Whatever interest Fairfax Media ends up having in NZME., it is unlikely to be a long-term holding, Morningstar Australia media analyst Brian Han says.
In a research note published after the announcement of APN and Fairfax's New Zealand merger plans, Mr Han said Fairfax had grabbed the opportunity presented by APN's decision to spin off its New Zealand media assets into a new listed entity, NZME.
"In our opinion, this is likely the first step towards rationalising Fairfax's exposure to the country, with the separately listed vehicle providing a neat exit mechanism down the track.''
There was no change to Morningstar's A71c value estimate for each Fairfax share.
The shares last traded at A90c.
Mr Han said Morningstar viewed the deal as a strategic positive for Fairfax, albeit with shares trading at a 20% premium to assessments.
The "no competitive advantage'' and high uncertainty ratings remained intact, reflecting the cyclical nature of the advertising industry and the structural challenges facing the print media assets.
Fairfax's New Zealand media operating profit had fallen from $86.7million in 2011 to $70.3million in 2015, and slumped a further 11.9% in the first half of the 2016 financial year, to $30.3million.
Morningstar is forecasting operating profit to continue its fall to an estimated $45.2million by 2020.
"In the face of this deterioration, we see strategic merit in combining with NZME. in order to increase scale in the New Zealand media market and remain relevant to audience and advertisers.''
NZME. itself was under enormous pressure.
Its operating profit dropped from $80.8million in 2013 to $67.5million in 2015, Mr Han said.
However, the alternative for Fairfax - maintaining the status quo in New Zealand, amid fragmenting audience and proliferating alternative platforms for news - was uninspiring, to say the least.
It was too early to speculate on the structure of NZME. if early-stage discussions led to a merger between the new vehicles and Fairfax's New Zealand properties, he said.
Fairfax's New Zealand division generated 2015 revenue of $384million and operating profit of $70.3million, equating to a margin of 18%.
NZME. in 2015 generated revenue of $433million and profit of $67.5million, equating to a margin of 15.6%.
The two entities were broadly of equal size and Fairfax should end up with about a 50% shareholding in NZME. if it successfully merged its New Zealand media business with NZME., Mr Han said.
"We will reserve our judgement as to whether the enlarged media entity can arrest the two businesses' alarming earnings decline in recent years.''
Transition from a print-centred model to a digital-centred, multi-channel model did not come cheaply, not to mention the inevitable execution hiccups along the way, he said.
Whatever interest Fairfax ended up having in NZME., it was unlikely to be a core long-term holding.
The deal could be part of a wider strategic plan to rationalise its asset mix before potential consolidation in Australia, if and when media ownership restrictions were abolished there, Mr Han said.
Separately, First NZ Capital said Fairfax Media's New Zealand business was worth just A5c to the company's stock price on a discounted cashflow basis and divesting the assets could help unlock the value of key assets such as the Domain Australian real estate website.
In a report titled "FXJ starts the self-help process'', the brokerage said Fairfax was "exposed if [it] does nothing''.
Its weak share price meant Domain was undervalued and has left FXJ exposed to a private equity bid and possible break-up, the report said.
"It is positive that the company appears to be taking steps to close the valuation gap and prevent the upside in Domain being extracted by an alternative owner.''
At a glance
Fairfax and APN said on Wednesday they were in exclusive talks about a potential merger of their New Zealand media assets this year, which would all be poured into an NZX-listed NZME., APN's local unit. If such a combination passed the Commerce Commission's scrutiny, Fairfax would initially have a holding in the combined media company.
