cash flows are set out in Section 8.1.

5.4 Conversion of BCL to Digital Transmission

BCL is exploring the introduction of DTT to complement existing analogue transmission services. As explained in Section 4.1, DTT enables a single analogue terrestrial channel to be replaced with four to six standard digital channels (or one HDTV channel) in the same spectrum bandwidth.

[Text deleted]

In our view it is almost certain that BCL should become involved in some form of digital transmission. There are a number of different digital transmission arrangements BCL could make, and BCL is undertaking further work to determine its optimum digital plan.

5.5Acquisition of Spectrum

TVNZ holds spectrum licences that permit it to transmit the following signals:

  • TV ONE on VHF frequencies;
  • TV2 on VHF frequencies; [and]
  • MTV on UHF frequencies; and
  • [Text deleted].

[Text deleted]

5.6 Set Top Boxes

[Text deleted]

5.7 [Text deleted] New Media

[Text deleted]

5.8 [Text deleted] CLEAR Contracts

[Text deleted]

5.9 Sale of CLEAR Shares

TVNZ has decided to dispose of its shares in CLEAR. [Text deleted] It is not known when a sale can be completed. Section 4.3 provides further details of the CLEAR shareholding.

5.10 Strategic Equity Partner

The worldwide media industry is becoming increasingly concentrated. Section 2.6 describes the formation and increasing size of global media conglomerates. All of TVNZ's competitors now have connections with large, diversified multi-national organisations. TV3 is owned by CanWest, which has television interests in Canada, Australia and Ireland. It also has radio interests in New Zealand. SKY is 39.7 % owned by INL, an Australasian newspaper and magazine publisher that is 49% owned by News Corp. Prime, which is due to begin broadcasting in August 1998, has television activities in Australia and Argentina and is affiliated with the Seven Network (which has interests in MGM and Australian telephony and pay TV operator Optus Communications Limited).

Access to programme content is being affected by industry consolidation. TVNZ is concerned that:

  • programming produced by parties related to its competitors will become unavailable. Examples include The Simpsons (produced by Fox, a subsidiary of News Corp) and Blue Heelers (produced by the Seven Network), both highly rating TVNZ programmes for which exclusive rights might be purchased by SKY and Prime respectively; and
  • it will not be able to compete with the purchasing power of global organisations. (It was unable to purchase international rights to broadcast rugby union in 1996 as these were acquired by News Corp).

TVNZ considers that the loss of access to content is one of the greatest risks it faces. TVNZ believes that it should form an association with an international organisation, preferably a global media conglomerate, to minimise the risk. TVNZ thinks that such an arrangement would have other benefits. It would:

  • provide access to expertise in pay TV, new media and the introduction of new technology;
  • provide access to new capital for business expansion; and
  • spread the risk associated with new developments.

    TVNZ believes that equity participation by a strategic partner is necessary to achieve the benefits described above. We note that regulations in overseas markets often require that the type of association TVNZ hopes for is achieved by contractual arrangements rather than equity ownership. For example, affiliation to major networks in both the U.S. and Australia is by contract because share ownership is prohibited. However, such affiliations are of relatively short term and do not align the commercial incentives of the partners.

    As Section 9.4 explains, some of the difference between the value to the Crown of retained ownership of TVNZ and TVNZ's potential sale price will relate to the strategic benefits provided by a global media conglomerate purchaser.

6 Public Service Broadcasting

6.1 Introduction

    This section of the scoping report focuses on the implications of a sale of TVNZ on "public service broadcasting". It examines the public policy side of television broadcasting that involves the content and style of television rather than regulatory issues. The key aspects of public service broadcasting are typically considered to be the provision of universal coverage, application of broadcasting standards, promotion of national identity, democratic support and supplementary (i.e. non-commercial) programming. These features of public service broadcasting are more fully explained later in this section.

    The analysis in this section does not attempt to establish the appropriate level or content for public service broadcasting. This will always be a matter of individual opinion and taste. Rather, we take the current level of delivery of public service broadcasting as a benchmark and consider whether there might be a reduction in this level if the ownership of TVNZ changed.

    This approach means that the analysis is independent of the levels of public service broadcasting considered to be appropriate. The analysis considers access to public service broadcasting, but is not concerned with the quantity. We note, however, that within the current structure there are explicit mechanisms available to increase the amount of public service broadcasting. As discussed below these are independent of the ownership of TVNZ.

6.2 Overview and Summary

    The regulatory structure for television broadcasting in New Zealand that emerged from the reforms of 1988 is based on a commercial system. Aspects of television service that have public benefits but are not supplied by the market are intended to be provided through NZ On Air funding.

    As noted above, public service broadcasting can be considered under five headings (coverage, standards, national identity, democratic support and supplementary programming). Our analysis suggests that a change of ownership of TVNZ would have little impact on the first four. Concerns about the quantity and range of supplementary programming of interest to minorities that would be available following sale have been raised by a number of parties, for example NZ On Air and SPADA.

    The market intervention model relies on public funding being able to purchase air time by making up the profit difference between the broadcaster's best commercial strategy and any desired public service broadcasting (typically a NZ On Air minority interest programme). There appears to be a perception by NZ On Air, SPADA and some members of the public that a change in TVNZ's approach could make this mechanism less effective.

    These concerns arise because those parties perceive there is a risk that an alternative operating strategy for TVNZ may be implemented after a sale. However the present directors and management are currently running TVNZ as a profitable commercial business as is required by the State Owned Enterprises Act. They could, at any time, identify another strategy that is commercially superior to the present one. In this respect, they are no different from any other potential owner of TVNZ (who may or may not change TVNZ's current general strategy). In our view, the fundamental risk, then, lies with the structure of New Zealand's commercially based television broadcasting system not with a sale of TVNZ. If members of the public have concerns about NZ On Air's minority programming effectiveness, we believe they should be addressed directly and independently of the ownership of TVNZ.

6.3 Previous Debate and Discussion

    Traditional discussion focuses on "public broadcasting". The analysis set out below is concerned rather with "public service broadcasting". This distinction reflects the change in the structure of television broadcasting in New Zealand brought about by the reforms of 1988. The reforms were a fundamental change in approach. Critical steps included:

    • an institutional separation of public intervention mechanisms by establishing a purchaser (the Broadcasting Commission, now known as NZ On Air) which would be at arms length from providers (commercial broadcasters, i.e. TVNZ and others); and
    • making the public interventions "supplementary". That is, the purchaser (NZ On Air) would be concerned with "making a difference" to what was otherwise a commercially operated broadcasting industry.

    In this way the interventions were designed to achieve only the publicly important "non-commercial" effects by providing marginal extra funding. This was intended to avoid deadweight costs of fully funding programmes that would otherwise have been partly or fully commercial. The aim was for interventions to alter television broadcasting by supporting programme material or broadcasting outcomes that would otherwise not be produced in a commercial environment, and to achieve this effect at minimum cost. The current situation in the television broadcasting industry continues to reflect the structure established in 1988.

    The agency which carries out the supplementary purchasing, NZ On Air, has functions specified in Section 36 of the Broadcasting Act 1989:

    "
  1. To reflect and develop New Zealand identity and culture by-
    1. Promoting programmes about New Zealand and New Zealand interests; and
    2. Promoting Maori language and Maori culture; and

  2. To maintain and, where the Commission considers it is appropriate, extend the coverage of television and sound radio broadcasting to New Zealand communities that would otherwise not receive a commercially viable signal; and
  3. To ensure that a range of broadcasts are available to provide for the interests of -

    1. Women; and
    2. Children; and
    3. Minorities in the community including ethnic minorities; and

  4. To encourage the establishment and operation of archives of programmes that are likely to be of historical interest in New Zealand -

    by making funds available on such terms and conditions as the Commission sees fit, for -

  5. Broadcasting; and
  6. The production of programmes to be broadcast; and
  7. The archiving of programmes."

NZ On Air's methods are further prescribed in other parts of the Act (including sections 37 and 39).

The consideration of public policy interventions in broadcasting is not a well-structured area of debate. Television has long been an item for public policy discussion and, like all media policy, views about broadcasting are diverse and difficult to converge. They reflect personal tastes as well as frameworks of analysis. As Spicer, Powell and Emanuel comment in The Remaking of Television New Zealand, 1984-1992 (in footnote 14 to Chapter 7, page 200).

    "Perhaps the reason that these terms ["public service" and "non-commercial"] do not appear in the [Broadcasting] Act is that they are elusive concepts on which there are a number of opinions."

As we are using current levels of public service broadcasting as a baseline, much of this complexity can be sidestepped. The debate about the quality and quantity of public service broadcasting will and should continue. As we discuss below, however, it is not central to the question of whether a sale of TVNZ would hinder the delivery of public service broadcasting.

Our approach is to consider five broad issues that arise in discussions of such policy:

  • coverage, ensuring that core broadcasting is available to most of the population;

  • standards, whereby quality is ensured with appropriate content choice and through independence of news and current affairs;

  • national identity and cohesiveness reinforcement, through including local programme content that supports national values;

  • democratic support, through acting as an independent forum for providing information and airing issues through public debate; and

  • supplementary programming, by showing minority and innovative material.

We are leaving the question of the existence and intensity of advertising to one side. The predecessor of TVNZ commenced advertising very shortly after the commencement of television broadcasting in 1961. Advertising revenue has been the principal source of television funding for over 20 years. The reform of television regulation in 1988 envisaged a fully commercial industry, and the establishment of TVNZ as an SOE reinforced its commercial motivation. In late 1997 the Government discussed the extent of advertising with TVNZ, which reduced non-programme time but declined to reduce advertising. The commercial basis of TVNZ is not often questioned, and in any event, the existence and intensity of advertising is independent of the ownership of TVNZ.

This analysis does not include consideration of Maori language broadcasting. Section 7.1 examines this issue.

Within the broad framework described above we can consider the current situation and the way it is likely to be affected by a change of ownership of TVNZ. The situation is as follows:

  • coverage is a concern of New Zealand On Air, if there is a problem. Coverage is provided voluntarily by TVNZ to approximately 98.5% and by TV3 to approximately 96% of the population. NZ On Air pays TVNZ approximately $1.6 million per year to extend coverage to another 1% (15,000 homes). We are not aware of any reason why this arrangement would not continue to be effective if TVNZ were to be sold. In any event, within the next five years direct broadcast satellite is expected to provide free-to-air channels to 99.9% coverage (to those homes prepared to purchase satellite dishes and digital demodulators) without the need for NZ On Air funding;

  • standards are regulated by the Broadcasting Standards Authority and other regulatory bodies. Existing standards apply now to public and privately owned television broadcasters and would continue to be applied to TVNZ after a sale. Thus we conclude there is no likely impact from a change in ownership;

  • national identity and cohesiveness reinforcement does not appear to us to be at risk in any ownership change. There are sound commercial reasons for the existing broadcasting of the material concerned - it is cornerstone programming. Indeed, there seems to be growing stress on local material as TVNZ believes viewers are more interested in New Zealand presentations;

  • democratic support also appears to us not to be at risk. Relevant material currently programmed seems to be valuable to the broadcasters and this commercial drive should see any new ownership providing at least a similar quantity and quality of news and current affairs (and changing the quantity and quality as commercial demands dictate, in the same way that TVNZ would). Appendix IV considers provision of election coverage. Existing arrangements are not affected or can be readily preserved in the event of a sale;

  • supplementary programming is influenced by the effectiveness of NZ On Air within a commercial environment. This area has been suggested by some interested parties as the only possible source of risk to public service broadcasting from a sale of TVNZ. This issue is discussed further below.

6.4 Minority Interest Programmes

    Discussions with TVNZ and its advisors suggest that there are sound commercial reasons for its present broadcasting schedule, including its present minority programming content. Indeed, they identify no non-commercial components of TVNZ's current strategy. There are both general and specific reasons for this.

    The requirement that Sunday morning be free of paid advertisements creates a series of "lower cost" slots for minority interest programming. Moreover, TVNZ seeks to position its two main free-to-air channels (TV ONE and TV2) in the public's mind in a certain light. This involves building up associations between the type of material that each will show (such as TV ONE's quality or experimental drama in the Sunday night theatre time slot) and the brands themselves (TV ONE and TV2).

    There is, therefore, a longer-term commercial branding and reinforcing logic that drives the selection of programmes and styles. The selection and organisation of content has implications beyond the short-term issues of immediate viewer numbers. Hence, the actual programme schedule is an outcome of the commercial strategy adopted by current directors and management.

    A change in ownership might lead to a change in directors or management, and possibly thereby, a reassessment of the programme schedule and its minority interest content. But such a reassessment might be carried out without a change of ownership. Current management could undertake it. They are charged under the State Owned Enterprises Act with ensuring that TVNZ is run as a commercial enterprise. Section 4(1) of the Act states:

      "The principal objective of every State Owned Enterprise shall be to operate as a successful business and, to this end, to be

  1. As profitable and efficient as comparable businesses that are not owned by the Crown; and
  2. A good employer; and
  3. An organisation that exhibits a sense of social responsibility by having regard to the interests of the community in which it operates and by endeavouring to accommodate these when able to do so."

The practical meaning of this is that TVNZ's commercial business strategy may, at any time, change from that now prevailing. Reasons could include new views or additional information, the pressures of technology, or the activities of competitors. A revised strategy could involve different positioning for the two channels. It could call for new methods of establishing the brands, which would flow into all TVNZ activities, including programming. In other words, changes in the quantity of minority interest programming shown on TVNZ are possible, whether there is any change of ownership or not. The quantity of minority interest programming could go up or down. New strategies may merely alter the make up of the different types of minority interest programmes shown. But the key point is that any change would stem from management's assessment of the best commercial strategy for TVNZ.

6.5 NZ On Air

    NZ On Air has the task of adding a public policy dimension to commercial television. It is concerned that the provision of a wide and diverse range of local material, such as a variety of drama, a range of documentaries, a mix of children's programmes, and programmes for special interests will be harder to achieve if TVNZ is sold.

    NZ On Air sees a possibility that a sale of TVNZ (including TV ONE) would close off unique options to broadcast its material, as there are minority programmes which TV3 will not consider transmitting, almost at any price. This uniqueness, NZ On Air says, stems from the power of the Government, as owner, directly or indirectly to require its channels (say TV ONE) to provide social goods in line with NZ On Air's objectives. It is also concerned that commercial broadcasters programme to attract the audiences that advertisers value - primarily 18 to 54 year olds.

    In our view NZ On Air's analysis of what it is about TVNZ that produces the opportunities is less convincing than its identification of the potential risk. NZ On Air believes that TV ONE's current format is such that TVNZ is able to more readily include minority programming within its schedule. It is not clearly demonstrated that the cause of the format is government ownership. The commercial judgement reason, that it is the branding of TV ONE and its (relative) positioning with TV2 that is the explanation, seems more probable to us. But NZ On Air's view is that government ownership is at least part of the answer. In support it notes that there is relatively little interest in TV ONE's older viewers from advertisers, suggesting that this is evidence of a non-commercial motivation.

    NZ On Air's concerns may also arise from the way the system of NZ On Air supplementation "floats" above the present commercial situation. The existing intervention system, that seems to rest on a relatively fixed dollar amount of funding, cannot assure any given level of public policy broadcasting, regardless of the ownership of broadcasters. Not only does the purchasing power of NZ On Air depend on the strategies of the commercial managers NZ On Air deals with, but NZ On Air believes those same strategies may close NZ On Air's access to the airwaves at any price for certain types of programme.

    NZ On Air points to TV3's reluctance to accept some funding as evidence of the risks from private ownership of TVNZ. It should be noted that TVNZ has also already declined NZ On Air funding in the past.

    In brief, NZ On Air has pointed to a potential risk to minority interest programming that could stem from a sale of TVNZ. However, that a sale of TVNZ is the cause of the risk is not well established. It seems more likely to relate to the amount of funding available to NZ On Air. The consequences of NZ On Air's concerns eventuating are also uncertain.

6 Public Service Broadcasting continued ...

6.6 SPADA

    The Screen Producers and Directors Association of New Zealand ("SPADA") has a similar view. It sees a problem in the commitment of foreign owners of television to New Zealand content. In support it cites the limited resources contributed by the major free-to-air channels for New Zealand productions in critical areas such as children's programmes and adult drama.

    SPADA's fear is that any change in the ownership of TVNZ (which it suggests would entail a foreign investor) would accentuate this situation and weaken NZ On Air's bargaining position. SPADA considers, as discussed above, that NZ On Air can only offer money, which can be declined, and that this situation will remain as long as the channels retain the freedom to set their programme content. SPADA does not see any improvement merely from increasing competition, with the onset of multi-channelling. SPADA's preferred approach is to have an Australian style quota system.

    SPADA have underlined the potential risk that NZ On Air has discussed. As suggested above, we believe it is inherent in our broadcasting system. But, even beyond that, it is unclear that their analysis is accurate. Local material is popular. In general it attracts high ratings and the channels seem to be interested in showing it. What is clear is that broadcasters will not pay more than is viable and the genre SPADA refer to are not cheap. It is also difficult to see why increasing transmission capacity will not improve the situation as NZ On Air's options to gain access widen.

    New Zealand has entered into commitments in the General Agreement on Trade in Services in respect of broadcasting. It has undertaken to treat overseas television programme suppliers no less favourably than New Zealand producers. An Australian style quota system would contravene the current terms of the agreement, and would require negotiation and agreement with the affected trading partners.

6.7 Other Views

    National Security

    Some members of the public see a particular political risk which has not been covered above. Noting the absence of a dedicated public service broadcaster in New Zealand, they see a need to provide a national "flagship" channel which is the authoritative voice of calm at times of national stress, such as threats to New Zealand security or major natural disasters. They see government ownership of TVNZ or, perhaps more particularly, TV ONE, as filling the role, and no broadcasting channel naturally available to fill this role if TVNZ is sold.

    This risk seems unclearly specified and remote. In a purely commercially driven system broadcasters should still be ready to provide the calming authoritative voice that is envisaged in a national crisis. Channels want to be seen as good corporate citizens, and to reinforce their empathy with audience groups. The competition to maintain credibility in the vital anchoring early evening news programmes supports this view. In any event, the police, civil defence organisations and other appropriate government bodies have emergency powers to deal with the situations envisaged.

    Future Public Policy

    It has been suggested that Crown ownership of TVNZ is necessary to enable the delivery of future, unidentified public policy objectives that cannot be accommodated by the Broadcasting Act and NZ On Air. However, the Crown has sovereign power to legislate the delivery of appropriate public policy, so that although Crown ownership of TVNZ may facilitate future public policy delivery or make such delivery more convenient, it is not essential. To suggest otherwise implies that, in the extreme, the Crown should own all businesses which might in the future be involved with the delivery of public policy. This is clearly impractical and unnecessary. For example, the Crown no longer owns banks but continues to apply public policy to home mortgage lending by independent interest rate setting mechanisms.

    Popular Entertainment

    Much of the public debate about the ownership of TVNZ does not relate to the public service broadcasting features of coverage, standards, national identity, democratic support or supplementary programming described in Section 6.3. Rather than being concerned about social welfare and public good, many members of the public are worried that popular entertainment which suits their particular tastes will no longer be available to them on a free to air basis, either as a result of competition with SKY or in the event of a sale of TVNZ.

    Section 6.1 describes the approach we have taken to the investigation of true public service broadcasting issues. We have not considered in this scoping review whether it is the role and obligation of the Crown to provide popular entertainment to the public, as this was not requested in our terms of reference. Nevertheless, we make the following observations about these related public concerns.

    Many members of the public believe that, particularly as they pay licence fees, the Government should represent their interests to ensure there is an "acceptable" programme schedule on TV ONE and TV2. This argument is poorly based for several reasons:

    • as a commercial broadcaster, TVNZ's principle source of revenue is from advertising. The licence fee is in fact collected by NZ On Air, and the amount passed on to TVNZ represents less than 5% of TVNZ's income;
    • the Government is not currently exercising influence over TVNZ's programming. To do so would be a breach of the Broadcasting Act and counter to the thrust of the State-owned Enterprises Act. TV ONE's schedule, for example, is the result of a commercial strategy being pursued by TVNZ; and
    • as a practical matter, it is difficult to see how the Government could make better choices in regard to popular entertainment programming than are made by TVNZ's management within a commercial framework. More fundamentally, what is "acceptable" programming to one viewer may not be preferred by others.

    As can be expected, TVNZ currently receives complaints from viewers who would like to see programmes that TVNZ does not show because they are not popular with others. Viewers are no longer content to watch one of only two channels as they did before 1988, and it may become even more difficult to produce widely accepted programme schedules in the future as more entertainment choices become available, viewer expectations increase and tastes change and diverge. Crown ownership (or any other ownership) of TVNZ cannot result in TVNZ satisfying the popular entertainment wishes of every member of the public, now or in the future.

    The motivation that TVNZ has to satisfy viewer demand for popular entertainment is identical to that of other private sector broadcasters. (Section 4 of the State-Owned Enterprises Act requires TVNZ "...to operate as a successful business and, to this end, to be as profitable and efficient as comparable businesses that are not owned by the Crown...".) We see no reason why any element of private sector ownership of TVNZ should materially change its objectives.

    Some industry commentators have suggested that:

    • the AC Nielson/AGB McNair "people meter" ratings described in Section 2.4 do not accurately reflect popular taste;
    • historical evidence of viewer selections from past programme offerings do not indicate future preferences; and
    • for these and other reasons TVNZ does not accurately and effectively provide programmes which New Zealanders most want to watch.

    Predicting future consumer preferences will be difficult in the television industry, as it is in any other industry. There is no evidence that TVNZ is less accurate in this regard than its competitors. In fact, to the extent that ratings can be relied upon, it appears that TVNZ is more accurate than its competitors. In our view, the commercial framework in which TVNZ operates appropriately motivates it to provide the most popular programmes, to the extent that they can be provided on a profitable, free to air basis. Again, we see no reason why:

    • the Government as owner should be capable of making better choices in regard to popular entertainment programmes than TVNZ; or
    • any element of private sector ownership of TVNZ should materially change its commercial motivation.

6.8 Trends in Broadcasting and their Implications

    To date public policy concerns about broadcasting have been based on the "special" nature of television. In part this stems from the scarcity and expense of television broadcasting channels. This is likely to end. While a timetable cannot be specified with accuracy, in future there will be many more channels.

    The extra channels come from technological innovation, including direct broadcast satellite transmission and digital compression. They will provide new ways of meeting some of the policy imperatives. In particular, meeting minority interest needs through speciality niche channels will be practical, which may change the way NZ On Air operates; perhaps altering the flow of support to the main free-to-air channels, including TVNZ.

    Channel proliferation will also necessitate consideration of the weight to be given to the "mainstreaming" issue. That is, the extent to which NZ On Air's role is to introduce the wider audiences of the main television channels to "new" material they would not otherwise seek out for themselves. At present Section 39 of the Broadcasting Act ensures that size of audience is a salient factor in selecting funding prospects. The focus in television has thus been on the main free-to-air channels. In a multi-channel environment choices between high cost mainstream and low cost specialised channel broadcasting will have to be made.

    Government ownership of TVNZ does not provide a satisfactory instrument for mainstreaming. The statutory commercial objective of TVNZ has been described previously. The provisions in the State Owned Enterprises Act that allow for the Crown to divert the firm from its commercial focus (i.e. Section 7) is similar to that available to NZ On Air. It is an explicit purchase arrangement. NZ On Air can therefore achieve the same "mainstreaming" as Section 7. In any event, fragmentation is likely to reduce the audience of TVNZ's main channels, thereby reducing its ability to mainstream.

6.9 Discussion and Conclusions

    There is little to suggest that a change of ownership of TVNZ would pose a significant threat to the prevailing level of public service broadcasting. In particular, the strong view of TVNZ's management and Chairman is that their present purely commercial strategy is what produces the programming on TV ONE and TV2.

    Our review of the categories of public policy issues has established that only the delivery of minority special interest programmes is perceived by some interested parties to face any real risk from a sale of TVNZ. NZ On Air has expressed concern about specific potential problems. SPADA have similar concerns. However we believe there is no compelling argument to suggest that minority special interest programmes will be directly affected by a sale.

    In the longer run the proliferation of channels will address many of the minority issues but will also intensify mainstreaming concerns. (At that time Crown ownership of TVNZ will not be capable of resolving mainstreaming concerns either).

    Some members of the public are concerned about possible risks from the lack of a "flagship" channel to provide an authoritative government communication vehicle in times of national stress. This seems to us to be of limited concern today, and ownership of TVNZ of little relevance to the issue.

    Overall, the existing structure of broadcasting was intended to encourage the directors and management of TVNZ to adopt strategies that are totally commercial. A separate entity, NZ On Air, was to provide the public policy driven broadcasting content. Our investigation has shown that this has largely come to pass.

    The intervention model via NZ On Air relies on public funding to purchase programmes. It does this by offering the broadcaster sufficient revenue to make up the profit difference between the broadcaster's best commercial tactics and any public service broadcasting delivery preferred by NZ On Air. In our view change in TVNZ's business strategy might make these arrangements less effective. Such a change could be the result of a change of ownership, or it could be undertaken by the current management under Crown ownership. It is a risk inherent in the broadcasting industry structure and is unaffected by ownership.

7.0 Potential Restructuring Impediments

7.1 Te Reo Maori

    Treaty of Waitangi Obligations

    In Article the Second of The Treaty of Waitangi, the Crown agreed:

      "to protect...all the people of New Zealand in the unqualified exercise of their chieftainship over...all their treasures (taonga)". (Translation of the Maori text)

    Relevant Court Cases

    There are several cases concerning the Crown's obligation under the Treaty of Waitangi that are relevant to Maori interest in the ownership of TVNZ. The notable cases are:

    • the "Broadcasting Assets" case (which proceeded through various courts from 1989 to 1994, and concerned the transfer of broadcasting assets from the Crown to Radio New Zealand Limited and TVNZ); and
    • the "Commercial Stations" case (which ran from 1995 to 1996, and concerned the sale by the Crown of its shares in the entity comprising the commercial stations of Radio New Zealand Limited).

    At the most basic level, these cases have established:

    • that te reo Maori is a taonga the protection of which was guaranteed to Maori by the Crown under Article the Second of the Treaty of Waitangi;
    • the survival of te reo Maori is not at all assured, and the Crown's protection of this taonga has been wanting; and
    • the Crown has a duty arising from the Treaty of Waitangi to assist in the preservation of the Maori language by the use of both radio and television broadcasting.

    The Privy Council in the Broadcasting Assets case in particular also noted that the Crown's obligation:

    • is not "absolute and unqualified" and does not require it to "go beyond taking such action as is reasonable in the prevailing circumstances";
    • is shared with Maori, who must themselves "take reasonable action, in particular action in the home, for the language's preservation"; and
    • involves "mutual co-operation", which in practice means consultation.

    In the Privy Council hearing the Solicitor-General gave an assurance that amounts to an undertaking by the Crown to follow a given timeframe "for the development of special purpose Maori television and for the extension of Maori language programming on commercial television ('mainstreaming')." The proposed milestones were hui, publication of papers, establishment of Te Mangai Paho, and further hui, all to culminate in the announcement of "Government policies on the development of Maori television."

    Crown Action

    The Crown has taken a number of steps to meet its Treaty obligations in respect of the broadcasting of te reo Maori as follows:

    • NZ On Air, which distributes the broadcasting fee, has been given a statutory duty "...To reflect and develop New Zealand identity and culture by promoting Maori language and culture...";
    • Te Mangai Paho has been established as a separate and independent Maori broadcasting funding agency whose sole objective is to promote Maori language and culture;
    • establishment funding and radio frequencies have been provided to a nationwide network of iwi radio stations that broadcast at least nine hours per day in Maori;
    • Radio New Zealand has been given a statutory obligation "to provide...programmes which reflect New Zealand's cultural diversity, including Maori language and culture"
    • TVNZ has agreed to provide Maori television broadcasters with certain access to transmission sites, production facilities and archive material (in an agreement between the Crown and TVNZ dated 25 July 1991);
    • in its Statement of Corporate Intent, TVNZ has an objective to "reflect, develop and foster New Zealand identity and culture by producing and broadcasting programmes about New Zealand or New Zealand interests, including Maori language and culture"; and
    • in the allocation of the radio spectrum, the Crown has retained rights to UHF frequencies which could permit the establishment of a national Maori television network.

    (The steps above are in addition to efforts by the Crown to promote Maori language other than by broadcasting, for example by recognising Maori as an official language in New Zealand, providing the right to speak in Maori in legal proceedings and establishing the Maori Language Commission.)

    Maori Expectations

    It is clear from the energy with which related court cases and Waitangi Tribunal claims have been pursued that Maori have very strong feelings about Maori broadcasting. It is also evident that their expectations of the Crown in this regard are high.

    In June 1997 the Ministry of Commerce published a discussion document on Maori television policy. The national Maori organisations published a response in "Maori Broadcasting - Report to Maori by National Maori Organisations". Written submissions were invited on the discussion document and several hui were held in June and July 1997. In general and in summary, respondents believed:

    • "It is the Government's role to assist with the promotion and protection of te reo Maori;
    • There should be a well - resourced, separate Maori television channel;
    • Both television and radio should be well-resourced;
    • Maori language and culture programming should also be heard on the "mainstream" networks;
    • Any separate Maori channel should be owned and controlled by Maori;
    • The channel should be nationally-networked;
    • Public funding for the development of Maori broadcasting should be dispersed by a specialised agency such as Te Mangai Paho, or New Zealand on Air."

    (Extract from "Maori Television: A Summary of Views" published by the Ministry of Commerce in September 1997.)

    Current Government Proposal

    On 1 September 1997 Cabinet agreed, in principle, on Government Maori broadcasting policy. Cabinet minute CAB (97) M33/19 sets out the policy in detail. In essence, it envisages a separate Maori channel owned and controlled by Maori and, in addition, arrangements to purchase air-time for Maori language broadcasting on the main commercial channels.

    Development of the policy is at an early stage. Planning is underway but a number of issues, such as arrangements for accountability and governance for the Maori channel, are yet to be resolved. We are not aware of any agreed timetable for completion of the proposal, but imagine that establishment of a separate Maori channel will take several months, at the very least.

    Requirement to Own TVNZ

    The Government is working to develop the policy above in a way that satisfies Treaty obligations. Retention of TVNZ by the Crown is not necessary to implement the policy and therefore should not be required for the Crown to meet its Treaty responsibilities.

    While an arrangement regarding Maori broadcasting that will permit the Crown to consider other ownership options for TVNZ is possible in principle, in practice there is some uncertainty. As previously noted, the Government's policy requires further development before implementation, and final details will be significant in determining the policy's acceptability. For example, consultation with Maori will need to be properly conducted.

    Requirement to Implement Policy

    TVNZ's television assets were arguably permitted to pass to it on the basis of the assurance given by the Solicitor General to the Privy Council during the Broadcasting Assets case. If the assurance is seen not to have been honoured, then the courts are likely to take a more critical view of further alienation of the assets. In order to be able to proceed with confidence, it will be necessary to be able to demonstrate that the Crown's assurance has been very substantially fulfilled by the development of a fully-fledged policy and implementation programme, albeit delayed until now.

    Maori Action

    Maori have very actively sought to prevent the Crown disposing of or restructuring its broadcasting assets. In the High Court, Court of Appeal and the Privy Council Maori have attempted to stop the transfer of Broadcasting Corporation assets to TVNZ and Radio New Zealand Limited, the sale of radio frequencies and the sale of Radio New Zealand Limited.

    For example, TVNZ was effectively established on 1 December 1988. However, due to Court injunctions obtained by Maori it could not acquire its assets and had to operate the network under licence until the completion of a Privy Council hearing in 1993. Sale of the commercial activities of Radio New Zealand was also delayed by Maori legal action.

    In October 1997, shortly after the Prime Minister raised the prospect of the sale of TVNZ, the New Zealand Maori Council threatened court action to prevent any sale. Maanu Paul, the Executive Chairman of the Council, is reported to have said "when you have fought so strenuously to get the Crown to accept through all the legal channels that the Maori language has to be protected and promoted you're not about to roll over and give that up overnight...we've fought too hard for this. If this sale is to become a reality then some protection for Maori must be made." (The Evening Post, 13 October 1997)

    Scoping Review Financial Analysis

    In order to assess the financial viability of TVNZ ownership options it is necessary to determine the implications of the Crown's Maori broadcasting proposal. For the purposes of the scoping review the following assumptions have been made in the valuations described in Section 9.0:

    • regardless of the outcome of the scoping review, the Government will change existing Maori broadcasting policy. The new policy will affect all of the ownership structures examined in the financial analysis, including the "status quo";
    • the arrangements described below for the delivery of the new policy will be used under all of the ownership structures. (Although different delivery mechanisms may be more efficient or beneficial for different structures, the arrangements below appear to be reasonably effective for all);
    • the policy chosen will provide a Maori television channel largely controlled by Maori;
    • to facilitate Maori control, Government monitoring and financial transparency the channel will be independent of TVNZ and separately funded. (The national Maori organisations believe "...Maori involvement and control...are essential Treaty elements...unlikely to be achieved on a TVNZ run system");
    • the new channel will have some financial effect on TVNZ. It will alter TVNZ's audience ratings and hence advertising revenue or change the amount of funding that TVNZ receives from NZ On Air and Te Mangai Paho. However, the financial effect will be similar for all of the ownership structures and is likely to be relatively small. Such financial effects have been ignored for the purposes of financial analysis;
    • in addition to a separate Maori channel, the Government will arrange for a certain amount of "mainstreaming" (i.e. Maori language promotional programming on the main channels during prime time);
    • Te Mangai Paho will purchase the delivery of mainstreaming from the main channels at full commercial prices in the same way that it currently purchases Maori language promotional programming. (Even if delivery is arranged by some other mechanism, such as by statutory requirement, the economic cost to the Crown as owner of the deliverer is likely to be similar); and
    • the price of the mainstreaming that Te Mangai Paho purchases will be the same as provided in Te Mangai Paho's current budget. (Although it is most likely that Te Mangai Paho's budget will alter, the effect on TVNZ's net profit is likely to be relatively small. Te Mangai Paho funding currently represents approximately 1% of TVNZ's revenue.)

    The delivery arrangements above would have insignificant or no financial effects on TVNZ under any of the ownership scenarios described in Section 9.0. However, a number of simplifying assumptions are embodied in the arrangement that are unlikely to be consistent with the Maori broadcasting policy eventually adopted. Although the Crown's Maori broadcasting policy may be different and affect TVNZ, that effect is likely to be small.

    Conclusions

    The Crown has an obligation to actively protect and promote Maori language through television broadcasting.

    The Government has approved, in principle, a policy for Maori language broadcasting that appears capable of meeting Treaty obligations.

    Under the policy, continued ownership of TVNZ should not be necessary for the Crown to meet its Treaty obligations.

    Under the policy, the cost of delivering Maori broadcasting appears to be unaffected (to any material extent) by changes to TVNZ's ownership structure.

    Development and implementation of the policy will take several months.

    There is some uncertainty regarding the acceptability of the eventual Maori broadcasting arrangements that can only be resolved after further development of the policy.

    In any event, the policy will need to be capable of immediate implementation, rather than merely promised, before the Courts are likely to accept that the Crown's Treaty obligations have been met.

    Until broadcasting arrangements that Maori consider acceptable are ready to implement, some Maori can be expected to attempt to prevent any restructuring or sale of TVNZ by court injunction.

    Even if a Maori broadcasting policy that would be considered acceptable by the Courts is implemented, it is possible that some Maori with higher expectations of the Crown will consider the policy inadequate and will commence legal proceedings.

    If the Crown decides to restructure or alter its ownership interest in TVNZ, the greatest delays to implementation might be due to the need to further develop Maori language broadcasting arrangements or to resolve potential Maori injunctions.

7.2 Competition

    The Commerce Act 1986 is directed at preventing anti-competitive behaviour and market dominance arising, or being strengthened, as a result of business acquisitions. The Commerce Commission can give clearances if it is satisfied that there are no market dominance concerns or, if there are, grant an authorisation on public benefit grounds. While some participants in business acquisitions may risk not seeking clearance or authorisation, it is assumed that any sale of TVNZ will be in the public domain and invite Commerce Commission involvement.

    TVNZ still occupies an important position in the television broadcasting sector and, through BCL, in supplying transmission services. If TVNZ were to be sold by the Crown, the number of potential buyers might be limited if the purchase of TVNZ by another industry participant were to be construed as resulting in the creation or strengthening of dominance in one or more markets. However, as the Commerce Act issues are complex, no party should be discounted as a potential purchaser.

    Application of the dominance test requires identification and detailed examination of the particular markets in which TVNZ and intending buyers operate. The way in which markets are defined can have a bearing on the outcome of a proposed acquisition. Markets are not constant and can change over time as can competitive conditions in a market.

    Based on the Commerce Commission's most recent decision in television broadcasting (in respect of Telecom and SKY), the current market definitions applicable to a purchase of TVNZ and/or BCL are as follows:

    Retail Television Broadcasting Market

    The Commerce Commission has ruled that FTA TV and pay TV are in the same market which is described as the "retail television broadcasting market". This covers the provision of broadcasting services to advertisers and to subscribers. This finding has resulted in TVNZ ceasing to be dominant in free to air broadcasting and SKY ceasing to be dominant in pay TV broadcasting. Market shares in the market are assessed largely on viewer patronage/ratings figures.

    Television Transmission Vehicles Market

    This market essentially consists of the national terrestrial based broadcasting frequencies. The national television frequencies held are:

    • TVNZ/BCL: 2 VHF, 1 UHF (1 UHF regional);
    • TV3/TV4: 2 VHF;
    • SKY: 4 UHF;
    • TAB: 1 UHF;
    • Prime: 1 UHF; and
    • Ministry of Commerce: 2 spare UHF.

    Competition in this market may also be influenced to a lesser degree by other transmission vehicles, being MDS, cable and satellite services. Satellite uplink frequencies are freely available and satellite capacity covering New Zealand directly is also available commercially.

    Television Transmission Services Market

    This market covers both transmission links and distribution services from high sites. BCL is the predominant service provider through its ownership or control of strategic high sites. Telecom participates by providing linking services for SKY and TV3.

    Programme Buying Market

    This market has an international setting and dominance does not appear to be an issue.

    TV3/CanWest, as the other major free-to-air operator competing for advertisers, would likely encounter difficulty receiving a clearance to purchase TVNZ as a whole. Authorisations are rarely given by the Commission. However, it should not be ruled out. TV3/CanWest may attract fewer competition concerns if TV ONE were separated from TVNZ. However, that possibility would depend on whether the Crown intended to constrain TV ONE from being an effective competitor to TV2, TV3 and TV4 for audiences and advertising.

    A purchase of TVNZ by SKY, INL or other related parties would also be carefully considered by the Commission. While the combined audience rating of a merged SKY and TVNZ would obviously be high (but not as high as TV3/TVNZ), it could be argued that they complement each other in the relevant market segments, being television advertising (in which SKY has a minor involvement) and pay TV (in which TVNZ has no involvement as a broadcaster). The continued presence of TV3/CanWest and to a lesser extent regional and other television broadcasters could be sufficient competition for the merged operation.

    The other television industry participants most likely to be interested in TVNZ have no significant involvement in New Zealand, so competition issues would not be an area of concern.

    In relation to BCL's terrestrial transmission and linking services, an acquisition of BCL by Telecom or a related party may give rise to dominance concerns. A purchase by SKY should be acceptable to the Commerce Commission.

7.0 Potential Restructuring Impediments continued ...

7.3 Regulatory Environment

    Introduction and Issues

    A notable feature of the broadcasting environment is its regulatory structure. In addition to generic commercial regulation that applies to broadcasting as it does to all other areas of economic activity, there are broadcasting-specific regulatory institutions. These were put in place in the context of the general reforms of 1988.

    At that time there was concern that the regulatory structure might not be adequate for the total private ownership of TVNZ. If this were still the prevailing view, it might have an impact on the sale process. This section examines this issue.

    This discussion of the regulatory structure is conceptually and practically distinct from most of the public policy aspects of broadcasting. These are considered in Section 6.0. The approach is to first survey the specific regulatory interventions that apply to broadcasting, and then to consider the more general regulatory setting.

    Broadcasting-specific interventions are structures and legislative measures typically dealing with the non-commercial side of broadcasting such as social standards and their implications.

    Generally speaking, the Ministry of Commerce takes a leading role on broadcasting policy and regulation as part of its duties assisting the Minister of Communications. Another section of the Ministry, Radio Operations, has a detailed regulatory role related to aspects of broadcasting (e.g. radio frequency management).

    Broadcasting Act 1989

    The Broadcasting Act contains provisions which establish broadcasting's unique institutional structure among which are several which have a broadly regulatory function.

    They are:

    • the Broadcasting Commission, (NZ On Air), which is referred to in Section 6.5 of this report. It has no regulatory functions other than its role in fostering the aims set out in section 36 of the Act. As discussed, it carries out these tasks (under sections including 37 and 39) by a process of market related interventions;
    • the Broadcasting Standards Authority is a major feature of the Act. It has a range of functions (see section 21 of the Act). They deal with standards relating to broadcasting and include: being an review body for receiving and dealing with complaints and encouraging codes of broadcasting practice; and
    • arrangements in Part VI of the Act, significantly amended in 1996, providing for the management of election broadcasting arrangements by the Electoral Commission and specifically including election broadcasting requirements on TVNZ.

    Advertising Standards Complaints Board ("ASCB")

    Since 1993 (and the passage of the Broadcasting Amendment Act) complaints about the quality of broadcast advertisements have been the province of the ASCB, unless neither the broadcaster nor the advertiser recognise its jurisdiction. The ASCB is a Board incorporated by the Advertising Standards Authority Incorporated. It is independent of the latter, which is a voluntary organisation that has wide membership of both advertisers and media in the relevant New Zealand markets.

    Radiocommunications Act 1989

    This Act created the property rights over the radio frequency spectrum. Its ongoing regulatory functions relate to those rights (such as section 103, covering transmissions other than in accordance with a licence) and the associated issues such as the externality of interference, the licensing and regulation of radio apparatus and the need to approve radio engineers.

    In brief, its functions are entirely focused on specific aspects of the various radio frequency related markets.

    Conclusion on Broadcasting Industry Regulations

    An overview of this set of mechanisms, judging them against their purpose, concludes that these institutions are both adequately designed and working well. There are ongoing issues, such as the continuing debate concerning alcohol advertising, or aspects of what is acceptable on television. But in general, these are taking place within the structure. The structure seems sufficiently robust to allow the expression of the relevant strong views.

    Overall, there seems to be no significant body of opinion suggesting that additional interventions are required or that the existing structures are faulty in design.

    We now turn to the more commercial aspects of the industry.

    General Regulatory Structure

    New Zealand's regulatory approach has been characterised as "lighthanded." This means in practice that there is a common framework which spans various industries. The framework is contained in the Commerce Act 1986. Specific departures for particular industries are allowed for by the capacity for authorisations by the Commerce Commission where it can be shown that the benefits outweigh the detriments.

    The fundamental thrust of the approach is to use the powerful forces of free market competition to achieve the improvements sought by consumers and other economic agents. Thus the Commerce Act is built around promoting competition.

    1988 Reforms

    When the broadcasting industry was being restructured, radio was a mix of public and privately owned stations. Television, on the other hand, was in the hands of a two channel publicly owned monopoly, TVNZ. A serious competitor was in sight, as a warrant had been approved for the establishment of a third national network, but the strength and sustainability of genuine competition in the market was unknown. Indeed, as the history of TV3 suggests, initial misgivings over the ability of such a rival to provide ongoing benefits of vigorous commercial competition were not misplaced in the early years of deregulation.

    The restructuring of TV3 allowed the involvement of CanWest, a serious and effective broadcasting industry participant, now operating in four countries. Its active participation has ushered in a significant change in the level of competition in the relevant markets. In addition to the influence of CanWest (which includes the creation of a fourth VHF channel out of TV3's existing spectrum rights) other developments on the commercial front include the successful establishment of SKY, now with five UHF channels (and with direct broadcast satellite under way).

    These, and other developments, have increased the degree of choice and competition available in the market. This has accrued to all consumers, including viewers and advertisers. A more detailed examination of this situation is reflected in the analysis of TVNZ's competitive position elsewhere in this report.

    Current Situation and Outlook

    The analysis shows that both BCL and TVNZ face far more competition today than they did in 1988. In particular, TVNZ now shares the VHF retail television markets with CanWest and will shortly be competing with Prime. Similarly there is vigorous competition for frequencies and programmes. The allocation of spectrum and the entry of a range of new participants (e.g. SKY and Prime) create a different environment. All these changes have increased the 'self-regulatory' nature of the markets TVNZ is involved in.

    BCL has moved from being a unique operation, with special assets and engineering capacity, to being one of a number of suppliers of services into its markets. It faces linking competition, for instance, from Telecom, and broadcast transmission from CanWest. Again, the last eight years have rendered significant changes to the competition prevailing locally.

    Looking ahead, not even very far into the future, technological changes will allow many channels to be fitted into the spectrum width of one today. This will mean that the competition in all relevant markets can potentially be significantly increased. Further, direct broadcast satellite transmissions, which Sky is already offering here for two channels, have the potential to substantially change the various markets again.

    Indeed these developments are the regulatory challenge of the future. There is a lack of clarity regarding the geographical location of some broadcasting operations and thus of jurisdiction of the appropriate controlling bodies.

    The commercial environment has changed significantly since the present structure was adopted for broadcasting in the late 1980s. In particular relevant markets have been characterised by increased competition. All the trends in the immediate and foreseeable future are in the same direction. This means that the general regulatory structure should be satisfactory for handling the commercial issues that arise in the markets associated with TVNZ.

    Conclusions

    The analysis of the social standards regulation mechanisms revealed that they seem to be working well and that they seem sufficiently robust to continue to function adequately.

    The changes in the number of market participants and their roles, along with ongoing technological development, has brought increased competition to the markets relevant to TVNZ. The general lighthanded regime should therefore be more than adequate to meet the demands that a privatisation of TVNZ would place on it.

    In summary, the current combination of specific and general regulatory institutions should be appropriate to handle an environment in which TVNZ has private owners, without any need for augmentation.

7.4 Other Potential Impediments

    Appendix III examines potential impediments that may exist in any restructuring of TVNZ (other than those explained in Sections 7.1 to 7.3). The following table summarises the results of the examination.

Restructuring Impediments

Potential Impediment Prevents
restructuring?
Complicates restructuring? Impairs
sale price?

Requires
corrective action?

         

Department of Conservation rental dispute

No

Not materially

Yes, slightly

No

         

SOE Act amendment

No

Not materially

No

Yes (1)

         

Overseas Investment Commission

No

Not materially

Probably not

No

         

CLEAR contracts

No

Yes

Yes

Yes (2)

         

Short term contracts

No

Not materially

No

No

         

Change of ownership provisions

No

Unlikely

Unlikely

Yes (3)

         

Confidentiality agreements

No

Not materially

No

No

         

Land titles

No

Not materially

Not materially

Yes (4)

         

Access rights

No

No

No

No

         

Tax review and investigation

No

Unlikely

Unlikely

Yes (5)

         

Electoral coverage

No

No

Not materially

Possibly (6)

         

Superannuation

No

No

Possibly

Yes (7)

         

Archives

No

Not materially

Probably not

Yes (8)

         

Asset sales

Uncertain

Uncertain

Uncertain

Uncertain (9)

         

    (1)Disposal of TVNZ requires legislative amendment (2)Consultation with CLEAR would be required on sale
    (3)A detailed review of change of ownership clauses is required on sale
    (4)Further investigation of Public Works Act offer-back obligations required
    (5)A more detailed review of tax implications is required on sale
    (6)Legislative amendment may be required on separation of TV ONE and TV2
    (7)Contribution caps for defined benefit schemes may need to be considered on sale
    (8)NZ On Air should be asked to identify any archiving required on sale
    (9)Complex restructuring (e.g. "Dissection" separation of TV ONE and TV2) will require further investigation

8.0 Financial Model

8.1 Model Basis

    [Text deleted]

8.2 "Base Case" Assumptions and Projections

    [Text deleted]

    "Base Case" Model Key Assumptions

    [Text deleted]

"Base Case" Financial Projections

9.0 Valuation

9.1 Methodology

    This section contains valuations of a number of ownership structures. When considering the value of assets retained in Crown ownership, we have generally relied on discounted cash flow analysis. Assets considered for sale have been valued by reference to trading multiples of listed television broadcasters and the multiples at which merger and acquisition transactions have taken place in the media industry.

    In all cases, TVNZ's investment in SKY has been separately valued at the market price on 14 April 1998 ($2.75 per share or $127 million in total). This assumes that the market price represents both:

    • an accurate measure of the present value of the future financial benefit accruing to an owner; and
    • the investment's disposable value (ignoring, for simplicity, the 3% to 5% discount that may be required to place, on an underwritten basis, a parcel of SKY shares the size of TVNZ's investment).

    In all cases TVNZ's investment in CLEAR has been valued at [Text deleted], being TVNZ's conservative estimate of the realisable price of the investment. Whether TVNZ is retained by the Crown, restructured or sold in any form, TVNZ intends to dispose of its CLEAR shareholding. Disposal price is therefore the appropriate value to attach to the holding.

    Discounted cash flow valuations have been derived from the "base case" model described in Section 8.0. The model projects TVNZ's core free-to-air business, excluding any potential [Text deleted] new media activities. These activities are described in Section 5.7. It is not possible to accurately model these developing opportunities. [Text deleted]. For the purposes of our analysis we have adopted this amount as an estimate of the net present value of all [Text deleted] new media opportunities.

    In our DCF valuations we have used a WACC of 12.0%. Appendix II.1 sets out the derivation of the discount rate.

    Valuations for sale scenarios have been based on trading multiples of listed television companies and on comparable merger and acquisition transactions in preference to discounted cash flow analysis. There are two main reasons for this. Firstly, being market based, the comparable multiples approach is likely to be the best guide to actual sale proceeds. Secondly, DCF analysis is limited by the difficulty in predicting the cash flows that purchasers will derive from TVNZ.

    The sale scenario valuations represent the prices that industry participants are expected to pay for 100% interests in the asset being valued (i.e. "trade sale" prices). Section 9.4 considers the potential differences between IPO sale prices and trade sale prices. Section 9.3 considers the synergy, strategic and other benefits that might explain the premium that sale prices represent to discounted cash flow retention values.

    Pricing multiples from merger and acquisition transactions are usually better benchmarks for trade sale prices than listed share price multiples, which generally exclude potential strategic and synergy values. However, as can be seen from Appendix II.4, merger and acquisition pricing multiples vary widely, and it is difficult to determine the extent to which any particular multiple is applicable to TVNZ. The listed share price multiples are derived principally from Australian television broadcasters that are similar in scale and operation to TVNZ. We regard these multiples as reliable, conservative "floors" for trade sale scenario valuation.

    Section 8.1 explains the difficulties in preparing reliable forecasts for TVNZ. All of the valuations, both discounted cash flow and sale scenario, are subject to uncertainty caused by these difficulties. The sale scenario valuations apply pricing multiples to forecast 1998 TVNZ earnings as determined by the model. Section 9.2 examines the sensitivity of the discounted cash flow valuations to alterations to model variables.

9.2 TVNZ Under Crown Ownership

    [Text deleted]

    Sensitivity Analysis

    [Text deleted]

9.3 Trade Sale

    Introduction

    [Text deleted]

    Price Earnings Multiples

    [Text deleted]

    Firm Value to EBITDA Multiples

    [Text deleted]

    Firm Value to Sales Multiples

    [Text deleted]

    Valuation Summary

    TVNZ Equity Value

    [Text deleted]

    Pay TV and New Media Value

    [Text deleted]

    Trade Sale Premium

    [Text deleted]

    Charter Operation

    If TVNZ were to be sold intact it is possible that some constraints would be imposed on the future programme content of TV ONE. Radio New Zealand has a charter that specifies, in general terms, Radio New Zealand's broadcasting objectives. A similar charter could be devised for TV ONE.

    Section 9.5 considers the discount to full price that "Contract" operation constraints might cause. As noted in Section 9.5, the market pricing information set out in Appendices II.2 and II.4 relates to broadcasters that are sometimes subject to restrictions similar to the Radio New Zealand charter.

    The extent to which a TV ONE charter will impair sale price would depend on its particular terms. The more onerous and inflexible the restrictions in the charter, the greater the sale price discount. [Text deleted]. If the charter specifies particular programme content or otherwise restricts the commercial activities of TV ONE, then value would be impaired by significantly more than this estimate.

9.4 Public Flotation

    Introduction

    Public flotation or IPO is an alternative to sale of TVNZ to an industry participant by trade sale. This section considers the possible realisable value of TVNZ in an IPO.

    Listed Company Pricing

    Section 9.3 contains details of the valuation of TVNZ based on comparable listed company prices as follows:

    TVNZ Equity Value

    [Text deleted]

    Recent TVNZ Results

    The recent performance of TVNZ, its current market position and perception of market and industry risk will influence sharemarket investors. TVNZ's 1997 net profit after tax was 50% below that for the previous year. TVNZ's audience ratings have steadily declined over recent years, and the New Zealand television advertising market is depressed. Limited future growth is expected for the free-to-air broadcasting industry and TVNZ's strategies regarding [Text deleted] new media are at an early stage of development. The advent of digital transmission also creates uncertainties regarding BCL's position and prospects. In our view, it will be difficult for sharemarket investors to attribute the full value set out above to TVNZ at present. (We believe that industry participants, who will have a full understanding of the issues above, will be better able to factor these matters into trade sale pricing). We do not believe it is practical to estimate the discount to full listed price that will result from these current uncertainties, but they increase the completion risk for a near-term IPO.

    IPO Discounts

    In pricing an IPO there is general market acceptance that the offer price must be at a discount to fully distributed value. The normal range for this discount is 5% to 15% with the final price dependent on the quality and prospects of the entity whose equity is being offered, the general attractiveness of the sector in which the entity operates, the size of the float and general market conditions. [Text deleted]

    Market Capacity

    The following table shows the issue size of all major IPOs undertaken in New Zealand in the last 10 years.

    New Zealand IPOs Over $100 million, 1987 to 1997

    [Text deleted]

    As can be seen from this table an IPO of, say, 50% of TVNZ [Text deleted] would be very large in the New Zealand market and would require strong participation of overseas institutional investors. We believe that, in normal market conditions, there is capacity for an IPO of 50% of TVNZ (provided it has an international tranche) without the need for an unusually large IPO discount.

    IPO Costs

    The fees and costs for major IPOs in New Zealand are summarised in Appendix VI. Inclusive of underwriting fees, they have ranged from 3.5% to 9.0% of issue size. Excluding Trust Bank, which had unique cost characteristics, and those where the underwriting fee and brokerage was at US market rates, the norm is 5.0% to 6.0% of issue size. However for a large float the costs will be lower in percentage terms. An IPO of, say, 50% of TVNZ should, in our view, cost from 3.0% to 5.0% of gross proceeds.

    Conclusion

    Based on the estimates set out above, we assess that:

    • [Text deleted]; and
    • the proceeds to the Crown, net of the IPO discount and issue costs, from an issue of up to 50% of TVNZ would be 85% to 92% of the estimated fully distributed (post listing) value.

9.5 Separation of TV ONE and TV2

    Introduction

    Separation of TV ONE and TV2 has been under consideration for some time. This section assesses the impact on value that might occur if the two channels are divided.

    The predecessor of TV2 was established as an independent organisation, South Pacific Television Limited, in 1975. After a few years it was amalgamated into the Broadcasting Corporation of New Zealand, which ran TV ONE. The two channels have been run jointly by the same organisation for approximately 20 years.

    Each channel has its own distinctive brand and personality. To the public, they appear to be different and individualistic. However, as explained in Section 2.4, each channel's image is intentionally designed as a part of TVNZ's strategy of complementary marketing. TVNZ aims to have TV ONE appeal to viewers who are not attracted to TV2 and vice versa. In addition, the appearance of separation of the channels may be reinforced by the low profile of TVNZ itself, which has no public "brand" recognition. Each channel's "visibility" is higher than that of TVNZ as all promotional activity is focussed on the channel brands to strengthen their image and avoid confusing their marketing message.

    The management of the television division has now been divided as part of the GNZTV project to create separate management responsibilities, budgets and brand development for each channel. There are now some separate managers and staff dedicated to each channel. This restructuring is a management device to focus responsibilities and accountabilities. It does not involve physical separation. The two channels still use common facilities for key aspects of their operations.

    In respect of operating functions, the following activities are undertaken jointly for the two channels (amongst others):

    • advertising sales;
    • programme purchasing; and
    • accounting and finance.

    In respect of assets and equipment, the following facilities are used jointly by the two channels:

    • control room;
    • programming suites; and
    • transmission networks and towers.

    In all material respects TV ONE and TV2 are a single business.

    The analysis of separation costs set out below investigates two separation structures. In the first, the separated TV ONE has minimal infrastructure and contracts out most of its activities to TVNZ. This structure is intended to minimise the potential loss of value on separation by minimising the duplication of facilities and maximising the complimentary operation of channels.

    In the second separation structure TV ONE has more staff, assets and scope of operations. As a result, there is greater duplication of costs. It also gives the new TV ONE greater independence and therefore will lose most of the benefits of complementary channel operation. As a result the second structure gives rise to a greater loss of value.

    The two separation structures are described in further detail in Appendix IV. Throughout this report they are referred to as the "Contract" and "Dissection" structures respectively.

    Contract Structure

    The value implications of the contract structure arise principally from:

    • the uncertainty that buyers perceive about the extent of the Government's interference in the future operation of TV ONE;
    • the limited term of operation of TV ONE available to them; and
    • the additional costs of administration of the entity that would own the spectrum licences, brand name and trademarks of TV ONE.

    In respect of uncertainty about interference, the contract arrangements we envisage are little different from some overseas broadcast licence restrictions. The market pricing information set out in Appendix II includes broadcasters with similar, or even more onerous, programme restrictions and potential for government interference. In respect of the limited term of operation, many broadcast licences have fixed terms. TVNZ's own UHF and VHF spectrum licences expire in 2010 and 2015 respectively. We believe that the impairment in sale price resulting from uncertainty and limitation of operating term will be no more than 5%.

    In respect of additional administration costs, we estimate that they should be no greater than $1.5 million per year. New Zealand Railways Corporation, a statutory corporation owned by the Crown that administers the long term lease of New Zealand's rail network corridor, has operating costs of approximately $1.3 million per year. The corporation's functions are similar, but possibly more extensive, than those envisaged for the entity that would own the TV ONE spectrum licences, brand names and trade marks. [Text deleted]

    The analysis above assumes that the contract operator of TV ONE is placed under the same programming constraints as currently faced by TVNZ (i.e. light handed regulation). If the contract operation arrangements specify programme content or otherwise restrict the commercial activities of the contract operator, then value would be impaired [Text deleted].

    Dissection Structure

    As noted above, TV ONE and TV2 currently operate as a single business. Dissection would involve a substantial reorganisation of TVNZ's activities. The principal financial implications would be:

    • additional operating costs arising from the duplication of facilities that are currently shared;
    • possible changes in ratings resulting from the two channels acting in a competitive rather than a complimentary manner. Such changes could be to the advantage of TV3, thereby reducing the combined value of TV ONE and TV2;
    • changes in the general price of advertising resulting from greater competition in the advertising market. Rather than comprising two principal providers (i.e. TVNZ and TV3), of whom one has a significant market share, the market would have three competing providers of similar size;
    • increases in programme costs, also as a result of greater competition between broadcasters; and
    • resulting differences in the sale price of the entity sold.

    Section 8.1 explains the difficulties in forecasting TVNZ's future financial results and assessing its value. Analysing separation is further complicated by the nature of the implications noted above. The most significant are market-related reactions to a more competitive environment. These reactions are difficult to predict.

    [Text deleted] Our approach to the analysis of separation costs assume that separation results in three main commercially driven FTA networks: TV ONE; TV2 (and MTV); and TV3 (and TV4).

    In terms of the cash flow impacts from separation, we have assumed:

    • additional operating costs [Text deleted];
    • a reduction in audience share [Text deleted] for both channels;
    • a reduction in general advertising prices [Text deleted]; and
    • an increase in overseas programme costs [Text deleted].

    [Text deleted]

    Our analysis indicates that the resulting loss of DCF value from Dissection would be [between 10% and 40% of the value of TVNZ in Crown ownership.] [Text deleted] In addition there would be a loss of premium on the sale of the balance of TVNZ [would be significant]. [Text deleted]

    The following diagram summarises the results of our analysis (using the mid-points of valuation ranges for convenience: [Text deleted]

    Dissection Valuation Impacts

    [Text deleted]

    Even acting fully commercially, our analysis indicates that TV ONE's value on Dissection separation may be close to zero. (For this reason, in our analysis we have not allocated any of TVNZ's existing debt to TV ONE as a separate entity). In our view, a separated TV ONE would probably be in a weak commercial position in the new television market. The commercial risks attaching to it (and thus the Crown as owner) would be relatively high, so that the commercial risk reduction achieved by the Crown on sale of the balance of TVNZ would not be as great as might be presumed.

    Under our basis of Dissection calculation both TV ONE and TV2 would operate commercially and independently. Their programme content is most likely to change, with both channels targeting the same audience. The proportion of news, current affairs and British programmes on TV ONE would very probably decline. (This raises the concern that the Government's objective in separating and retaining TV ONE may not be achieved under Dissection other than by extensive funding of programme content via NZ On Air and/or an acceptance that TV ONE cannot be profitable as a stand-alone entity).

10.0 Sale Options, Methods and Issues

10.1 What Should be Sold?

    If the Crown decides to reduce its ownership interest in TVNZ, the first question that arises is: what precisely should be offered for sale?

    BCL and SKY

    In Section 4.2 we concluded that, if TVNZ is to be sold, BCL and TVNZ's investment in SKY are likely to be valued at least as, and possibly more, highly if they are retained within TVNZ. More importantly, the value of TVNZ is likely to be discounted by investors (in particular strategic acquirers) if BCL is sold separately. The valuations in Section 9.0 and the analysis in this section assume that BCL remains as part of TVNZ.

    CLEAR

    TVNZ has decided to sell its investment in CLEAR. In our view, the CLEAR investment has little or no bearing on consideration of the Crown's ownership of TVNZ. Sale of the CLEAR investment may take place independently, either before or after any sale of TVNZ. We do not believe the value of the Crown's interest in TVNZ will be materially influenced by the disposal of the CLEAR investment or its timing.

    TV ONE and TV2

    Of central importance is the structure of the television division. We have considered the following basic sale options:

  1. Sell TVNZ as is, intact;
  2. Retain TV ONE under the Contract structure and sell the balance of TVNZ; or
  3. Retain TV ONE under the Dissection structure and sell the balance of TVNZ.

Option A: Sale of TVNZ Intact

Clearly this is the cleanest sale option. To the extent that option B is perceived by buyers as constraining or potentially constraining their freedom to act, option A is likely to be value maximising. Option C inevitably involves value loss, as discussed in Section 9.5. Option A would also reduce the complexity of the sale process itself.

Option B: Retain TV ONE - Contract Structure

This structure is described in Section 9.5 and Appendix IV. Essentially, it allows the buyer to operate all of TVNZ as in option A, but the Crown retains ownership of TV ONE's brand and frequencies which the acquirer has the right to use for an initial period of (say) 10 years.

The key advantage of this approach is that it keeps the elements of TV ONE that could be argued to be strategic (its brand and frequencies) under Crown ownership and provides for influence over TV ONE's programming, while allowing for a sale which should deliver close to the same value as in option A and avoid Crown exposure to ongoing TVNZ business risk (in the case of a 100% sale).

An alternative to the TV ONE "Contract" model would be simply to rely on a programming charter as part of the sale contract or as part of the terms of a "golden" or "kiwi" share structure. This approach would avoid the complexity of the Contract structure, and possibly some of the valuation discount associated with that complexity. However, in terms of ensuring continued Crown influence, this is a somewhat weaker option than the TV ONE Contract structure. The latter relies not just on operating restrictions, but goes further to "institutionalise" the retention of TV ONE's brand and frequencies, and limits the period of external management of TV ONE.

The more restrictive the charter terms or kiwi share powers are, the greater the likely impact on sale valuation. Sole reliance on the charter or kiwi share powers might encourage a more restrictive drafting of those terms than would be the case in the TV ONE Contract structure, with consequent impact on the sale value.

Option C: Retain TV ONE - Dissection Structure

This structure involves a complete operational split of TVNZ's broadcasting division to provide TV ONE with all of the physical, human and financial resources required to enable it to operate under continued Crown ownership independent of the balance of TVNZ, which would then be sold. As described in Section 9.5, there would be a substantial negative impact on the value of TVNZ (as a whole, including TV ONE) under this approach.

Conclusion

The table below provides a summary comparison of the principal implications of each sale option and the status quo (continued Crown ownership).

Comparison of Sale Options

  "A"
Sale of TVNZ Intact
"B"
TV ONE Contract Structure; Sell Balance
"C"
TV ONE Dissection
Structure; Sell Balance
Status Quo (Continued Crown Ownership)
         
Maximise Value ++ + xx xx
  Cleanest sale option Minor value loss from Contract structure Significant value loss from operational split Sale value higher than retention value
Minimise Crown's Ongoing Business Risk + + x xx
 
Retain Direct Crown Influence over TV ONE x + ++ ++
         

    + Beneficial to the Crown
    x Adverse for the Crown

    If the Crown decides to sell TVNZ in some form, then option A appears to be the preferable sale structure if the Crown does not wish to retain direct influence over TV ONE (but rather relies on delivery mechanisms such as NZ On Air to achieve public service broadcasting objectives). If the Crown does wish to retain direct influence over TV ONE, then option B (or reliance on a programming charter) has several advantages over option C.

10.2 Best Method of Sale?

    In the event that the Crown decides to sell TVNZ (under one of the structures discussed in Section 10.1 above), it could undertake a sale via three principal sale methodologies: trade sale, IPO or a combination of both. In this section we discuss the advantages and disadvantages of each of these sale methodologies, taking account of the Government's assumed objectives. We focus here on a sale of 100% of the Crown's interest, and consider partial selldowns in Section 10.3.

    Trade Sale

    A 100% trade sale would involve the Crown offering for sale all the shares or assets of TVNZ to a single industry purchaser or consortium. This method of sale has the following advantages:

    • maximise price. A 100% trade sale would allow control to pass to the new owner. It is generally the case that trade buyers will pay a premium for control. The degree to which the Crown is able to "capture" such a premium would be a function of the level of competition within the sale process and the level and type of control being offered for sale. We believe that TVNZ would be attractive to a significant number of international trade buyers, and that sale proceeds are likely to be maximised by a trade sale for 100% of the company;
    • minimise completion risk. Because trade buyers invest for strategic as well as financial reasons, they are likely to be less sensitive to changes in market conditions at the time of sale. The risk that a sale cannot be completed would therefore be lower in a trade sale than in an IPO;
    • minimise the level of residual risk. Trade sales are generally carried out on a "caveat emptor" basis in which the vendor could choose not to provide any representations or warranties. This means that potential purchasers would be required to undertake their own investigations of the company being sold and make their own assessments of value and the issues affecting the business. The Crown has adopted this approach in past SOE trade sales;
    • shorten the sale timetable. Sales to trade buyers generally take less time to complete than public offerings. This is because the timetable for an international IPO would be driven by the documentary and registration requirements of the regulatory authorities in the major markets targeted in the IPO. After completion of general preparations, the execution phase of a trade sale would typically take three months (see Section 10.8). An international IPO would require approximately four months; and
    • minimise sale costs. The costs of undertaking a trade sale (principally financial and legal advisory fees) would be lower than those associated with an IPO. For TVNZ, total transaction costs as a percentage of gross sale proceeds are likely to range from 0.5% to 1.0% in a trade sale and 3.0% to 5.0% for an IPO.

    A trade sale would have several important implications for the Crown, in that the sale process would:

    • rely on competition. A trade sale is most likely to maximise value when there is sufficient interest from credible bidders to ensure a competitive sale process, and the shareholding being offered for sale had strategic value to such potential purchasers. If this was not the case a trade sale might not maximise the sale price. This has obvious implications for any sale of a non-controlling partial shareholding in TVNZ, and any structure which imposes foreign ownership restrictions (see Section 10.7 below);
    • not achieve wider ownership objectives. Because a trade sale would involve selling TVNZ to a single buyer or consortium it would not allow the Government to achieve any objectives it may have with respect to ensuring wider public ownership of TVNZ; and
    • require significant disclosure. In order for the Government to both maximise value and minimise residual risk it would be necessary to disclose commercially sensitive information to potential purchasers. The release of this information could potentially harm TVNZ's competitive position.

    If the Government decided to sell through a trade sale then it would need to decide which of the three main trade sale approaches would best achieve its objectives. These are sequential negotiations with selected parties, simultaneous negotiations with selected parties, or an open competitive tender. The Crown has traditionally adopted the latter approach.

    An open, competitive tender would involve approaching all parties considered likely to have an interest in TVNZ. Parties confirming their interest would then be provided with a background document and requested to provide detailed expressions of interest (usually incorporating preliminary bids) by a given date. Of the parties which submitted expressions of interest, a small number would be given the opportunity to undertake a detailed review of TVNZ. Based on these investigations the short-listed parties would be requested to submit final binding offers by a given date. The Crown could either accept one of these offers or negotiate with the preferred bidder(s) to try and increase the offer.

    The principal advantages with this approach are that it would:

    • maximise the number of parties contacted and maximise competition by ensuring that each participant knows it is competing against other potential purchasers;
    • be open and fair, giving all participants the same opportunity and therefore reducing the potential for any party to criticise the sale process on the basis of being disadvantaged or excluded;
    • have a set timetable in order to maintain the momentum of the sale process and place pressure on participants to allocate sufficient resources to meet deadlines; and
    • ensure that the Crown received all offers at the same time in order to compare bids.

    One disadvantage with this process is that confidential information could potentially be released to a large number of parties.

    In our view, an effectively managed competitive tender sale process would be the best means of maximising risk-adjusted sale proceeds, minimising completion risk, ensuring that the sale process would be demonstrably open and contestable and ensuring that the Crown could have confidence that offers received were adequate.

    IPO

    If the Government wished to ensure widespread public ownership of TVNZ then offering the Company for sale via an IPO would achieve this objective.

    The sale of TVNZ by IPO would however have the following disadvantages:

    • pricing. As discussed in Section 9.4, we believe the value of TVNZ as a listed entity is less than that which could be achieved in a trade sale. In addition, the IPO would need to be priced at a 5-15% discount to TVNZ's assessed fully distributed value. A 100% float of TVNZ would be a very large offering by New Zealand standards and would likely require a discount at the upper end of this range;
    • completion risk. The success of an IPO would be dependent on the market conditions prevailing at the time of the offer. Market conditions would include not only sentiment in the New Zealand and overseas sharemarkets but also factors which specifically impact on the valuation and desirability of TVNZ (such as audience and advertising revenue share trends, competitors' strategies, and developments in technology). The pricing of the IPO and the ability for an IPO of TVNZ to be successfully completed could only be gauged with certainty much closer to the anticipated launch date, therefore a sale which used any form of IPO would be subject to completion risk;
    • promoter risk. Under the Securities Act 1978 and amendments, a shareholder selling equity via an IPO would be designated as the "Promoter" of the issue. A promoter has the same liability as the "Issuer" for the contents of any offering documents. It is likely that the Crown would be designated as the promoter of an IPO of TVNZ. Under these circumstances the Crown would be responsible for any errors, omissions or misleading statements in the offering documents as it would not be possible to limit its liability through specific representations and warranties. The Crown would be relying on the Board and management of TVNZ to ensure that all information material to a decision to invest would be disclosed to the public equity markets and that the information disclosed is accurate. The size of TVNZ is such that an IPO would probably include a US tranche, which would result in legal risks greater than arise from a purely domestic IPO;
    • timetable. Typically it would take four months after preliminary preparations to complete an IPO (versus three months for a trade sale);
    • higher transaction costs. The cost of undertaking an IPO is typically higher than for a trade sale given the higher level of legal and accounting fees plus brokerage, management and underwriting fees. Total transaction costs for an IPO of TVNZ would typically range from 3.0% to 5.0% of gross sale proceeds, compared to trade sale costs of up to 1.0%; and
    • timing. As noted in Section 9.4, TVNZ's current circumstances mean that an IPO would not be ideal in the immediate future.

    Conclusion

    Ord Minnett's view is that an IPO would be unlikely to achieve a number of the Government's objectives, including maximising sale price and minimising completion and pricing risk. An IPO would, however, enable public participation in the ownership of TVNZ.

    Combination of Trade Sale and IPO

    If the Government wished to achieve wide public ownership and capture most of the valuation benefits of a trade sale, it could combine an IPO and a trade sale. This would imply the sale of a strategic shareholding to a cornerstone shareholder contemporaneous with, or prior to, an IPO. The same objectives could be achieved by the Government by making it a condition of the sale that the successful trade buyer of TVNZ undertake an IPO within an agreed timeframe.

    Partial Sale to Cornerstone Shareholder and IPO by the Crown

    Under this approach the Government would sell a strategic stake to a trade purchaser and offer the balance of its shareholding for sale via an IPO.

    The advantage of this approach is that it should increase the total sales proceeds received by the Government relative to a full IPO and enable the Government to shed its exposure to the ongoing business risk of TVNZ. The enhancement in sale proceeds would partly be achieved through reducing the size of the IPO discount (as the size of the IPO would be reduced). More significantly, price enhancement would also be derived through the Government "capturing" a strategic premium for the portion sold via trade sale and a higher sharemarket valuation for the float portion to the extent that investors gained comfort in the strategic acquirer's ability to add value. Pricing risk for an IPO would also be reduced because the trade sale would provide a benchmark price against which the IPO issue price could be determined.

    For the Government to receive a strategic premium for the shareholding being sold via partial trade sale, it would need to sell a shareholding of sufficient size to give the successful purchaser effective control. The level of shareholding needed to achieve control would be a function of the proposed structure of the share register, the presence of other large shareholders (say with holdings of between 5% and 10%) and any restrictions or special provisions in TVNZ's constitution or imposed as part of the sale process.

    This approach would have most of the same disadvantages as an IPO including completion risk, promoter liability and higher costs. It would also have the additional disadvantage that the timetable for completion of an IPO and sale to a cornerstone shareholder could be significantly longer than for either an IPO or trade sale in isolation. Whilst theoretically the sale of a strategic stake could be undertaken at the same time as preparations for an IPO, this process would probably be extremely difficult because the identity of the cornerstone shareholder would need to be determined prior to the IPO.

    Trade Sale Followed by IPO by the New Owner

    Under this approach the Government would sell its entire shareholding to a single trade buyer or consortium with a requirement for the purchaser to sell down some of its holding in TVNZ via IPO within an agreed timeframe of, say, two to three years subject to market conditions. This structure was successfully used in the privatisations of Telecom and Air New Zealand Limited.

    The approach would have all of the advantages of a trade sale including the potential to achieve a strategic premium for the sale of the Government's entire shareholding in TVNZ, although any such premium is likely to be somewhat lower than for a full trade sale with no requirement to sell down (see the discussion in the following paragraph). This approach also has the advantage that it would allow the Government to shed its exposure to TVNZ's business risk immediately and complete a sale within a short timetable. This method of sale would also result in the risks associated with an IPO being carried by the successful purchaser, whilst still allowing the Government to ultimately achieve its public ownership aims.

    The disadvantage of this approach is that the number of buyers interested in TVNZ could possibly be reduced and trade buyers could discount their bids to take account of the risk and value implications of having to sell down a shareholding in TVNZ. However we believe that this discount compared to the valuation in a straight trade sale may in fact be modest, for the following reasons:

    • some of the strategic investors would in any event view an IPO as a natural component of their financing strategy. These investors may simply not want to finance 100% of the equity value of TVNZ long term on their own balance sheet, or they may perceive a float as providing useful insurance against sovereign risk. For these buyers no discount would be applied because of the float requirement;
    • the control premium (but not all aspects of the strategic premium) is captured by the Crown if the trade buyer is left with effective control; and
    • the two to three year time frame on the IPO requirement allows the trade buyer time to enhance the fundamental value of the shares in an IPO closer to, or in excess of, the premium price the strategic investor paid initially.

    Conclusion

    If the Government's objectives included a desire to achieve wide public ownership of TVNZ then the sale method would need to involve an IPO. Our assessment is that selling all of TVNZ via a trade sale with a condition of sale being a requirement to float a portion of TVNZ within an agreed timeframe (subject to market conditions) would be the best means of maximising price whilst still achieving the Government's desired ownership objectives.

    Imposing a requirement on the successful purchaser to sell down a shareholding in TVNZ could reduce the level of buyer interest and may reduce somewhat the price trade buyers would be willing to offer relative to the value in straight trade sale. However, most of the valuation advantages of a trade sale would be captured, and the risks of an IPO would be avoided by the Crown.

    Comparison of Sale Methodologies

    The table below summarises our assessment of each of the sale methodologies reviewed:

    Summary of Principal Features of Sale Methodologies

      Combination
Assumed Objectives Trade Sale IPO Partial Trade Sale with Crown IPO 100% Trade Sale with IPO Selldown
Maximise competition
and value.
++ x +
Premium for strategic stake but still incur IPO discount.
+
Potentially maximises value except to extent bidders discount offers due to IPO risk.
Public participation. x + + +

Minimise completion
risk.

+
Subject primarily to price.
x
Ability to complete IPO dependent on market conditions at issue launch.
x
Ability to complete IPO dependent on market conditions at issue launch.
+
Minimise residual risk. + x
Promoter risk.
x
Promoter risk.
+
Avoid ongoing exposure to TVNZ business risk. + + x
Until IPO completed.
+
Avoid disclosure of commercially sensitive information.
x
+
x
x
Sale timetable (for execution phase).

3 Months.

4 Months. 5+ Months. 3 Months. IPO in two to three years.
Crown transaction costs. Low. High. High. Low.

    On balance, the two sale methods which appear to best satisfy the Crown's objectives are the straight trade sale of TVNZ, or the combination of a trade sale with the requirement that the buyer sell down via an IPO within, say, three years.

    Both approaches have the advantages of minimising the risks to the Crown in the sale process (i.e. completion risk and promoter risk). The pure trade sale is likely to maximise proceeds through the capture of a strategic premium. The combination trade sale and subsequent buyer IPO ultimately provides for public participation in TVNZ ownership, but may not deliver the same sale proceeds as trade buyers may incorporate a discount for the requirement to undertake the IPO. It would be possible to construct a sale process designed to test both approaches (see Section 10.8).

10.0 Sale Options, Methods and Issues continued ...

10.3 Partial or Full Sale?

    If the Crown decides to reduce its ownership interest in TVNZ, and makes a choice between the sale structures A, B and C described in Section 10.1 and the three sale methods described in Section 10.2 above, it must then address the question: should the Crown sell all or only a portion of the shares?

    There are two main reasons to consider a partial rather than a full sale:

    • it might provide another means of retaining direct influence or control, while reducing the Crown's exposure to the business; and
    • it might represent a value maximising strategy, either with the intention of always retaining the residual stake or as the first step in a staged selldown (particularly if the retained shareholding is expected to rise in value under the influence of the strategic investor and the EBIT improvement strategy)

    We consider each of these possible rationales in turn below.

    Partial Selldown to Retain Influence

    If the Crown opted for the Contract or Dissection structures (options B or C in Section 10.1 above), then there would be no reason to consider a partial selldown of the balance of TVNZ to retain influence or control over programming. That objective would be achieved directly by the sale structures themselves.

    If the Crown opted for a sale of TVNZ intact, as is, then a partial selldown could be considered as a means of retaining Crown influence or control. However, this approach has a number of disadvantages:

    • it continues the Crown's exposure to television business risks (and introduces the spectre of an implicit Crown guarantee in favour of the new shareholders);
    • it is a relatively inefficient means of retaining the option to directly influence TV ONE's operations (if it is accepted that structures such as option B can provide such influence without significant value loss); and
    • once a portion of TVNZ (intact) is sold, it becomes difficult to introduce at a later date any structure or constraints that would allow the Crown to sell the balance of its shareholding but still retain some direct influence over TVNZ or TV ONE.

    In addition, there is a tradeoff between retaining true control (i.e. over 50% of the shares) and obtaining a control premium in the sale price (in the case of a sale to a strategic investor). A premium for a minority stake may be extracted from a strategic investor if the sale agreement provided a first right of refusal to the remaining Crown shares or other similar terms which entrench the buyer's position. However this premium would come at the expense of the Crown not being able to run a fully competitive process for any subsequent selldown.

    Partial Selldown to Maximise Value

    A partial selldown might be considered as part of a strategy to maximise value. This approach might initially appear to have merit for TVNZ. In the case of a trade sale, the argument would be that a strategic premium is largely captured in the initial sale (of, say, 51% of the shares), while the remaining shareholding benefits from the EBIT improvement programme and the influence of the strategic investor. In the case of a partial selldown via an IPO, the argument would rely more on the firmer pricing of a smaller float, then the EBIT improvement strategy to lift the value of the remaining stake.

    Whether a partial selldown, either as an end in itself or as part of a staged selldown, would in fact maximise value must be assessed on a risk adjusted basis. Any Crown decision to sell TVNZ is likely to be based largely on two fundamental objectives: the desire to minimise the Crown's exposure to business risk, and the desire to realise greater value in a sale then would be the case if TVNZ were retained in Crown hands. The question is then: would a partial selldown produce an optimum result for the Crown in terms of risk and value?

    The most fundamental concern with a partial selldown is that it perpetuates the Crown's exposure to television business risk. This risk might extend to the belief (particularly among public shareholders) that the Crown is providing an implicit guarantee of TVNZ's performance, despite any Crown statements to the contrary. In the extreme, the Crown would implicitly be seen as carrying 100% of the risk associated with TVNZ's operations, but only a portion of the economic interest and upside. Also, the potential conflicts between the Crown as owner and regulator are amplified in the situation were the Crown shares ownership with other investors who have purchased their interests based in part on presumptions as to the rules under which the business will operate.

    In terms of risk exposure, therefore, it is difficult to see how a partial selldown could be a better position for the Crown than the strategy of being either "all in or all out".

    The valuation impact of a partial selldown must be assessed separately for each of the three main sale methods considered in Section 10.2: trade sale, IPO and combination trade sale and IPO.

    Partial Trade Sale

    The media industry is notable for the large number of partial shareholdings strategic investors have in other companies. Reasons for this are likely to include foreign ownership restrictions, anti-monopoly and media cross-ownership rules, and either the investor or investee companies wanting to "cover their bets" or spread their risk in terms of industry relationships, and technology or capital risk.

    The frequency of such partial shareholdings and hence the industry's familiarity with this style of investing, does not in our view necessarily imply that trade investors will prefer such an arrangements in the case of TVNZ or that total sale proceeds would be maximised by a partial selldown. Points to consider include:

    • if 100% of TVNZ were offered for sale, without foreign ownership restrictions or an overly constraining programming charter, the uniqueness and relative "cleanliness" of the opportunity would itself generate substantial strategic investor interest;
    • TVNZ is not a large company by global media industry standards. Strategic investors would not baulk at a 100% purchase on the basis of size or capital exposure;
    • if some media companies did prefer to hold only, say, 51% of TVNZ, they could organise their own bidding consortium or post-acquisition selldown. These buyers can still therefore participate in a competitive sale process for 100% of TVNZ;
    • although it is true that a large part of the control premium is effectively paid on the first 51% of the shares, other elements of the strategic premium (e.g. programme purchasing synergies; expertise in pay TV strategies) are payable on all shares purchased. The Crown would have only one opportunity to capture this premium. It can capture the premium on all of the shares in a 100% trade sale. In a partial selldown the strategic premium is largely lost on the retained shares. While it is true that the fundamental value of the remaining stake is likely to rise under the influence of the strategic investor (and the EBIT improvement programme), the opportunity to achieve elevated trade sale multiples on that stake would be lost;
    • trade buyers will be capable of forecasting the potential improvement in the fundamental value of the residual stake (and indeed might be more bullish about "backing themselves" than the Crown might forecast). They would incorporate part of this upside in the purchase price in the case of a 100% sale;
    • trade buyers are likely to be wary of the Crown as the single other major shareholder, and may in fact pay less (on a per share basis) for a cornerstone stake then they would pay for 100%. The Crown may seek to alleviate this risk by committing to sell the remaining stake in an IPO by a certain date. However, as discussed in Section 10.2, a better strategy is likely to be to pass this IPO obligation on to the trade buyer as part of a 100% trade sale; and
    • to the extent that the strategic investor has a 100% interest in companies supplying products or services to TVNZ (e.g. programmes) but only, say, a 51% interest in TVNZ itself, it would have an incentive to transfer price to capture benefits in the wholly-owned subsidiary. This has obvious impacts for the actual improvement in the fundamental value of the Crown's remaining stake in TVNZ.

    Selling a smaller stake than 50% is also likely to be sub-optimal in terms of value maximisation. While the Crown preserves the ability to sell a controlling stake in the future, it cannot (by definition) obtain that premium on the initial stake, and the presence of an incumbent minority trade investor is likely to inhibit competition for the controlling stake.

    Partial IPO

    Compared to a 100% sale by IPO, an IPO for a portion of TVNZ would have the advantages of firmer pricing (less supply of stock relative to the demand) and the opportunity for the Crown's residual stake to benefit from any improvement in TVNZ's performance.

    The disadvantages include:

    • the risks discussed above of continuing exposure to the business and possible shareholder perception of an implicit Crown guarantee; and

      LI>the risk that, if the markets perceive the IPO as only the first part of a staged selldown, the IPO and secondary market pricing of the shares may suffer from the "overhang" of the Crown's residual shareholding.

    More fundamentally, as we conclude in Section 10.2, there do not appear to be any advantages to a 100% IPO relative to a combination trade sale and IPO, and therefore even less reason to pursue a partial IPO which introduces the additional disadvantages above.

    Partial Combination Trade Sale and IPO

    The attraction of this sale method is that it captures a strategic premium and allows for public participation in TVNZ. To achieve this, however, probably requires that at least 70% to 80% of the shares are sold (with ultimately, say, 51% held by the strategic investor and at least 20% to 30% for an IPO of sufficient liquidity to attract global institutional investors). There seems little point in the Crown retaining a 20% to 30% stake in this scenario. The Crown would suffer most of the disadvantages discussed above for a partial trade sale and a partial IPO, without any meaningful upside.

    Conclusion

    On a risk adjusted basis, we do not believe that a partial selldown maximises value compared to a 100% sale under any of the possible sale methods.

10.4 Value "Clawback" Mechanisms

    An alternative to the strategy of retaining a partial shareholding in an attempt to capture future upside in the value of those shares would be to sell all of the shares but retain the right to a "clawback" on a portion of the upside. Mechanisms to achieve this typically fall into two categories:

    • additional performance-related payments, whereby the Crown would receive a purchase price "top-up" two to three years after the sale, based on some agreed valuation parameters, if TVNZ's audited performance exceeds a specified level; or
    • a portion of the "excess" profits made in any subsequent selldown of TVNZ shares by the buyer.

    Clearly these mechanisms can only apply to the trade sale or combination trade sale with IPO scenarios.

    A clawback mechanism would have significant presentational advantages to the Crown as vendor if the value of the shares rose markedly after a sale. However it is not clear that the inclusion of such a mechanism would actually boast the total sale proceeds. In particular:

    • trade buyers will factor the mechanism into their valuation, and discount the initial purchase price accordingly. At best, this is likely to offset the probability weighted value of the clawback. At worst, the added complexity of the structure may lead to a net value impairment;
    • clawbacks are difficult to structure, negotiate and police. They rely on precisely defined and all-encompassing adjustments for factors such as dividends paid in the interim period and changes in accounting policies; and
    • they can have the effect of reducing the trade buyer's incentive to maximise the current value of TVNZ (in favour of transfer pricing, delaying improvements, etc.).

    Overall, we believe the advantage of value clawback mechanisms is presentational rather than in the total value actually realised. The complexity of these mechanisms may actually lead to value impairment.

10.5 Strategic Equity Partners at Different Levels

    TVNZ could consider the option of introducing strategic equity partners at different levels of the organisation, for example forming a joint venture with a strategic partner to enter pay TV. This strategy could extend to forming multiple alliances at different levels within TVNZ focussing on different aspects of the company's business.

    From TVNZ's perspective this strategy has several advantages:

    • it realises most of the benefits which strategic investors can provide (expertise, sharing of capital risk, programming, etc.), at least in the specific areas of focus of the partnership(s);
    • it could be undertaken by TVNZ (presumably with Ministerial approval) on the Company's own timetable, i.e. it would not be seen as an SOE privatisation, and would not be effected by the political impediments (including Maori broadcasting concerns) associated with a sale of TVNZ itself; and
    • it offers the prospect of multiple strategic alliances with global media companies, without providing control of TVNZ itself to any particular partner.

    However, we have several concerns with this strategy:

    • it is unlikely to maximise the value of the individual opportunities presented to the strategic partners in the way that a competitive sales process for TVNZ itself would. In the latter approach, the highest bidder would implicitly be placing the greatest value on the development options within TVNZ, and showing the greatest willingness to pay away some of this value to the Crown as vendor;
    • the existence of strategic partners in particular areas of the business will potentially make TVNZ as a whole less attractive in the event that the Crown subsequently decided to sell. The impact on value will depend on the nature and extent of TVNZ's relationship with the incumbent partner(s). The value impairment could be due to one or more of the following factors:

        concern that the incumbent(s) have an advantage in the bidding process for TVNZ itself, leading to a less competitive process;

        the incumbent(s) may have developed aspects of TVNZ's business in ways that other potential purchasers believe are sub-optimal for them, effectively closing off more highly valued options; and

        concerns about the general competitive relationship between the bidder and the incumbents, and the potential for conflict between the parties over the management of TVNZ itself; and

    • the strategy effectively introduces the Crown to several of the risks of a partial selldown of TVNZ (e.g. possible conflicts between the Crown and the partner(s), shareholder/regulator issues and possible investor perception of an implicit Crown guarantee), but does not deliver any of the immediate benefits of a Crown selldown (cash proceeds and reduced ownership exposure).

    We believe the Crown's interests are best served by any strategic investor being introduced at the top level (i.e. as a TVNZ shareholder) in a competitive sales process. This will also align the interests of the Crown and the investor (in the case of a partial selldown).

10.6 Timing: Now Versus Later?

    TVNZ's financial performance declined from 1996 to 1997, and an EBIT improvement programme is one of the central platforms of management's strategic plans. This raises the question: should the Crown delay any sale until TVNZ's financial performance has improved, enabling buyer valuations to be based on the higher earnings figures?

    This question must be addressed separately for each possible sale method.

    Trade Sale

    We do not believe that delaying a trade sale would be advantageous for the Crown, for the following reasons:

    • trade buyers will in any event form their own views about the growth prospects of the business, including the value they could add to the company, and their bid prices will reflect this upside (particularly in a competitive sale process);
    • from TVNZ's perspective there is an immediate need for and benefit from introducing a strategic investor; and
    • trade buyers will themselves value the opportunity to acquire and influence TVNZ before fundamental decisions are taken regarding TVNZ's strategic direction on digital transmission, pay TV and new media

    IPO

    Financial institutions will also be willing to price growth into their share valuations, to the extent that TVNZ's management is able to present a compelling justification for their forecasts. In this scenario, the sharemarket would in effect be applying a higher multiple to a lower (current) earnings figure, and should approach the value that would pertain if the float was delayed pending improvement in earnings (at which point the multiple applied would factor in less growth).

    However, precisely because the market is more dependent on management projections than are trade buyers, it will naturally question strong growth projections and be inclined to apply a discount to them. There is therefore likely to be a valuation advantage in delaying a sale by IPO until the forecast earnings growth is substantially achieved. Conversely, if the passage of time reveals only that this earnings growth is elusive, this will have a detrimental effect on value.

    Combination Trade Sale and IPO

    The arguments here are much the same as for the trade sale: trade buyers will factor their own growth forecasts into their pricing. If the Crown undertakes the IPO concurrently, it will benefit from the market's comfort in the presence of the strategic investor, and use the trade sale price as a benchmark. If the trade buyer is given two to three years to undertake the selldown itself, the timing issue is taken care of as part of the sale structure.

    Conclusion

    Only if the Crown is contemplating a sale by IPO would a delay in the sale potentially offer benefits. This benefit is dependent on TVNZ actually achieving its earnings growth forecasts. Trade buyers (in either a straight trade sale or a combination sale) will in any event prepare their own forecasts and capture future growth in their bids now.

    The other point to note is that, as a practical matter, "now" is many months away and the EBIT improvement strategy may by then be starting to produce results (see Section 10.8).

10.7 Foreign Ownership Restrictions

    Foreign ownership restrictions on media companies are common in other countries. If foreign ownership restrictions were to be considered for TVNZ, they could be applied either through regulation and subsequent monitoring of disclosed foreign holdings, or through a two share class structure (as used by Air New Zealand Limited) where foreigners can only hold one class of shares. Issues to consider in the case of TVNZ include:

    • most of the potential strategic investors in TVNZ are foreign, and ownership restrictions which make it less attractive for them to invest will have a negative impact on a trade sale valuation;
    • there is no external requirement for ownership restrictions (such as is the case for Air New Zealand Limited in terms of the bilateral landing arrangements between governments);
    • there are no foreign ownership restrictions in respect of other New Zealand television broadcasters (i.e. TV3 and SKY), media organisations or entertainment providers;
    • it is hard to reconcile the usual nationalistic motivation for imposing foreign ownership restrictions on media companies with the practical realities of TVNZ's programming: most of TVNZ's programme content is already foreign sourced, and locally produced programmes (news, sport, current affairs as well as local drama) all respond to New Zealand audience preferences and would be less successful if they did not do so; and
    • the OECD's draft Multi-lateral Agreement on Investment ("MAI") seeks to remove foreign ownership restrictions. We understand that New Zealand Government officials are proposing to register a limited number of "reservations" to the agreement, and foreign ownership restrictions on media companies are not being contemplated.

    Of particular concern is the valuation impact of imposing foreign ownership restrictions. Case studies of Air New Zealand Limited and other overseas listed companies show that the restricted foreign shares usually trade at significant premiums to the locally held shares, mostly ranging from 15% to 50% (depending on the relative demand/supply balance for each class of stock). More importantly, in instances where these restrictions were relaxed, the total market capitalisation of the companies increased.

    This suggests that, if floated with foreign ownership restrictions, the value of TVNZ would be impaired by those restrictions. The impact on value would be even more direct in the case of a trade sale if foreign strategic investors were prevented from acquiring a controlling stake or the value of the remaining shares was depressed as a result of only being able to sell those shares to domestic investors.

10.8 Sale Implementation

    If the Crown decides to sell all or part of its ownership interest in TVNZ, or decides that it is appropriate to prepare for a possible sale, then we see the preparation phase of the process (as distinct from the actual sale execution phase) dividing into three categories:

  1. Crown decisions on fundamental aspects of the sale;
  2. refining the sale structure; and
  3. general preparation for the sale.

Crown Decisions

Prior to the launch of the execution phase of the sale process the Crown will be required to make a number of fundamental choices between sale options available to it. The earlier these decisions can be made, the sooner the efforts of TVNZ, officials and advisors can be focussed on developing the final sale structure. The key decisions relate to the issues discussed earlier in this section, namely:

  • retention of TV ONE (TVNZ intact versus "Contract" structure versus "Dissection" structure);
  • the use and nature of a programming "charter" arrangement;
  • public participation (trade sale versus IPO versus combination sale);
  • partial versus full sale; and
  • foreign ownership restrictions.

Refining the Sale Structure

Once the Crown has provided some direction which narrows the wide range of sale permutations to a more manageable number of options, it will be possible to take the development of these options to the next level of detail. For example:

  • if the Crown opts for the TV ONE "Contract" structure, the next steps would include developing the precise terms of the TV ONE "lease" arrangement and the programming charter;
  • if the Crown opted to undertake an IPO (either by itself or in combination with a trade sale) then consideration should be given to the extent to which public investor participation is to be encouraged (for example through price discounts, partly paid structures, loyalty bonuses, etc.); and
  • to the extent that there remained multiple sale options under consideration (perhaps because the choice between the options was not clear) thought could be given to designing a sale process that encouraged bids on more than one basis. For example, strategic investors might be given the choice to bid on one or both of a pure 100% trade sale and a 100% trade sale with an IPO selldown obligation. This way the Crown will be able to judge the value loss (if any) of imposing the IPO obligation.

General Preparation

In parallel with the above, preparations for a sale would need to occur on a broad front. Key elements of this include:

  • appointment of a Sale Subcommittee of the TVNZ Board, with delegated responsibilities to direct the Company's preparations and, in particular, the internal due diligence process;
  • formation of a working group (comprising officials, TVNZ management and advisors) to manage TVNZ's preparation;
  • preparation of the draft prospectus or information memorandum (even well in advance of any final decision to sell);
  • undertaking a formal due diligence process; and
  • ensuring that TVNZ's internal financial and legal systems are prepared for the added level of enquiry created by the sale process.

In addition, TVNZ would hopefully be making as much progress as possible on some of the issues discussed elsewhere in this report ([Text deleted] STB design; spectrum acquisition; etc.).

Officials will need to focus on the two matters which are likely to be critical to the overall timetable:

  • progress on Maori language television broadcasting arrangements; and
  • any new legislation or regulation which will be required to facilitate a sale in the form envisaged by the Crown.

Complex restructuring arrangements, such as a Dissection structure of TV ONE, will be likely to extend the time required for the preparation phase.

Sale Execution Phase

Once sale preparations have been completed to a general state of readiness, the execution phase can be initiated at almost any time. The main practical constraint would be the desire to avoid running the execution phase over the main holiday periods (Christmas and the northern hemisphere summer, particularly July and August). The likely time required for a global sale process for TVNZ (assuming no delay due to Maori language broadcasting, political or other external impediments during the execution phase) would be as follows:

  • trade sale, three months (one month of finalising the sale documents and preparing for bidder due diligence; two months of sale execution);
  • IPO, four months (two months of final preparations and signoffs; two months of sale execution); and
  • combination trade sale and IPO, five months (three months for the trade sale, then two months for executing the IPO, assuming the IPO follows immediately).

Key issues for an IPO include the need for Board signoff of the prospectus and investment statement, the role of the Crown as promoter (and hence the need for complete internal due diligence) and the market-related pricing and completion risks.

Key issues in a trade sale include the need to withstand intense external due diligence by potential acquirers, and the implications for TVNZ of the release of commercially sensitive information in this process.

11.0 Important Notice

Terms of Reference

    Ord Minnett has been engaged by Treasury to scope the Crown's ownership interests in TVNZ. The terms of reference for the scoping review are attached to Treasury's request for proposals that is contained in Appendix I. In subsequent discussions Treasury has provided guidance on the application of the terms of reference to detailed aspects of the scoping review.

    Advisory Team

    Ord Minnett has engaged Andersen Consulting, the New Zealand Institute of Economic Research (Inc.) and Buddle Findlay (all four firms together the "Advisory Team") to assist with the scoping review.

    Purpose of this Report

    The purpose of this scoping report is to provide Treasury with a basis for a report to Ministers that will permit the Government to evaluate its ownership interests in TVNZ. The report is confidential to Treasury. It is not to be used for any other purpose or disclosed to any other party.

    Sources of Information

    In undertaking the scoping review the Advisory Team has relied on the information provided by TVNZ and Treasury and on publicly available information. The Advisory Team has not audited or independently verified the information and has relied on its accuracy and completeness. Many critical aspects of the review are the subjects of continuing investigation by TVNZ. The scoping review is based on the information disclosed by TVNZ up to the preparation of this report, generally 29 April 1998.

    Market Conditions

    The conclusions reached in this report are based on interest rates, market and other economic conditions prevailing at the date of this report that may change significantly and rapidly.

    Financial Projections

    This scoping report contains financial projections prepared by the Advisory Team with the assistance of TVNZ. Section 8.0 describes the basis of the projections and difficulties encountered in their production. Actual results achieved in the future by TVNZ will differ from the financial projections.

    Disclaimer

    Whilst information, analysis and conclusions in this report are provided in good faith, the Advisory Team expressly disclaims any liability for any errors or omissions or for any loss or damage suffered as a consequence of the Advisory Team's reliance on either:

    • the sources of information;
    • the financial projections; or
    • market economic conditions prevailing at the date of preparation of this report.

Appendix I

5 December 1997
Mr Chas Cable
Ord Minnett Securities
P O Box 5092
AUCKLAND
Fax: 09 356-1310

Dear Mr Cable

Invitation to submit A proposal to scope the Crown's ownership interests in Television New Zealand Ltd (TVNZ) for the Treasury

1. The Government wishes to evaluate its ownership interests in Television New Zealand Ltd (TVNZ). The scoping report will be used as the basis of a report to Ministers prepared by Treasury. We invite your firm to submit a proposal to undertake this work. The terms of reference are annexed to this letter.

2. Due to the commercial sensitivity of the contents of the terms of reference, we request, in accordance with general commercial practice, that you not discuss the contents of this letter with any party other than the core members of your team. Even if you choose not to submit a proposal we would nevertheless expect you respect this request.

Proposals

3. Proposals to undertake the scoping work should be clear, concise and a maximum of 40 pages in length. Treasury will only interview short listed candidates. Proposals should include:

  • a conceptual outline of how the scoping work will be conducted;
  •  identification of the key issues;
  •  a proposed critical path, including a draft timetable and resource plan;
  •  identification of the skills necessary for the scoping work and how they will be supplied;
  •  disclosure of any possible conflicts of interest;
  •  the names and a short curriculum vitae of consultants to be used, referees where appropriate, and other relevant work experience; and
  •  detail of the proposed fees. Tendering parties may quote a fixed price or per diem plus expenses, but must estimate a final all inclusive total cost. Differing staff charging rates, allocation of staff to the parts of the scoping exercise and expected time are to be identified. All fee proposals should be inclusive of GST.

4. The tenderer must make any arrangements necessary, including the formation of a consortium, to ensure that all the required skills are available for the scoping exercise.

Support from the Treasury and TVNZ

5. The advisor will be responsible and accountable to the Treasury. The advisor will have access to all relevant information to assist it with the scoping exercise, subject to the requirement to phase the project (this is discussed in the annex). The advisor will be expected to develop a close but objective working relationship with the directors and management of TVNZ.

Copyright

6. The report, any background material produced or collected by the advisor, and any computer models prepared will be the property of the Treasury.

Confidentiality

7. Disclosure, or use of the information for any purpose other than compiling the report is prohibited without the specific authority of the Treasury.

Non-representation

8. The successful tenderer will execute an agreement not to represent any party seeking to purchase the company in any work related to the purchase of the business, without the written agreement of the Treasury.

Contract

9. The successful tenderer will be expected to sign a contract which details the terms and conditions of appointment. A copy of our standard contract will be provided to short listed parties.

Selection of Advisors

10. Selection will be based on an assessment of a firm's or consortium's:

  • ability to commit a team with the appropriate mix of skills and resources, strength of the team leader and the ability of the team to work together;
  • level of industry knowledge, experience, understanding of the business and the factors which drive its value, the sectors within which the business operates and knowledge of New Zealand capital markets;
  • ability to manage the business evaluation process including the team's approach to the assignment, the strategies suggested and ability to meet the deadlines;
  •  understanding of the legal, tax, regulatory, accounting and Treaty of Waitangi issues which could affect the business evaluation; and
  •  the level of the proposed fees.

One-off Advisory Project

11. This is a one-off advisory project. A fresh tendering process would be employed for the selection of advisors to aid in any sale process.

Applications

12. Six copies of the proposal should be supplied to the Treasury by 9 am on Wednesday 17 December 1997. We expect to interview shortlisted parties on Friday 19 December 1997. We expect to appoint the successful tender before Christmas. Proposals should be addressed to:

John Wilson
 Asset and Liability Management Branch
The Treasury
No 1 The Terrace
6th Floor
PO Box 3724
WELLINGTON

Telephone: 64 4 472 2733
Fax: 64 4 499 0437

For further information and clarification of the above brief, please contact me or Peter MacIntyre at the Treasury.

Yours sincerely

A J Wilson

for Secretary to the Treasury

scoping the Crown's ownership interest in TVNZ

We would expect the successful applicant to combine a global perspective of broadcasting and telecommunications with significant knowledge of these sectors in New Zealand, including the New Zealand public policy environment. Specifically, Treasury's advisor would be required to submit a report which brings out all relevant factors, including:

(a) The potential value to the Crown of continued ownership given the strategic plans of the Company

This analysis should include:

  •  a description of the nature, scope and performance of the Company;
  •  an assessment of TVNZ's medium term strategic plan and of the impact of that strategic plan on the value of TVNZ (The company is currently implementing its Great New Zealand Television Project which will have major implications for its future performance, its structure and focus);
  •  on-going capital expenditure requirements of the Company;
  •  an evaluation of the assets and liabilities of TVNZ including investigation of current and potential contingent liabilities facing the company;
  •  an investigation of existing contractual arrangements and contractual arrangements under discussion;
  •  analysis of the risks and opportunities inherent in continued Crown ownership including the risks posed by technological change and competition; and
  •  a review of public policy issues such those related to the Treaty of Waitangi, competition policy and social issues;
  •  analysis of impediments to sale.

(b) The expected value of TVNZ under alternative ownership strategies

While Television One will not be sold, the value of the TVNZ Group under alternative ownership strategies should be estimated. This will help to reveal the costs and benefits of the options available to the Government. The analysis will also include advice on strategies which could allow the Crown to maximise value under alternative ownership strategies while retaining Television One. These strategies should include analysis of a variety of mechanisms which could ensure a continuation of the services of TV One.

(c) The best sale method

This analysis should include:

  • methods of sale, including trade sale, float and some combination of the two or any other value maximising sale method. Scenarios involving limits on who can invest, the nationality of the investors and, in the case of a float, the number of shares which can be bought, should be investigated. Under a trade sale, scenarios involving partial float by any new owner should also be examined;
  •  identification of any legal, commercial or other risks involved in sale for both the Crown and the Company under these methods;
  •  analysis of the value maximising method including the costs of sale under each method;
  •  analysis of the best structure of sale and sequencing of the sale of any key components of TVNZ;
  • estimates of the time it would take to complete any sale; and
  •  advice on the next steps and the key issues involved in implementing the various sale methods.

    Treasury's advisor will be expected to make the issues and the options clear.

Timetable and Phasing of Work

TVNZ currently has a number of projects underway, such as the Great New Zealand Television Project, which are designed to strengthen the company's competitive position. The company is also investigating options with respect to its distribution assets such as Broadcast Communications Limited. The Company plans to clarify or finalise these projects in the first quarter of 1998. Many of them will have a significant effect on the direction of the Company's strategic plan. TVNZ's management and staff therefore face some significant demands, particularly when this work is combined with external scoping.

The scoping advisor will therefore need to establish a phased timetable which will allow the Company to complete its work programme as planned and the advisor to complete its business evaluation report and deliver it to Treasury before the end of March 1998. This will require close consultation with the company and discussion with Treasury. The advisor would be expected to begin to engage with company personnel, on a basis that is mutually convenient for both the Company and the advisor, beginning in February. Phasing work, to begin with an assessment of TVNZ's distribution business followed by work on the television networks towards the end of the timetable, would offer a number of advantages.

A company representative will participate in the selection panel.

Appendix II.1 WACC Derivation

There are several models available to derive a WACC for use in DCF analysis, typically differing in their treatment of investor's personal taxation rates and the presence of dividend imputation. We have used the models based upon the original CAPM formulation of Sharpe-Lintner, and the modified CAPM developed by Lally (Brennan-Lally).

The Sharpe-Lintner formulation was derived for classic tax environments such as exist in the United States, which unlike New Zealand and Australia (among others), have not implemented dividend imputation regimes. The Brennan-Lally model incorporates the effects of dividend imputation. Other things being equal, imputation credits increase the value of dividend payments to private investors, increasing the value (and decreasing the post-corporate but pre-investor tax cost of capital) of the dividend paying company. In addition imputation diminishes any value gains from leverage arising from the tax deductibility of debt interest.

The common features of both models are:

  • each implicitly allows for any value effects of gearing by adjusting the discount rate;

  • the equity beta which measures the systematic risk of the geared company is typically estimated using least squares regression of company stock prices against the stock market; and

  • the WACC is specifically intended to be applied as a discount rate for unlevered post-corporate, but pre-investor tax free cash flows.

The key features that distinguish the Brennan-Lally from the Sharpe-Lintner specification are:

  • Brennan-Lally treats the effect of dividend imputation as a change in the personal taxation rates on dividends, which impacts upon the pre-investor tax equilibrium return required by investors; and

  • the equilibrium rate of return approach results in a different gearing relationship between the geared equity beta and the unlevered asset beta.

We have used standard versions of both CAPM specifications, which are set out in the formulae below:

Common Definitions: The Brennan-Lally CAPM:

The Sharpe-Lintner CAPM:

A key variable for any CAPM based discount rate is the asset beta. The table below sets out betas from a number of third party beta sources, in addition to Ord Minnett's own Ordinary Least Squares regression estimates.

Reviewing the asset betas of the companies most comparable to TVNZ, we believe TVNZ's asset beta falls in the range of 0.60 to 0.90. We have adopted an asset beta of 0.75 for our "base case" valuation. TVNZ uses the same figure in its internal analysis.

Based on this asset beta, and other assumptions shown in the table below, Ord Minnett believes that a discount rate of 12% is appropriate for the DCF valuation of TVNZ.

Cost of Capital and CAPM References:

Modigliani, F and Miller, M.H. (1963)

Corporate Income Taxes and The Cost of Capital: A Correction

American Economic Review June pp 433-443.

Brennan, M (1970).

Taxes, market valuation and corporate financial policy

National Tax Journal, 23, pp 417-427.

Lally, M (1992).

The CAPM under dividend imputation

Pacific Accounting Review 4(1) pp31-44.

Officer R (1994).

The cost of capital of a company under an imputation tax system

Accounting and Finance, 34(1), pp1-17.

Lintner, J (1965).

The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets, Review of Economics and Statistics, February 1965 pp. 13-37

Sharpe, W (1964)

Capital asset prices: A theory of market equilibrium under conditions of risk

Journal of Finance, September 1964.

Appendix II.2 Listed Television Broadcasters Pricing

Price Earnings and Sales Multiples

     

1997A

1998F

   

Mkt Value of Equity (m) (1)

 P/E

P/E Rel(2)

  P/E

 P/E Rel(2)

New Zealand

 
 

INL

NZ$ 1,025.8

16.0x

96%

19.2x

120%

 

SKY(3)

NZ$ 1,023.7

n/a

n/a

107.8

678%

Australia

 
 

Seven

A$ 1,857.8

20.4x

113%

21.1x

121%

 

Publishing & Broadcasting

A$ 3,939.9

21.8x

121%

20.5x

118%

 

Ten Network

A$ 2,311.4

23.3x

130%

22.0x

127%

 

Prime Television

A$ 345.6

21.5x

119%

18.2x

105%

 

Mean

 

21.7x

121%

20.5x

118%

Canada

 

 

Baton Broadcasting

C$ 981.5

245.4x

1099%

60.1x

327%

 

Canwest Global Communications

C$ 4,033.3

28.4x

127%

25.2x

137%

 

Chum

C$ 611.1

37.5x

168%

30.6x

166%

 

TVA Group

C$ 373.2

23.8x

106%

19.2x

104%

 

WIC

C$ 987.4

79.0x

354%

60.4x

328%

     

Mean

 

82.8x

371%

39.1x

212%

United Kingdom

 
 

Carlton Comm

£ 2,764.9

13.0x

82%

14.6x

82%

 

Granada Group

£ 8,964.6

19.0x

119%

17.8x

100%

 

Scottish Media

£ 470.0

17.1x

107%

14.9x

84%

 

Ulster Television

£ 113.8

19.9x

125%

18.7x

105%

             

Mean

 

17.3x

108%

16.5x

93%

United States

 
 

AH Belo

US$ 3,375.9

40.7x

200%

38.0x

188%

 

BHC Comm

US$ 3,330.8

25.4x

125%

84.0x

416%

 

Hearst-Argle

US$ 1,899.0

35.8x

176%

28.7x

142%

 

Sinclair Broadcasting

US$ 2,263.8

n/a

n/a

246.8x

1222%

 

Young Broadcasting

US$ 680.4

n/a

n/a

58.2x

288%

             

Mean

 

34.0x

167%

91.1x

451%

Source: Ord Minnett/Flemings Research, Bloomberg

(1)Market value of equity as at 14 April 1998

(2) Price earnings multiple relative to the local market average

(3) SKY is not considered to be directly comparable to TVNZ. It is included here for reference only

CanWest is currently selling down its interest in Ten Network by IPO. Once this is completed our research analyst expects Ten Network to trade just below the multiples of Publishing and Broadcasting.

Appendix II.2 Listed Television Broadcasters Pricing Continued

 

1997A

1998F

 

Ent. Value(1)

(incl. Net Debt)

Ent. Value/

Sales

Ent. Value/

EBITDA

 

Rel(2)

Ent. Value/

Sales

Ent. Value/

EBITDA

 

Rel(2)

New Zealand

 

INL

NZ$ 1,342.8

1.4x

10.8x

113%

1.3x

10.1x

106%

SKY(3)

NZ$ 1,106.7

6.3x

23.9x

252%

4.9x

16.0x

169%

Australia

 

Seven

A$ 1,842.8

2.5x

8.9x

97%

2.3x

9.2x

104%

Publishing and Broadcasting

A$ 4,033.9

3.6x

11.8x

128%

3.4x

11.3x

129%

Ten Network

A$ 2,338.4

4.3x

13.9x

151%

4.2x

13.0x

148%

Prime Television

A$ 492.8

4.0x

12.8x

139%

n/a

n/a

n/a

                 

Mean

 

3.6x

11.9x

129%

3.3x

11.2x

127%

Canada

 

Baton Broadcasting

C$ 1,222.4

4.8x

22.8x

253%

2.4x

13.6x

170%

 

Canwest Global Communications

C$ 4,400.3

5.3x

16.0x

178%

n/a

n/a

n/a

 

Chum

C$ 580.8

2.2x

14.2x

158%

n/a

n/a

n/a

 

TVA Group

C$ 408.7

2.1x

9.6x

107%

n/a

n/a

n/a

 

WIC

C$ 1,276.7

2.6x

11.4x

127%

n/a

n/a

n/a

                 

Mean

 

3.4x

14.8x

165%

2.4x

13.6x

170%

United Kingdom

 

Carlton Comm

£ 2,670.2

1.5x

7.2x

64%

1.4x

6.5x

58%

 

Granada Group

£ 11,696.0

2.9x

11.2x

99%

2.8x

10.7x

95%

 

Scottish Media

£ 519.1

2.7x

11.5x

102%

2.4x

9.9x

87%

 

Ulster Television

£ 111.4

3.2x

12.9x

114%

n/a

n/a

n/a

                 

Mean

 

2.6x

10.7x

95%

2.2x

9.0x

80%

United States

 

AH Belo

US$4,978.0

4.0x

13.2x

101%

3.5x

10.8x

93%

 

BHC Comm

US$1,862.0

4.2x

8.6x

66%

n/a

n/a

n/a

 

Hearst-Argle

US$2,386.0

6.2x

13.5x

103%

5.8x

13.0x

113%

 

Sinclair Broadcasting

US$3,204.8

6.2x

15.1x

115%

n/a

n/a

n/a

 

Young Broadcasting

US$1,336.2

5.1x

9.0x

69%

n/a

11.0x

96%

                 

Mean

 

5.1x

11.9x

91%

4.7x

11.6x

101%

Source: Ord Minnett/Flemings Research, Bloomberg

(1)Enterprise value as at 14 April 1998

(2) EBITDA multiple relative to the local market average

(3) SKY is not considered to be directly comparable to TVNZ. It is included here for reference only

EBITDA multiples remove the effect that differing gearing structures, taxation treatments and amortisation practises have on a company's earnings and consequently its valuation.

Appendix II.3 Listed Television Broadcasters Descriptions

Set out below are summary descriptions of the major English speaking television markets (Australia, the United States, Canada and the United Kingdom) and the main broadcasters in those markets. The aim of this appendix is to provide some background on the companies featured in Appendix II.2 and guidance as to the applicability of their share pricing parameters to TVNZ's valuation.

Australian Listed Television Broadcasting Companies

The Australian television industry is dominated by three major national free-to-air commercial networks; Seven Network, Nine Network and Ten Network. Two Government owned and funded television broadcasters, ABC and SBS, operate alongside the commercial stations. ABC is a public broadcaster and is not permitted to broadcast commercial advertisements, while SBS is a multi-cultural broadcaster which is permitted to broadcast only up to five minutes of advertising per hour in between programmes.

The industry, while dominated by the three commercial networks, is made up of a large number of television stations which service an area in one of three geographic segments:

  • the five mainland state capital cities;
  • major or aggregate regional markets; or
  • smaller markets.

The 15 capital city stations which broadcast under one of the Seven, Nine or Ten call signs, reach approximately 65% of the Australian population and attract almost 80% of all commercial television advertising revenue. Seven Network and Ten Network own stations in each of the five mainland state capitals, while Nine Network owns three stations and has affiliates in the other two.

The three networks also have major regional television affiliate stations which reach a further 28% of the population and attract most of the balance of the commercial television advertising revenue. Prime, a Seven Network affiliate, is the largest of these regional affiliates having 10 stations and broadcasting to regional markets with an aggregate population of 4.5 million.

The Australian television industry is highly regulated by comparison to New Zealand. The Australian Broadcasting Authority, under the Broadcasting Services Act, is responsible for licensing, programming, ownership and control of commercial broadcasting services. It also administers the allocation of broadcasting frequency spectrum.

The Broadcasting Services Act imposes restrictions on:

  • audience reach, No person or entity may control television licences with a combined audience reach of more than 75% of the Australian population;
    • cross media ownership, There are limits on cross-ownership of commercial television licences, radio licences and newspapers within the same licence area;
    • foreign ownership, Foreign ownership is limited to 15% for an individual interest in any commercial television licence and 20% for the aggregate of foreign interests. No foreign person or entity may be in a position to control a television licence; and
    • local content, A minimum of 55% of programming broadcast between 6.00am and midnight must be of Australian origin. There are also specific quotas for drama, children's and documentary programming.

    There are also limits on broadcasting of commercials and programme promotions specified in the industry's Code of Practise.

    While there are structural differences between the New Zealand and Australian television industry, particularly in respect of constraints on ownership, we believe the Australian commercial networks provide the most meaningful proxies for TVNZ because:

    • their capital city television stations attract the bulk of commercial television advertising revenue in Australia;

    • their programming reach (including affiliates) is almost 93% of the total population; and

    • the market shares of the major free-to-air broadcasters are similar to those of the main New Zealand channels.

    Of the television broadcasters in Australia, the most meaningful valuation proxies are Seven Network, Publishing and Broadcasting Limited (which owns Nine Network) and Ten Network.

    Publishing and Broadcasting Limited is the largest of the Australian media companies. It has two significant divisions: Nine Network and magazine publishing. In addition it has investments in movie production, pay TV in Australia and telecommunications licences in several Asian markets. It is owned 44.9% by the Packer family.

    Seven Network is the second largest of the Australian television broadcasters. From its strong base in television broadcasting it has expanded into a number of related activities over the last 2-3 years. It is a major shareholder in the recently relisted US movie production company Metro-Goldwyn-Mayer, is a participant in the consortium building the new Australian Rules stadium in the Melbourne Dockland and has investments in the Australian pay TV industry through Optus Communications Limited. Kerry Stokes, the executive Chairman, is the largest shareholder with approximately 24%.

    Ten Network is the third of the major Australian television broadcasters. It recently listed on the Australian Stock Exchange. It owns and operates five commercial television stations in the five mainland capital cities. It also has minority shareholdings in Southern Cross Broadcasting and Telecasters Australia both of which are regional affiliates of Ten Network. It also has a 10.8% shareholding in Television and Media Services Ltd to which it outsources the majority of its production and outside broadcast facilities.

    Ten Network has very successfully targeted the 16 to 39 age group rather than compete directly against the Seven Network and Nine Network.

    CanWest owns a 15% shareholding in Ten Network, the maximum an individual foreign entity can own, but also owns Subordinated Debentures and Convertible Debentures which give CanWest a 57.5% economic interest.

    Prime is a listed regional television station that has market capitalisation of A$365 million with relatively low liquidity. Paul Ramsey, the Chairman, is the largest shareholder owning 39%. It has grown aggressively in the last two years acquiring Golden West Network, the sole commercial broadcaster in regional Western Australia, for A$71 million and 50% of Nine Network in Argentina for an estimated US$74 million. It also acquired 34 UHF licences in New Zealand and intends to commence broadcasting in September 1998.

    United States Listed Television Broadcasting Companies

    The television industry in the United States has traditionally been dominated by three major national free-to-air networks: NBC, ABC and CBS, albeit that their market shares are significantly less than the market shares held by the major television networks in Australia and New Zealand. Fox Television has acquired 22 television stations, which cover approximately 40% of the US television audience and is now considered the fourth national network. There are also two aspirant networks, United Paramount owned by BHC Communications and Viacom and Warner, owned by Warners and Tribune. The free-to-air networks' main competition comes from cable television systems which operate in almost every city in the United States. More recently digital satellite broadcasters have added to this competitive pressure.

    Ownership of the US television industry is fragmented, ranging from privately owned individual stations, broadcasting companies owning stations in a number of different geographic markets to major conglomerates such as News Corp which own television stations as one of a number of separate divisions. Even where one entity owns a number of stations it is unusual to have a common affiliation with one network. Instead it is more likely that different stations will be affiliated to different networks. CBS is the only major network listed in its own right. ABC is owned by Disney, Fox Television is owned by News Corp and NBC is owned by General Electric.

    In June 1995 Westinghouse Electric Corporation, a diversified industrial conglomerate, acquired 100% of CBS for total consideration of US$5.1 billion. It subsequently decided to become a pure-play broadcasting company and began divesting its industrial businesses. This process is expected to be completed in 1998.

    In 1997 it also undertook the acquisition of Gaylords cable networks for US$1.6 billion and the radio broadcasting assets of American Radio Systems for US$2.6 billion.

    As a result of these transactions CBS now has four significant ongoing operations:

    • television, the Television Group owns and operates 14 television stations which reach 32% of US TV households;
    • network, the Network division produces and distributes programming and develops and sells syndicated programming;
    • cable, the Cable Group consists of four cable networks plus two sports programming providers and a network services provider; and
    • radio; following the American Radio Systems acquisition The Radio Group is the largest radio network in the USA, comprising approximately 170 stations.

    The market is forecasting strong revenue and profit growth now that the restructure and divestment process is largely completed.

    AH Belo is a diversified media company with a market capitalisation of US$3.4 billion. It owns 20 television stations throughout the USA, of which four are affiliated to ABC, six to CBS, five to NBC and two to Fox which collectively reach 14.1% of total US television households. Excluding network owned and operated stations, Belo is the third largest television station group in terms of revenue and seventh largest in terms of household reach. It also owns six daily newspapers, shareholdings in several cable channels and a television programming production company.

    BHC Communications is a television broadcasting and production company which is owned 79% by Chris-Craft Industries Inc. It has three wholly-owned stations and interests in another six through its 59% owned subsidiary United Television Inc. BHC launched a national television network, United Paramount Network, in January 1995. It subsequently sold a 50% interest in this to Viacom Inc. This is still in a start-up phase having just added a third evening of programming and intending to add a fourth late this year and accordingly is still incurring losses. BHC broadcasts reach approximately 20% of American TV households.

    Hearst-Argyle Television Inc is a listed subsidiary of The Hearst Corporation. It was formed in August 1997 by the merger of Hearst's Broadcasting Group with the former Argyle Television Inc. It owns 12 television stations and operates a further three. Hearst-Argyle Television Inc. owns two radio stations and a television production company. These stations include more ABC affiliates than any station owner other than ABC itself. Its television stations have an audience reach of approximately 11.5% of US TV households.

    Following the relaxation of regulatory constraints in 1996 there has been a high level of acquisition activity in the US broadcasting industry. This coupled with the strong domestic economy and expected operating improvements from economies of scale have lifted multiples for the broadcasting sector to historical highs.

    Given the different regulatory environment, the fragmented nature of the television industry in the United States, the diversified nature of the companies that own the major networks and the smaller market share held by the free-to-air networks, meaningful comparisons with TVNZ and the New Zealand industry are difficult.

    Canadian Listed Television Broadcasting Companies

     

    Canada has one of the most fragmented markets in the world with approximately 100 private regional stations. There are two national networks, the government owned Canadian Broadcasting Corporation and CTV which was successfully taken over by Baton Broadcasting in November 1997.

    The other significant broadcaster is CanWest, which is on the verge of becoming the third full national broadcaster only lacking a licence in Alberta. CanWest also has television investments in Ten Network in Australia, Ulster Television in Northern Ireland, TV3 in the Republic of Ireland, TV3 and TV4 in New Zealand as well as More FM radio in New Zealand.

    Western International Communications has diverse interests in media including nine television stations, predominantly in Ontario, twelve radio stations and interests in telecommunications, television production, satellite network services and pay TV. CanWest has just launched a full takeover bid for Western International Communications.

    United Kingdom

    The UK has five analogue terrestrial free-to-air channels, the public service broadcasting channels (BBC1 and BBC2), the government owned commercial channel (Channel 4), the regional confederation of Channel 3 (ITV) and Channel 5. Channels 4 and 5 and ITV are all advertising financed. The ITV network was previously a federal system made up of 16 companies. This has consolidated through recent merger and acquisition activity so that three companies now control most of the ITV operators, namely, Carlton Communications, Granada Group and United News and Media. Channel 5, a consortium consisting of United News and Media, CLT-Ufa, Pearson and Warburg Pincus, successfully tendered for the newly issued independent license. The Independent Television Commission has recently also issued three multiplexes to British Digital Broadcasting, which is owned by Carlton Communications and Granada Group.

    The industry in the UK is highly regulated and in the past has been subject to political influence, the most recent example being the CanWest led consortium being deemed an unacceptable bidder for the Channel 5 licence notwithstanding they were the highest bidder. There are also restrictions on the ownership of ITV franchises, concentration of advertising market share and restrictions on the amount of advertising which can be broadcast.

    Television viewership in the UK is dominated by the ITV franchises and BBC1, although the viewership and advertising share of Channel 5 and cable and satellite are growing rapidly.

    Audience Share - All Individuals (28/04/97 - 15/06/97)

       

    ITV

    32.2%

    BBC1

    31.3%

    Cable and Satellite

    13.1%

    BBC2

    10.3%

    Channel 4

    10.2%

    Channel 5

    2.9%

    Carlton Communications is a diversified media company with interests in television broadcasting and production, video production and distribution, film processing, video and sound editing products and post-production services.

    Granada Group is a diversified media and leisure company with interests in television production and broadcasting, hotels, pay TV operator BSkyB, catering and entertainment centres. Its ITV broadcasting interests include Yorkshire-Tyne Tees Television and London Weekend Television.

    United News and Media is an international media and information group with interests in national and regional newspapers, magazines, business services and financial services as well as broadcasting and entertainment. It has interests in ITV companies Meridian Broadcasting, Anglia Television and HTV as well as a 29% interest in Channel 5. It also has a 19% interest in Village Roadshow.

    Pearson is a diversified media company that publishes through subsidiaries that include The Financial Times, The Economist, Penguin and Longman. It owns Thames and two other television operations, Tussauds visitor attractions and three Lazard companies.

    Other operators include Scottish Media, the last independent broadcaster of any size in the UK, which holds the licence to provide Channel 3 to Central Scotland and also produces programmes. Scottish Media purchased its northern neighbour, Grampian in June 1997 and purchased 15% of Irish broadcaster Ulster Television in August 1997. It has since sold its interest in Ulster Television to CanWest, which currently holds 29.9%.

    The UK free-to-air broadcasters are of limited relevance as valuation proxies for the following reasons:

    • the major industry participants are diversified investment companies with a wide range of activities many of which are not related to the television industry;

    • public service broadcasters with high market shares are funded by compulsory licence fees;

    • the regulatory environment has created significant differences in financial performance between operators; and

    • the relatively low cap on advertising (seven minutes per hour) has resulted in significant variances between advertising rates and therefore revenue amongst the various ITV franchises (the cap results in unusual revenue effects between metropolitan and regional channels with different ratings, as the limited available advertising slots can be sold for extreme prices at times of high demand).

Appendix II.4 Television Broadcasters Merger & Acquisition Pricing

Announcement Date

Target

 

Acquirer

Purch Price (m)

% Acquired

Ent. Value/ Sales

Ent. Value/ EBITDA

 

P/E

 

P/E Rel(1)

4/98

6 TV, 3 radio stations

Emmis Broadcasting

US$397.0

100.0%

n/a

15.9x

n/a

n/a

3/98

WIC Western Intl Comm

Shaw Comm

C$49.9

5.2%

2.6x

11.2x

76.9x

322%

3/98

LIN Television Corp

Hicks, Muse, Tate & Furst

US$1,644.9

100.0%

6.5x

15.3x

34.2x

168%

2/98

Sullivan Broadcast Holdings

Sinclair Broadcast

US$470.0

100.0%

6.9x

10.3x

n/a

n/a

2/98

Ulster Television

CanWest Global Comm

£ 23.9

18.2%

3.7x

14.9x

23.0x

100%

12/97

Seven Network Ltd

Various Instos

A$220.6

13.7%

3.0x

10.9x

18.1x

79%

7/97

Heritage Media's broadcast

Sinclair Broadcast

US$580.0

100.0%

n/a

14.5x

n/a

n/a

6/97

HTV Group Plc

United News & Media

£ 260.8

70.1%

2.8x

30.6x

49.6x

311%

6/97

Yorkshire-Tyne Tees TV

Granada Group plc

£ 620.0

100.0%

2.3x

19.0x

30.7x

193%

6/97

Grampian Television Plc

Scottish Media Group

£ 105.0

100.0%

4.4x

16.2x

26.3x

161%

3/97

Argyle Television Inc

Hearst Broadcasting

US$322.2

100.0%

6.3x

15.7x

n/a

n/a

11/96

Westcountry Television Ltd

Carlton Comm Plc

£ 85.0

100.0%

2.3x

n/a

26.2x

168%

11/96

Golden West Network

Prime Television Ltd

A$71.0

100.0%

2.4x

n/a

n/a

n/a

9/96

Providence Journal Co

AH Belo Corp

US$1,429.6

100.0%

5.4x

27.2x

n/a

n/a

7/96

New World Comm Grp

News Corp Ltd

US$2,173.0

82.0%

6.0x

33.5x

n/a

n/a

7/96

Renaissance Comm Corp

Tribune Co

US$1,094.4

100.0%

6.4x

11.6x

22.3x

136%

8/95

Sunshine Broadcasting

Seven Network Ltd

A$107.0

100.0%

3.7x

10.5x

14.7x

85%

8/95

Turner Broadcasting System

Time-Warner

US$6,880.7

82.2%

3.1x

23.0x

81.5x

543%

8/95

CBS Inc

Westinghouse Electric

US$5,122.3

100.0%

0.9x

11.8x

18.2x

121%

7/95

Capital Cities / ABC Inc

Walt Disney Co

US$18,836.7

100.0%

3.0x

13.3x

27.7x

185%

7/95

Outlet Communications

NBC

US$396.0

100.0%

7.9x

18.1x

37.4x

249%

2/95

WRDW-TV

Gray Comm Systems

US$35.9

100.0%

4.3x

n/a

16.0x

107%

10/94

Park Communications Inc

Park Acquisitions Inc

US$711.4

100.0%

4.2x

11.6x

26.1x

174%

2/94

HTV Group Plc

Flexitech Plc

£ 27.0

20.0%

1.1x

15.9x

40.5x

166%

1/94

Anglia Television Plc

MAI Plc

£ 283.0

100.0%

2.0x

n/a

29.5x

134%

12/93

LWT Holdings Plc

Granada Group plc

£ 766.0

100.0%

2.7x

n/a

39.1x

178%

         

Mean

       

3.9x

16.7x

33.6x

188%

Median

       

3.4x

15.3x

27.7x

168%

Source: Bloomberg, AMDATA, IFR Securities Data

(1) Price earnings multiple relative to the local market average

Appendix II.5 Television Broadcasters Merger & Acquisition Descriptions

United States

The US television industry was very fragmented as a result of industry regulation. The liberalisation of ownership and audience reach from the 1996 amendment of the Telecommunications Act has resulted in substantial rationalisation of both the television and radio industries as industry participants seek greater critical mass to achieve economies of scale in operations and to strengthen their negotiating position with advertisers, the networks and other programme suppliers. Acquisitions in the USA market have typically been at substantially higher multiples of enterprise value to sales and enterprise value to EBITDA than acquisitions in other markets. This is in part due to the higher average trading multiples in the USA equity markets. For example, the average enterprise value to sales multiple of the 14 acquisitions analysed was 5.1 (range 0.9 to 7.9) and the average enterprise value to EBITDA multiples was 17.9 (range 10.3 to 33.5). This compares with average current multiples of television broadcasters as follows.

US Acquisition and Trading Multiples

 

Acquisition Multiples

Trading Multiples (1997)

Enterprise Value to Sales

   

- Range

0.9 - 7.9x

4.0 - 6.2x

- Average

5.1x

5.1x

     

Enterprise Value to EBITDA

   

- Range

10.3 - 33.5x

9.0 - 15.1x

- Average

17.9x

11.9x

Several of the entities acquired had made losses in the most recent year, which makes their price earnings and price earnings relative multiples largely meaningless.

The acquisition of LIN Television in March 1998 by Hicks, Muse, Tate and Furst Inc, a Dallas based investment fund set up in 1989, is typical of the majority of television industry acquisitions in the USA in the last two to three years.

Since the liberation of the telecommunications industries in 1996 Hicks, Muse, Tate and Furst Inc. has built up one of the largest radio groups in the USA. It has a demonstrated ability to achieve economies of scale in the broadcasting industry. The LIN Television acquisition is its second investment initiative in the US television industry. In November 1996 it set up Sunrise Television to acquire television stations in the DMA markets ranked 50 to 150. To date it has acquired seven middle-to-small-market stations for total consideration of US$205 million.

LIN Television is one of the best performing television broadcasters in the USA. Hicks, Muse, Tate and Furst Inc. acquired it for US$1.645 billion, a sales to enterprise value multiple of 6.5 and price earnings relative to market of 168%. LIN Television owns and operates eight network affiliated stations and has local marketing agreements with another four stations. Concurrent with the LIN Television acquisition, Hicks, Muse, Tate and Furst Inc. acquired 100% of another television station which will be included in LIN Television once the acquisition is completed. It intends to use LIN Television as its acquisition vehicle for stations in DMA markets ranked 1 to 50.

United Kingdom

In the UK the majority of acquisition activity has resulted from rationalisation of the 16 ITV companies following the award of new ten year licences in 1993. Originally ownership of ITV was limited to one large franchise plus one small franchise or a maximum 20% shareholding in a second franchise. In 1990 the Broadcasting Act was changed to allow full ownership of two large franchises and in 1996 further amended to change the ownership limit to 15% of total viewership. Acquisitions have resulted in the following concentration of ownership:

  • Carlton Communications owns Carlton, Westcountry, Central, 20% of Meridan Broadcasting and 60% of GMTV;

  • Granada Group owns Granada, London Weekend Television, Yorkshire Tyne-Tees and 20% of GMTV;

  • United News and Media owns Anglia Television, HTV and 80% of Meridan Broadcasting; and

  • Scottish Media owns: Scottish TV, Grampian and 20% of GMTV

The acquisition activity has been driven by a desire to achieve economies of scale particularly in selling advertising and gaining greater negotiating strength with programme suppliers. It should be noted that these major ITV companies have also diversified their television investments outside their ITV franchises. Carlton Communications and Granada Group each own 50% of British Digital Broadcasting which has won the digital terrestrial licence, while Granada Group also has a 10.8% shareholding in BSkyB. United News and Media has a 29% shareholding in Channel 5.

The UK television acquisitions have typically been of contiguous ITV franchises or those in close proximity which provide significant strategic benefits from cost rationalisation and advertising selling. The five ITV companies acquired since November 1996 were all profitable when acquired. These acquisitions were made at an average price earnings relative multiple of 187% (range 161% to 311%). If we exclude the acquisition of HTV by United News and Media this average becomes 156%. This compares with the current 1997 price earnings relative average for the four listed proxies of 108%.

General Conclusion

In determining the appropriate trade sale pricing multiples to apply to TVNZ from the ranges of both merger and acquisition prices in Appendix II.4 and listed share prices in Appendix II.2, we have considered the features in Appendices II.3 and II.5 that distinguish TVNZ from the other broadcasters.

Factors that would make TVNZ particularly attractive to trade buyers include its strong market share, the opportunity to acquire and manage two well branded channels rather than one, and the relatively unrestricted operating environment in New Zealand (in terms of ownership controls and programming restrictions). Acquisition opportunities which combined these features would be unlikely to arise in other television markets.

Conversely, trade buyers might argue that compared to TVNZ's closest listed proxies, the Australian commercial free to air broadcasters (where the threat of pay TV competition is more distant), TVNZ faces a successful incumbent pay TV competitor in SKY. SKY has outbid TVNZ for important sports rights and is close to achieving an audience share sufficient to attract significant advertising revenue.

Although they cannot be quantified individually, we have taken these positive and negative factors, and the other factors discussed in Appendices II.3 and II.5, into account in determining our trade sale valuation range.

Appendix III Other Potential Restructuring Impediments

Set out below is a summary of the significant issues that may arise in any restructuring of the ownership of TVNZ (other than those already described in Section 7.0).

Department of Conservation Dispute

[Text deleted]

SOE Act Amendment

Section 11 of the State-Owned Enterprises Act 1986 prohibits the sale of any shares in TVNZ. An amendment to this Act will be required for any restructuring which involves disposal of TVNZ shares. A sale of shares in BCL (or any other subsidiary) by TVNZ itself is not caught by Section 11 of the State-Owned Enterprises Act.

Overseas Investment Commission

If 25% or more of TVNZ's shares are to be sold to an "overseas person", consent is required under the Overseas Investment Regulations 1995. Similarly, a purchase of TVNZ's assets by an "overseas" person will require consent. An "overseas person" includes non-New Zealand residents, overseas incorporated companies, and New Zealand companies where non-residents and overseas companies own 25% or more of the voting shares.

As an SOE, TVNZ is a "strategic asset" under the current overseas investment policies. Accordingly its sale to an overseas person requires the consent of the Treasurer under the Overseas Investment Regulations. Moreover, as BCL owns or leases rural and national park land, consent of the Minister of Lands will be required as several sites exceed the land area limits set out in the Schedule to the Regulations. Applications requiring the Treasurer's and Minister of Land's consent take approximately 20 to 30 working days.

Under present policies, the Government remains committed to attracting overseas investment. If this policy continues, it would be unusual for an overseas person with good reputation and experience in, and commitment to, broadcasting to be declined consent under the Overseas Investment Regulations.

CLEAR Contracts

[Text deleted]

Short Term Contracts

[Text deleted]

Change of Ownership Provisions

[Text deleted]

A more detailed examination of output agreements and BCL transmission agreements should be undertaken in the event of sale. The other parties to such agreements may be competitors of potential purchasers of TVNZ and may attempt to withhold consent to a change of ownership. However, change of ownership provisions cannot prevent restructuring and are not expected to represent a significant complication.

Confidentiality Agreements

A number of contracts contain confidentiality provisions that would limit the information that could be revealed to potential buyers of TVNZ or its parts. Examples include output agreements with programme suppliers, contracts relating to sports rights and the various contracts with CLEAR and its shareholders. Asset sales (and due diligence investigations generally) often encounter difficulties with confidentiality constraints. It is usually not practical or necessary to renegotiate the contracts involved. In TVNZ's case, only the CLEAR agreements are likely to cause significant difficulty.

Land Titles

Generally, the Treaty of Waitangi Act and the State-Owned Enterprises Act permit the Crown to compulsorily purchase any of the freehold land that TVNZ acquired on establishment which the Waitangi Tribunal recommends be returned to Maori claimants. Such land is subject to "Waitangi memorials".

An important BCL transmission site at Hedgehope in Southland is involved in the Ngai Tahu claim. Agreement has been reached to return the property to Ngai Tahu and for BCL to lease it back. This arrangement will be formalised when settlement legislation is passed, at which time Treaty of Waitangi memorials will be removed from all other South Island properties. TVNZ does not consider the new arrangement to be disadvantageous. Another important BCL transmission site at Hikurangi in Northland is subject to a Treaty claim, and five other properties are subject to claims or discussions about return to Maori.

In the Auckland Grammar School Board v Department of Survey and Land Information case the Land Valuation Tribunal held that, in the particular circumstances involved, a 5% to 10% reduction in value was a fair allowance for the risks associated with Waitangi memorials. However, in previous Crown asset sales Waitangi memorials on property titles have not proved to be an impediment to sale.

Several of BCL's major transmitter sites were acquired by the Crown under the Public Works Act. The sites include Mount Kaukau in Wellington and Waiatarua in Auckland. (These two sites have a government valuation of $3.4 million, 46% of the $7.5 million value of BCL's 19 freehold transmitter sites). The Public Works Act provides that, in general, such sites must be offered back to the previous owner when no longer required by the Crown.

To ensure that the offer back procedure is not triggered on the sale of an SOE, the SOE Act amendment referred to above typically provides for the Public Works Act obligations to be deferred and passed on to the SOE under new ownership. The Crown may wish to make similar arrangements in the event of a sale of TVNZ. However, such an arrangement may not be available in a separate sale of BCL or other type of asset restructuring as no SOE Act amendment is required. In any case, if TVNZ or any part of it is sold, Public Works Act obligations should be investigated further to determine whether property should be offered back, a legislative amendment should be passed or other action should be taken.

Access Rights

BCL has approximately 460 transmission sites held subject to various deeds of lease or occupation licences. BCL has no formal right of access to some sites. Although establishing formal access to these sites would be preferable in the event of a restructuring, TVNZ does not see this as a critical issue or an impediment.

Some of the deeds of lease and licences are in the name of TVNZ or other related parties rather than BCL. In the event of a separate sale of BCL, such leases and licences would need to be assigned to the appropriate company.

Taxation

We have not investigated the income tax, stamp duty, GST or Australian capital gains tax implications of any restructuring in detail. There would be a loss of accumulated imputation credits if TVNZ were to be sold. We are not aware of any other adverse tax consequences from sale of TVNZ, and think that serious complications are unlikely. A sale of underlying assets or complex restructuring will give rise to other tax issues. A detailed review of these matters will be necessary before any restructuring takes place.

The Inland Revenue Department is currently investigating TVNZ. Section 2.12 provides details of the amount of tax liability in dispute. The investigation would need to be disclosed in any due diligence process. No other action would be needed in any restructuring.

Electoral Coverage

The Broadcasting Act 1989 requires TVNZ to provide air-time for opening and closing electoral addresses. If TVNZ is sold as it is, the provisions of the Act will remain effective. Although it is unclear whether TVNZ will receive payment for the electoral broadcast air-time, and therefore whether the provisions of the Act impair value, those provisions should not prevent a sale of TVNZ.

The Act does not specify which of TVNZ's channels must undertake the electoral broadcasts. If TV ONE and TV2 are separated in any restructuring, an amendment to the Act will be necessary to determine which of the channels will retain the electoral broadcasting obligation. In addition, there may possibly be other forms of restructuring which would result in successors to TVNZ escaping from the obligations of the Act unless corrective action is taken.

It should be noted that the electoral coverage provisions of the Act have been amended for every election since its inception. Any sale of TVNZ will constrain, to some extent, the Governments ability to modify electoral television broadcasting arrangements. (These arrangements appear to be outside Section 7 of the State-Owned Enterprises Act. As noted above, they have been made without clear recompense to TVNZ for their cost. The Government may feel more constrained in compelling privately owned broadcasters to provide election coverage as they may object to Government intervention and will expect full commercial compensation). The Government may wish to re-examine the provisions of the Act and consider more neutral approaches or increased coverage by other broadcasters.

Superannuation

Section 2.11 describes the superannuation schemes to which TVNZ employees contribute. The consent of the administrators of the GSF and NPF schemes may be necessary if TVNZ or BCL were to be sold. In previous Crown asset sales this consent has been provided. There are no restrictions on or implications of change of ownership in respect of the TVNZ and BCL schemes.

68 employees are members of defined benefit GSF and NPF schemes. The GSF scheme is not fully funded. The variable contribution required of TVNZ is likely to be a concern for potential buyers if TVNZ is to be sold. The Crown may wish to consider whether a cap or limitation on the amount of company contributions is appropriate.

Archives

NZ On Air is required, as part of its statutory functions, to encourage the establishment and operation of archives of programmes that are likely to be of historical interest to New Zealand. From 1989 to 1 July 1997 NZ On Air provided funding of approximately $4 million to assist TVNZ to archive selected programmes. Since the termination of this funding arrangement there has been some disagreement between TVNZ and NZ On Air concerning NZ On Air's continuing rights (if any). TVNZ currently makes the archive programmes available to the public and may be required to continue to do so if it is restructured. If, as an alternative, TVNZ copied and provided the 118,000 items to NZ On Air the cost would be approximately $1.5 million. TVNZ's contractual position with NZ On Air would need to be disclosed in due diligence in the event of any sale of TVNZ but should not prevent any ownership restructuring.

In addition to the selected programmes whose archiving NZ On Air previously funded, NZ On Air is also concerned that other programme material of potential historical interest will become inaccessible if TVNZ is sold. It appears to us that this issue is of minor significance, as NZ On Air does not currently consider that archiving of such material justifies expenditure of its resources.

NZ On Air is the mechanism for the provision of any necessary non-commercial archiving. Its operations would not be affected by any changes of ownership of TVNZ. However, NZ On Air considers that the funding available to it is inadequate to undertake the archiving it would like. NZ On Air is also concerned that the "purchaser model" it operates under (i.e., achieving its objectives by negotiation and the payment of agreed price) may not be sufficiently powerful to secure access. If TVNZ is restructured, further investigation of archiving issues may be necessary.

Asset Sale

Most of the ownership structures valued in Section 9.0 involve retention of TVNZ, sale of shares in existing companies or very simple asset restructuring. The commentary set out above covers the significant difficulties that could occur in respect of these types of restructuring. The Dissection structure (and any other more elaborate reorganisations of TVNZ assets not considered in Section 9.0) would require assignment of contracts, re-employment of staff, transfers of property and other more complex rearrangements. For example, the 25 July 1991 agreement between the Crown and TVNZ providing Maori with access to broadcasting facilities would need to be duplicated and equivalent access provided by the new entity formed to own one of the two channels. It is beyond the scope of this report to fully investigate potential implementation issues relating to such far reaching reorganisations of TVNZ assets.

Appendix IV TV ONE Separation Structures

To evaluate the Crown's ownership interest in TVNZ it is necessary to assess, in terms of financial value, the options available to the Crown. The scoping review terms of engagement, which are contained in Appendix I, require that such analysis be undertaken.

There are a large number of different ownership and operating structures that the Crown could implement. Many will not be feasible, and many will be very similar. In order to simplify the comparison between options the scoping review focuses, in the first instance, on four basic scenarios. These scenarios are intended to represent the principal options, and to span the range of options, available to the Crown. The analysis of the four basic scenarios will provide the information necessary for initial, fundamental decisions to be made in respect of the Crown's ownership interest. Sensitivity analysis and other work undertaken elsewhere in the scoping review investigates variations on the four basic scenarios.

The four basic scenarios are:

  1. retain all of TVNZ as it is;
  2. sell all of TVNZ as it is;
  3. separate and retain TV ONE (with a small infrastructure, asset base and role) and sell the rest of TVNZ; and
  4. separate and retain TV ONE (with a larger infrastructure, asset base and role) and sell the rest of TVNZ.

The purpose of this appendix is to more fully define each basic separation scenario. Each definition is intended to represent an ownership structure that appears to be, from a preliminary analysis, achievable and value maximising. (Further analysis of impediments and operational matters may suggest refinements to the basic scenarios). The definitions are also intended to be comparable. All deliver the same level of social and public service benefit (i.e. the level currently being delivered by TVNZ).

The separation scenarios assume that a part of TVNZ relating to the broadcasting of TV ONE is separated and retained by the Crown and that the remainder of TVNZ is sold as a single entity. These scenarios are the most difficult of the four to define and analyse. TVNZ does not have a separate legal entity or stand-alone department which broadcasts TV ONE in isolation. Common facilities are used for the broadcasting of all TVNZ channels. The restructuring necessary to achieve a separation will be complex, and there are a number of ways that a separated TV ONE could be structured.

Contract Structure

The Contract structure is the basic scenario which separates TV ONE and gives it minimal infrastructure and functions. This separation scenario assumes that a new company or entity is formed to own TV ONE. The company owns the licence rights to the radio frequencies on which TV ONE is now broadcast together with the brand name and trademarks of TV ONE. It grants to TVNZ the right to broadcast on the frequencies and the right to use the TV ONE brand. It specifies limits on the format and content that TVNZ may transmit. For example, it might require that TVNZ include one hour of news in prime time each evening. TVNZ would purchase the programme content, sell the advertising, pay all operating costs and retain for itself the net profit from broadcasting TV ONE. The Crown would receive the value of the rights to broadcast TV ONE within the sale price for TVNZ.

The new entity that is formed to own TV ONE would have a Board of directors and secretarial staff with very limited roles, primarily monitoring adherence to the TV ONE programme specification and renegotiating the operating rights on expiry.

We have assumed, for the purposes of analysis, that the operating rights have a term of 10 years. Longer or shorter periods are possible, and we have not undertaken a detailed evaluation to determine the most efficient term for the rights. On maturity, the new entity will be able to sell broadcasting rights for subsequent periods (at least until the radio frequency licences expire in 2015). To ensure that TVNZ maintains the value of the TV ONE brand, it may be appropriate for TVNZ to receive an incentive, for example a share of, say, 20% of the sale price of subsequent broadcast rights.

The greatest difficulty in establishing the structure described above is likely to be the specification of format for the TV ONE programme schedule. The greater the limitations on content the greater the likely loss of value to the Crown on separation. It is possible that policy objectives may require that the specification differ from the current TV ONE format. However, to ensure that our evaluation of the basic scenarios is comparable, the programme content limitations are assumed to be the same as those imposed on TVNZ at present. (These include Broadcasting Act, Broadcasting Standards Authority and other public broadcaster regulations, and the general "good corporate citizen" requirements of the SOE Act).

Under the structure described above, in which the constraints on, and profit motivation for, TVNZ are unchanged from the status quo, it can be assumed that TVNZ's operating strategy, programme schedules, revenues and costs will be essentially the same as its current business plan.

 

In summary, the Contract structure has the following features:

  • a new Crown-owned entity owns the TV ONE radio frequency licences;
  • the new entity also owns the TV ONE brand name and trademarks;
  • the new entity has no other significant assets or liabilities;
  • TVNZ is granted rights to broadcast TV ONE for, say, 10 years;
  • the rights are subject to some constraints on programme content;
  • the constraints are equivalent to TVNZ's current operating constraints;
  • TVNZ pays no annual or continuing fees for its rights;
  • TVNZ purchases all programme content;
  • TVNZ sells all advertising and retains all advertising revenue;
  • TVNZ incurs all operating costs;
  • TVNZ thereby retains all risks and profits from operation of the channel;
  • the Crown receives the value of the rights to broadcast within the sale price of TVNZ;
  • the new entity incurs some operating costs of a secretarial nature;
  • at the end of the 10 year period the broadcasting rights revert to the new entity; and
  • the new entity is then able to sell rights to broadcast in subsequent periods.

Dissection Structure

This separation scenario assumes a new company or entity is formed to own TV ONE that is completely independent of TVNZ and BCL. Directors, management and staff of the new company would:

  • determine the programme schedule;
  • purchase most of the programme content from independent producers;
  • produce a limited number of their own programmes (for example news programmes);
  • sell advertising for the channel; and
  • purchase transmission services from BCL.

The new company would own: <

  • the licence rights to the radio frequencies on which TV ONE is now broadcast;
  • the brand names and trademarks of TV ONE;
  • the programme rights currently owned by TVNZ to the programmes now being broadcast on TV ONE; and
  • limited amounts of office equipment, furniture and fittings.

The new company would also own or lease offices and studios necessary for the production and compilation of its own programme schedule. It would not own transmission assets, but would purchase transmission services from BCL.

The new company would:

  • earn revenue from advertising;
  • pay the cost of purchasing or producing programmes;
  • pay the cost of transmitting the programmes;
  • incur marketing and selling costs in relation to the sale of advertising; and
  • incur payroll, rental, and other office or administrative expenses.

The arrangements described above are similar to the structure of Channel 4, the UK government owned commercial channel.

The structure described above assumes that separation of TVNZ broadcasting assets is legally and practically possible. Appendix IV describes some of the practical difficulties in creating a Channel 4 model for TV ONE. A full investigation of the impediments to separation and the preparation of a detailed implementation programme are beyond the scope of this report. It may prove to be impossible to separate TV ONE in exactly the way envisaged in the structure above.

Appendix V Banking Facilities

Note Issuance and Short Term Advances Facilities

[Text deleted]

Overdraft

[Text deleted]

Multi-Option Facility Agreement

[Text deleted]

Money Market Facilities

[Text deleted]

Appendix VI IPO Costs

Fees and Costs for New Zealand IPOs

Glossary

ABC
 
ABC Inc (wholly owned by The Walt Disney Company)
Analogue transmission
 
Transmission using analogue modulated signals
BBC
 
British Broadcasting Corporation
BCL
 
Broadcast Communications Limited
BRITE
 
British Independent Television Enterprises Limited
CanWest
 
CanWest Global Communications Corporation, a Canadian television broadcaster with international media interests
CAPM
 
Capital asset pricing model
CBS
 
CBS Corporation, a major national US network
CLEAR
 
CLEAR Communications Limited
CNN
 
Cable News Network Inc (a subsidiary of Warner)
Columbia
 
Columbia Tristar International Television
DCF
 
Discounted cash flow
Digital transmission
 
Transmission using signals consisting of digital data streams
Disney
 
The Walt Disney Company
DTH
 
Direct to home satellite broadcasting
DTT
 
Digital terrestrial transmission
EBIT
 
Earnings before interest and tax
EBITDA
 
Earnings before interest, tax, deprecation and amortisation
FTA
 
Free-to-air, non-subscriber television
GNZTV
 
Great New Zealand Television Project, a TVNZ profit improvement and restructuring project
HDTV
 
High definition television
INL
 
Independent Newspapers Limited, 49% owned by News Corp
IPO
 
Initial public offering
Multiplex
 
A digital data stream comprising multiple concurrent channels
NBC
 
National Broadcasting Company (wholly owned by General Electric)
News Corp
 

The News Corporation Limited

Nine Network
 
A major Australian television broadcaster, wholly owned by Publishing and Broadcasting Limited
NTA
 
National Transmission Agency
Ord Minnett
 
Ord Minnett Securities -NZ- Limited
Pay TV
 
Subscriber only television
Polygram
 
Polygram Proprietary Limited
Prime
 
Prime Television Limited (an affiliate of the Seven Network)
Saturn
 
Saturn Communications Limited, a Wellington based cable TV operator owned by UIH
Seven Network
 
Seven Network Limited, one of the major national Australian television networks
SKY
 
SKY Network Television Limited
SOE
 
State owned enterprise
SPADA
 
The Screen Producers and Directors Association of New Zealand
STB
 
Set top box
Telecom
 
Telecom Corporation of New Zealand Limited
Ten Network
 
TEN Group Limited
TV3
 
TV3 Network Holdings Limited New Zealand (wholly owned by CanWest)
TVNZ
 
Television New Zealand Limited
UIH
 
United International Holdings
Universal
 
Universal Studios (a unit of Seagram Company Limited)
VID
 
Volume incentive discount arrangements whereby TVNZ provides advertising price discounts to agencies and advertisers who meet agreed minimum placement targets
WACC
 
Weighted average cost of capital
Warners
 
Time Warner Inc
WIN
 
World International Network