Tuesday, November 21, 2006

THERE are many similarities - and a substantial difference - between the $4
billion media joint venture Kerry Stokes and Kohlberg Kravis Roberts entered
into yesterday and the deal James Packer struck with CVC Asia Pacific only a
month ago. While at face value they appear identical, with both media
proprietors selling half-shares in their media business, built around a
leading free-to-air network, to private equity firms, the key difference is
what they plan to do with the vast amounts of capital released. Unlike
Packer, who plans to deploy the $4.5 billion released from the sale of a 50
per cent stake in PBL Media into his faster-growing and higher-returning
gaming operations, Stokes has no gaming business or anything similar to it.
For Packer, the deal was a financing exercise driven by financial logic -
extracting capital from mature and low-growth assets to fund expansion into
an immature and high-growth sector. Acquisition currency was a secondary
benefit. For Stokes, the emphasis is on creating a currency for expansion in
a media sector that, thanks to Helen Coonan's reforms, is set for a
convulsive realignment of ownership. It was instructive that in announcing
the deal yesterday, Seven Network and KKR referred to the creation of a
vehicle with "the strategic and financial flexibility to take advantage of
the dynamics of the Australian and New Zealand media landscape". The
partners plan an expansion of their Australasian media interests in an
environment where, once the changes to cross-media and foreign ownership
rules are proclaimed, large slabs of the media previously denied to Stokes
and foreigners will be available.

Stokes already has a $200 million seat at the table, having snatched a 14.9
per cent stake in West Australian Newspapers last month. That stake will
remain within Seven Network, along with some pay TV rights and the C7
litigation - and the $3.2 billion of cash released by the deal with KKR.

Seven Media Group will have $350 million of initial acquisition funding
capacity, but that doesn't even hint at its actual capacity. Stokes says
Seven has no plans to return cash to shareholders, and with a balance sheet
that will contain no net debt and more than $2.5 billion of cash, he clearly
plans to redeploy the capital.

If Seven's $3.2 billion war chest were matched on a dollar-for-dollar basis
by KKR, one of the world's largest and more aggressive buy-out firms, and
geared on the same basis as Seven Media, the partners would have $17 billion
to spend. They could roll up WAN and Fairfax and still have half that $17
billion left to play with.

The relationship creates flexibility. Private equity firms, because of the
gearing - Seven Media will have $2.5 billion of debt sitting on $1.5 billion
of equity - need access to the underlying cash flows of any acquisition.
Stokes doesn't.

If the anticipated takeover frenzy does break out next year, Stokes will
have the capital and capacity to participate through Seven Network without a
guarantee of ending up with 100 per cent ownership. That gives him tactical
flexibility.

If he makes acquisitions and succeeds in achieving full ownership, the
assets can be on-sold into Seven Media and most of the capital extracted.
Equally, Seven Network and KKR could, where the situation dictates or where
there are no prospective synergies, create new vehicles and potentially
involve other investors.

KKR, the losing bidder for the half-share of PBL Media, must be glad it
missed out. Not only do Seven's TV operations have momentum, Stokes and his
team are focused almost exclusively on the sector.

There is potentially more growth and acquisitions in prospect for Seven
Media than its PBL counterpart, given PBL has competing demands for its
capital.

Like PBL, Stokes is a veteran deal-maker who traded media assets during the
last outbreak of takeover activity in the sector in the 1980s. This time,
both have found a way to keep their feet on their businesses while cashing
in on the bonanza created by the coincidence of the private equity
phenomenon and the frenzy around media assets - and the protection the
Coonan "reforms" provided for free-to-air network cash flows.

With CanWest considering its options for Ten Network, ownership of all three
networks might change even before the new laws are proclaimed.

The media joint ventures created by PBL and Seven create a currency for
otherwise high-priced acquisitions, thanks to their leverage, which greatly
reduces their cost of capital.

If the joint ventures go well, they will generate leveraged returns on the
capital contributed. If they don't go well, the media partners are
positioned to buy back the outstanding interest cheaply. In the meantime,
they have the use of the billions of dollars released.

For Seven, KKR's vast global network, its practically unlimited access to
cheap capital and its extensive experience in media businesses mean that
there are other possible value-adding dimensions to the relationship, both
in terms of the value that might be added to Seven's Media assets and the
possibility of expanding with KKR overseas.

Unlike PBL, Stokes did not conduct an auction for the interest in Seven
Media. That signals that in the aggressive KKR, he believes he has found a
partner that has more to contribute than cheap funding. There were
references to the "cultural fit" of the organisations - which could be
regarded as an indirect reference to their shared vision for really
aggressive expansion.