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Buy STV Group# 18 January 2016 STVG

Data Price 485p Plenty still to go for Target price 650p (was 530p) We increase our STV target price to 650p (from 530p) and we Market cap £192m retain our Buy stance. The share price has been very strong of EV £215m Net debt £23m late and the equity story is well underpinned. Core advertising Interest cover 16x and digital performance trends remain attractive into 2016, with Pension deficit £15m fresh catalysts in view (retransmission fees; M&A spec in TV Free float 100% assets; EPG shift/weaker BBC). The valuation is still also Index FTSE SmallCap Sector Media undemanding. STV trades on 12x PE, with an ordinary yield of Next news Feb - Prelims 2% and leverage at multi-year lows.

UK sales 100% European sales 0% Profit forecasts trimmed: The recent FY2015 pre-close update was brief but North American sales 0% encouraging overall. Our headline forecasts are now trimmed, although we tweak Rest of World sales 0%

the divisional inputs (Production down, Consumer up). We still factor in nothing for Description upside from (expected) regulatory change, yet a 10% CAGR in EPS out to FY2017 STV Group holds the UK channel 3 TV licence for looks plausible. Scotland. It also operates TV production businesses as well as local advertising websites. STV declining leverage, eyes on uses of cash: We forecast net debt/EBITDA of < 1x at FY period end, with the balance sheet in very good shape now. We forecast Performance annual free cash flow of £8m after pension. The dividend is very well covered, c4x. Source: Bloomberg

600 STV is a scarce and key strategic Media asset; relationship with ITV ailso much

500 improved: The recent £110m takeover of UTV’s TV assets by ITV now leaves STV

400 as the owner of the remaining C3 network licences. In the run-up to Christmas, ITV

300 Plc was also closely linked to Comcast. UK TV assets clearly have M&A potential.

200 This is not reflected in the current STV PE multiple of 12x PE, in our view. 100 Resilient in a fast-evolving TV landscape: STV’s reach is > 90% of Scotland, with 0 Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan share of commercial viewing almost three times its nearest rival. Forecasts for the UK Price Relative advertising industry are encouraging, with TV retaining a > 40% share amidst seismic Analyst change in Media. STV is well placed in national airtime, its largest revenue line, with Alex DeGroote downside protection on the cost side under its NAA (Network Affiliate Agreement). +44 (0) 20 7418 8863 [email protected] Organic initiatives bearing fruit: Outwith linear TV, STV’s suite of emerging products (eg City TV, Digital and stv.tv) addresses new revenue streams. In the case of #Corporate client of Peel Hunt VOD (video on demand), this is high margin. STV is now also capturing more data on consumers, which will prove valuable in the future. Production should have more than just option value, with a lot of work being undertaken behind the scenes. Regulatory backdrop favourable: Retransmission fees would add material value to STV, in our view. Debate over the BBC Charter renewal will also feature heavily in Media 2016 and we see the risk on the upside for all commercial media, including STV.

Stats Source: Company accounts, Peel Hunt estimates Y/E Dec Sales EBITDA Op Margin Adj PBT Adj EPS EPS growth PER DPS Div yield FCF yield EV/EBITDA (£m) (%) (£m) (p) (%) (x) (p) (%) (%) (x) 2014A 120.4 21.8 16.2 17.3 37.6 13.1 13.0 8.0 1.6 4.5 10.1 2015E 122.8 23.1 16.7 19.3 39.3 4.5 12.5 10.0 2.0 5.2 9.3 2016E 132.3 24.7 16.6 21.1 43.1 9.7 11.4 12.0 2.5 3.3 8.6 2017E 140.8 26.7 17.1 23.3 47.7 10.8 10.2 14.0 2.9 5.7 7.7

Marketing Communication This document must be treated as a marketing communication for the purposes of Directive 2004/39/EC as it has not been prepared in accordance with legal requirements designed to promote the independence of research; and it is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This report is prepared solely for the use of Alex DeGroote Peel Hunt STV Group# 18 January 2016

Report overview

Increase target price to 650p STV was one of our key Media ‘top picks’ for 2015. In this report, we now reiterate our Buy stance on STV for 2016 with a revised target price of 650p. First, we put the current share price into some context then we address the following key STV investment themes:

• outlook for STV forecasts, including the recent FY trading update, top-down prospects for advertising in 2016 and beyond, and performance in new initiatives; • our thoughts on the company’s valuation, and the rationale for our revised 650p target price; • cash generation and STV’s use of cash going forward, including dividend payout; • what the ITV Network consolidation means for STV, taking into account the recent UTV takeover; • the importance of TV itself in a fast-changing media and technology landscape; • retransmission fees, and the regulatory environment; and • progress on STV’s new business initiatives, together with an update on Production; 2016: Broadcast sector in focus At Peel Hunt, we believe 2016 will be the ‘high-tide’ mark for the UK broadcast sector. Hence, we also provide detailed analysis on the shifting sands for the sector at large. Share price in context and STV equity story overview

44% TSR, 2015 We selected STV as one of our top picks for the Media sector in 2015. Its share price performance in the year was impressive: +44% TSR.

Over the longer term, in absolute terms, the STV share price has now quadrupled since 2011 (eg from 105p, to 485p today). In terms of valuation multiples (excluding pension), this can be expressed in terms of a PE re-rating from 3x prospective, to 12x. By way of contrast, ITV Plc trades on 17x PE.

Chart 1: STV share price and EPS multiple expansion since 2011 Source: Peel Hunt estimates, PE and EPS on LH side

45.0 450 40.0 400 35.0 350 30.0 300 25.0 250 20.0 200 15.0 150 10.0 10.2 10.9 100 7.4 5.0 50 3.1 3 0.0 0 2011 2012 2013 2014 2015

EPS P/E Share price (rhs)

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Over the same period, STV’s EPS has increased from 32.7p to 39.3p (forecast). Likewise, ITV Plc has performed very well since 2011. Both of these Media names have shared the benefit of a powerful cyclical recovery in advertising.

Chart 2: STV share price since 2011 Chart 3: ITV share price since 2011 Source: Bloomberg, LH axis share price Source: Bloomberg, LH axis share price

450 300 400 250 350 300 200 250 150 200 150 100 100 50 50 0 0 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015

We identify the STV equity story in terms of ‘old’ and ‘new’ factors. Self-help is a recurring theme throughout, as is management’s track record. Commonly we have heard from various institutions that ‘they have done everything they said they would’.

Table 1: STV: Equity story evolution Source: Peel Hunt Old equity story Comments New equity story Comments Solid organic Alongside PE multiple expansion, EPS has been in an Improving Ofcom licences renewed out 2024. The Scottish referendum has ‘come profit ‘up cycle’ since 2009. This is organic growth as STV regulatory and gone’, at least for now. Negotiations for BBC Charter renewal – performance has not undertaken any acquisitions (no forex either). backdrop effective 2017 – are underway. Finally, a new Digital Media Bill is due out this year, which may well qualify retransmission fees.

Improved reach STV offers products in online, VOD and TV. Reach is Digital business STV has created a scale, highly-profitable VOD business (> 35% in Scotland growing significantly, with important business margins). The cost is largely sunk and consumer usage of on demand is advantages. growing rapidly.

Resumption of STV resumed its dividend payout in 2013. A reliable Progressive The company has indicated 10p and 12p dividends for FY2015/16 dividend yield on STV enhances the story in terms of TSR. dividend/uses of respectively. The payout ratios could improve further. Likewise a special cash dividend is plausible.

De-leveraging STV’s net debt has fallen from £52m in 2010 to Outlook for STV is focused on the ‘right’ parts of the advertising market, TV and digital c£23m in FY2015E. Excluding the IAS pension deficit, advertising (including video on demand). WARC/Group M forecast overall UK ad this equates to net debt:EBITDA of 1x. This is modest market growth rates of > 6% in 2016. leverage, and provides optionality.

De-risked STV has renegotiated its operating relationship with Bid spec The recent £110m takeover of UTV Media’s Irish TV assets by ITV raises ITV, with less gearing now. An ETV exercise could also the ante for STV, the final piece of the jigsaw in terms of ITV’s partially de-risk the DB scheme. consolidation. ITV itself is a bid target, linked to Comcast in the run up to Christmas.

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Media sector: 2015

6th best performing name in 2015 The table below – taken from our Media sector marketing documents – highlights the sector’s ‘winners and losers’ on a TSR basis. STV ranks sixth, ahead of ITV and well ahead of UTV. Rightmove is the best performing stock.

Figure 1: Media Sector: Key 2015 performance metrics Source: Peel Hunt

Digital and growth in focus It is hard to name a unifying theme in such a disparate clutch of stocks, in so many different subsectors. However, top-line growth is likely to be the common denominator, and the best performing sector has been the digital/internet marketing sector (eg companies such as Rightmove, 4imprint, Next 15, MoneySupermarket).

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Outlook for STV forecasts FY2015 Encouraging trading update At the end of December, STV published its FY2015 pre-close trading update, ahead of its prelims due on 15 February.

‘It is confirmed that earnings are in line with the Board’s expectations. A full update of performance against KPIs will be provided ….in February 2016.

It is announced today that an enhanced digital news service will be launched in February 2016. This service, which will sit within the STV Family of consumer services, will strengthen STV’s position as the provider of the most popular commercial digital news service in Scotland.’

Our interpretations We see this as an encouraging and timely message by STV to the stock market. Digging deeper, we tease out the following pointers: • H2 weighting to FY2015 outcome: STV is delivering on our FY expectations, despite a clear H2 bias overall and some softness in Production. Divisionally, we have adjusted Consumer up and tweaked Production down. • Consumer solid: H2 2015 was very satisfactory for STV on the back of H1 national airtime growth of 3% and regional airtime also picked-up in H2. Digital, in particular VOD – a high-margin revenue stream – has continued to perform well. • Production disappointing, with scope now to improve: Some adverse phasing has clearly impacted STV’s divisional top-line performance in 2015, and to a lesser extent its profits. This should reverse in 2016, in our opinion, together with hopes for improved commissioning and the impact of some senior hires. • Leverage reduced again: STV’s FY 2015 net debt, £23m in our forecasts, will be at a multi-year low. STV will have surplus free cash flow, above dividend payouts. STV is exploring ETV options (enhanced transfer value), which should have a long-term benefit for DB liabilities. • Investment: City TV licences in Glasgow and Edinburgh have already been launched. Three other local licences must launch in 2017. Whilst these are low-cost stations, the 2015/16 Consumer margin will be diluted slightly before it breaks even in 2017. Overall, this leaves us with clean PBT of £19.3m and clean EPS of 39.3p for FY 2015. FY 2016 and beyond Further out, we also take into account a raft of recent top-down advertising industry forecasts, along with this bottom-up company guidance,

STV exposed to advertising STV is a FTA (free-to-air) broadcaster. ‘Traditional’ advertising accounts for c90% of the company’s group revenue. As we discuss later in detail, ITV ’sells’ STV’s national airtime. Hence, it is important to have a grasp of the background factors that influence this key revenue-line item.

A useful starting point is the UK outlook from the trade body WARC and two major advertising agency groups (Group M/WPP and Zenith/Publicis), depicted below. As can be seen, they are uniformly bullish in their most recent updates.

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Projections of 6-9% nominal ad growth are posited for the UK in 2016. Why is this?

‘ … I attribute it to the healthy UK economy, marketers’ embrace of digital communication and strong demand for TV, which remains cheap on historical and international terms’ (Jonathan Barnard, Zenith Optimedia).

Chart 4: UK ad growth in 2016: By agency group Source: Company accounts, Peel Hunt estimates

10.0%

8.0%

6.0%

4.0%

% nominal growth nominal% 2.0%

0.0% WARC/AA Zenith Group M

Series1

UK ad growth being raised, global At the same time as upgrading the outlook for UK ad forecasts, the likes of growth trimmed Zenith and Group M are downgrading their global outlooks slightly. Zenith, for example, now forecasts 4.7% global growth in 2016, versus 5.0% in September/Q3.

Major events in 2016: Good for A raft of major events are also due to take place in 2016, which should helpfully advertising influence the general levels of advertising internationally, although only at the margin for UK broadcast: the Olympic Games; UEFA Football championships; and US presidential election. The Olympics will be transmitted by the BBC and Euro 2016 shared between it and ITV. In more detail UK adverts > £19bn industry According to WARC, UK advertising is a £19bn industry, including direct mail. The internet already comprises >30% of the industry total although, if anything, we suggest this is an under estimate.

Internet/online on rapid growth path. Breaking down advertising into more detail, we can see below that the forecast Selected other media declining growth rates by Media in 2015/16 vary considerably. TV, the largest traditional advertising medium, is set to grow by 6.9% and 4.9%, respectively, according to WARC. However, Regional newsbrands are set to record declines of 3% and 2.2%, respectively. Intuitively, print should remain weak.

Modest slowdown assumed in TV WARC anticipates a modest slowdown in overall YoY TV growth rates in 2016. growth rates in 2016 TV advertising is a £5bn industry and, in turn, TV is a mix of spot advertising, sponsorship and VOD advertising through online players. We separate VOD because it is increasingly material to ITV/STV and is a high-margin revenue stream (low-marginal cost).

VOD growth rates are stellar According to WARC, VOD was c£145m across the UK in 2014. However, going forward, this revenue stream compounds at attractive high-teens growth rates, and lifts overall TV ad growth. The working assumption at this stage is that VOD does not cannibalise FTA TV advertising.

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Table 2: UK advertising growth prospects by media (£m and % growth rates) Source: Peel Hunt estimates, WARC/AA 2014 2014 2015E 2016E TV 4911 5.8% 6.9% 4.9% o/w Spot 4463 5.4% 6.4% 4.0% o/w VOD 145 15.1% 17.2% 20.6% Radio 575 7.2% 4.3% 4.8% Outdoors 1019 3.0% 6.3% 4.7% National newsbrands 1370 -4.7% -4.3% -1.9% o/w Digital 214 16.4% 11.9% 11.6% Regional newsbrands 1253 -3.6% -3.0% -2.2% o/w Digital 174 24.7% 16.8% 15.4% Magazines 993 -4.3% -3.3% -1.7% o/w Digital 267 5.9% 8.0% 7.4% Cinema 202 9.5% 6.4% 3.6% Internet 7194 15.0% 12.6% 11.3% o/w Mobile 1623 58.9% 43.4% 35.4% Direct Mail 1835 -1.1% 1.9% 1.0% Total 193521935219352 5.8%5.8%5.8% 6.2%6.26.26.2%%% 5.6%5.65.65.6%%%

Some notes of caution amidst 2016 We are encouraged greatly by the bullish top-down prognosis for the UK and TV euphoria from important sources. Media investors should pile into UK TV! At the same time, our own slightly more cautious views on ad growth are framed partly by stories we hear from the Media Plc arena, some historical perspective and our common-sense macro observations.

• Plc anecdotes: At the November IMS, the ITV Family NAR growth was +6% YoY, believed to be ‘ahead of the wider market’. ITV is reticent about commenting publicly on 2016 expectations. • Historical perspective: As a % of GDP, advertising has been falling in the UK since 2000 (> 1% at its peak). This could be explained by: (1) a move away from expensive, above-the-line advertising, to cheaper below-the-line marketing; and (2) an increased use of data and targeted advertising, moving away from the ‘spray and pray’ model of yesteryear. • Peak-trough analysis: Advertising is cyclical, following the economic cycle. The last ‘trough’ was in 2008/09 on the back of the financial crisis. We are now more than five years into the upturn. • Macro: In the run-up to Christmas, and on the back of weak service-sector output, the ONS revised down annualised UK growth rates to 2.1% (from 2.3%). Consensus UK GDP forecasts are for 2.5% and 2.6% growth in nominal terms, in 2016 and 2017, respectively. With an ongoing decline evident in the ratio of adspend/GDP, it seems hard to reconcile the exuberant 6-9% growth rates. • Definitions and maturity: Finally, it is also worth repeating that the definitions of TV advertising are not necessarily consistent across the marketplace. For example, STV also operates a Regional business, which is more volatile and only linked loosely to National. And, above all, STV is a somewhat more mature operator than many new TV entrants. Hence, for our own company forecasts we would err on growth rates below the WARC/AA industry forecast.

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‘The total television market is becoming increasingly difficult to measure, particularly in the short term, as all broadcasters have different definitions and include sources of revenue other than pure spot advertising.’ (Source: ITV)

Forecasts In considering all of these factors, what do we forecast for STV across its Consumer-line items, leaving Production to one side? In the table below, we disaggregate non digital and digital activities across the division.

Table 3: STV: Consumer divisional forecast Source: Peel Hunt estimates Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15E Dec-16E Dec-17E Dec-18E FY FY FY FY FY FY FY FY FY Consumer --- non digitalnon digital National airtime 70.0 67.9 67.4 72.1 77.8 80.9 83.7 86.7 89.3 growth -3.0% -0.7% 7.0% 7.9% 4.0% 3.5% 3.5% 3.0% Regional airtime 14.8 12.9 13.1 12.3 12.6 13.0 13.4 13.8 14.2 growth -12.8% 1.6% -6.1% 2.4% 3.0% 3.0% 3.0% 3.0% Sponsorship 4.0 3.8 3.8 4.6 5.3 5.7 6.0 6.3 6.6 growth -5.0% 0.0% 21.1% 15.2% 7.0% 5.0% 5.0% 5.0% City 0.0 0.6 1.6 1.8 2.2 2.6 8.0% 8.0% 8.0% Other 2.0 1.9 1.7 5.3 5.5 5.7 5.7 5.7 5.7 growth -5.0% -10.5% 211.8% 10.0% 3.0% 3.0% 3.0% 5.0% Consumer revenue ex digital 90.8 86.5 86.0 94.3 101.8 106.8 110.6 114.6 118.3 growth -4.7% -0.6% 9.7% 8.0% 4.9% 3.6% 3.6% 3.3% Operating costs (77.3) (73.2) (70.8) (78.0) (84.3) (88.9) (92.4) (95.3) (97.9) growth -5.3% -3.3% 10.2% 8.1% 5.4% 3.9% 3.2% 2.7% Operating profit airtime 13.513.513.5 13.313.313.3 15.215.215.2 16.316.316.3 17.517.517.5 17.917.917.9 18.18.18.118.111 1118.818.88.88.8 19.819.819.8 growth -1.5% 14.3% 7.2% 7.4% 2.6% 1.0% 3.9% 6.9% Operating margin 14.9% 15.4% 17.7% 17.3% 17.2% 16.8% 16.3% 16.4% 17.0%

Consumer --- digitaldigitaldigital Digital growth 4.2 1.9 3.5 4.3 5.3 6.5 8.7 11.1 13.5 growth 84.2% 22.9% 23.3% 22.6% 33.0% 27.6% 21.6% Digital ex growth 5.2 3.0 0.0 0.0 0.0 0.0 0.0 0.0 growth -42.3% 0.0% 0.0% 0.0% 0.0% 0.0% Digital revenue total 4.2 7.1 6.5 4.3 5.3 6.5 8.7 11.1 13.5 Operating profit digital (0.1)(0.1)(0.1) 1.21.21.2 1.71.71.7 1.31.31.3 1.61.61.6 2.62.62.6 3.63.63.6 4.4.4.74.777 5.5.5.75.777 growth 42% -24% 23% 62.5% 38.4% 30.5% 21.2% Operating margin -2.4% 16.9% 26.2% 30.2% 30.2% 40.0% 41.3% 42.3% 42.2%

ConsumerConsumerConsumer --- totaltotaltotal 95.095.095.0 93.693.693.6 92.592.592.5 98.698.698.6 107.1107.1107.1 1111113.3113.33.33.3 111191191919.3.3.3.3 121212512555.6.6.6.6 131313113111.8.8.8.8 Growth -1.5% -1.2% 6.6% 8.6% 6.4% 5.5% 5.3% 4.9% Operating profit tttotaltotalotalotal 13.413.413.4 14.514.514.5 16.916.916.9 17.617.617.6 19.119.119.1 20.520.520.5 21.621.621.6 23.523.523.5 25.525.525.5 growth 8.2% 16.6% 4.1% 8.5% 7.1% 5.8% 8.5% 8.8% Margin 14.1% 15.5% 18.3% 17.8% 17.8% 18.0% 18.1% 18.7% 19.3%

Margin dynamics We forecast that the Consumer division margin, ex digital, will decline by c50bps to 16.3% in 2016 YoY, to reflect mainly the near-term ramp of City losses and the launch of the new digital news initiative. It should be noted that STV is also losing some high-margin premium rate telephony business. At the same time, we continue to forecast high > 35% margins in the Digital revenue stream. This is broadly an offset. From 2017, we anticipate some recovery in the core margin.

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Sensitivity

Low operational gearing It is worth flagging up that as a result of STV’s most-recent commercial agreement with ITV, the NAA, STV is now less operationally geared than before. We estimate operational gearing from incremental airtime revenue at c20%, up or down. This mainly reflects the variability in STV’s largest cost item, the network affiliate fee. Ordinarily, the ‘flow through’ in a broadcaster would be much higher than 20%. This will de-risk STV in the event of a declining top line (eg unexpected cyclical decline). Group forecasts Group estimates ex retransmission This divisional forecast significantly informs our STV group forecasts, given fees Consumer is 90% of revenue and > 90% of group EBIT. Production is the delta, in terms of group profits. Elsewhere, we should be clear that we do not build a value for retransmission fees into our core assumptions.

Table 4: STV: Summary P&L forecasts Source: Peel Hunt estimates Y/End December £'000 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E Consumer 95.0 93.6 92.5 98.6 107.1 113.3 119.3 125.6 131.8 Production 9.8 8.4 10.2 13.5 13.3 9.5 13.0 15.2 19.0 RevenueRevenueRevenue 104.8104.8104.8 102.0102.0102.0 102.7102.7102.7 112.1112.1112.1 120.4120.4120.4 1212122.8122.82.82.8 1313132.132.2.2.3333 140140140.8140.8.8.8 150150150.8150.8.8.8

EBITDA --- totaltotaltotal 16.916.916.9 17.417.417.4 19.519.519.5 20.120.120.1 21.821.821.8 23.123.123.1 24.724.724.7 26.726.726.7 29.229.229.2

Non cash costs Depreciation - total (2.5) (2.4) (2.4) (2.1) (2.0) (2.2) (2.2) (2.2) (2.2) Share option costs 0.0 0.0 0.0 0.0 (0.3) (0.3) (0.3) (0.3) (0.3)

Consumer 13.4 14.5 16.9 17.6 19.1 20.5 21.6 23.5 25.5 Production 1.0 0.5 0.2 0.4 0.4 0.2 0.5 0.8 1.1 Clean oClean operatingoperating ppprofitprofit --- totaltotaltotal 14.414.414.4 15.015.015.0 17.117.117.1 18.018.018.0 19.519.519.5 20.620.620.6 22.222.222.2 24.224.224.2 26.726.726.7

Net interest (2.3) (2.3) (4.0) (2.8) (2.2) (1.3) (1.1) (0.9) (0.7)

PBT nPBT normalisednormalisedormalisedormalised 12.112.112.1 12.712.712.7 13.113.113.1 15.215.215.2 17.317.317.3 19.319.319.3 21.121.121.1 23.323.323.3 26.026.026.0 Normalised EPS ddilutedilutedilutediluted (actual)(actual)(actual) 31.831.831.8 32.732.732.7 29.229.229.2 33.233.233.2 37.637.637.6 39.339.339.3 43.143.143.1 47.747.747.7 53.253.253.2 Normalised EPS basic (actual) 33.233.233.2 34.534.534.5 30.330.330.3 34.434.434.4 38.738.738.7 40.440.440.4 44.044.044.0 48.448.448.4 53.953.953.9 Normalised EPS @ adjusted tax ––– for KPI 36.436.436.4

In this context, we see STV’s target of 10% CAGR in EPS, out to 2017, as a stretch target, albeit very plausible. As a reminder, the base year for this is 2014/36.4p, struck on adjusted basis with the tax at 20% (vs the actual/38.7p shown above).

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Thoughts on valuation Increasing STV target price to 650p Target price increased to 650p We are increasing our own STV valuation to 650p, from 530p. Current and historic multiples are shown in the table below. The multiple expansion from 2010 should be evident again.

Table 5: STV Spot multiples Source: Peel Hunt estimates Y/End December £'000 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E Share price average 84.2 121 98 187 353 Share price current 485 485 485 485 Number of share in issue 38.0 38.8 39.1 39.1 39.1 39.4 39.1 39.1 39.1 Market cap 32.0 46.9 38.3 73.1 138.0 191.1 189.6 189.6 189.6 Year end cash (debt) (52.2) (54.5) (45.3) (35.7) (29.4) (23.2) (20.8) (14.7) (7.5) Pension fund deficit (22.9) (30.9) (23.0) 1.3 (14.9) (14.9) (14.9) (14.9) (14.9) EV 107.1 132.3 106.6 107.5 182.3 229.2 225.4 219.3 212.0 EV / sales 1.0x 1.3x 1.0x 1.0x 1.5x 1.8x 1.7x 1.5x 1.4x EV / EBITDA 6.3x 7.6x 5.5x 5.3x 8.4x 9.9x 9.1x 8.2x 7.2x PER 2.6x 3.7x 3.4x 5.6x 9.4x 12.3x 11.3x 10.2x 9.1x Dividend yield 0.0% 0.0% 0.0% 1.1% 2.3% 2.1% 2.5% 2.9% 3.2% ROIC inc goodwill 44.4% 60.5% 61.1% 35.6% 50.9% 50.0% 44.9% 45.2% 41.9% ROIC ex goodwill 58.8% 88.8% 90.3% 43.5% 67.1% 65.7% 56.2% 55.4% 49.6% ROCE 31.3% 38.9% 53.1% 61.0% 61.0% 65.9% 61.1% 62.6% 43.8% FCF yield 10.3% 22.6% 27.4% 14.8% 6.2% 5.5% 3.4% 5.9% 6.9%

At 650p STV would trade on 15.1x 2016E PE, and 11.8x EV/EBITDA (including pension). From the current levels, we are suggesting that there is c30% upside in the share price.

These points are relevant to the STV valuation:

Understated asset value: STV has net assets of £3.5m. Arguably STV’s main economic asset is its Ofcom licences for two franchise areas in Scotland. Nothing at all is capitalised for this on the balance sheet.

Retransmission fees: We await more detail on the substance. On our own estimates, we value this industry revenue/gross profit stream at £270m in total, in which the Channel 3 share is £108m. STV’s share is £6m (or £4.5m, after some reinvestment). This is clearly material. As a growing perpetuity, this is worth c165p per share. We discount this by 50%, to err on the conservative side. This is still c80p per STV share (15% of the current valuation).

Closing the rating gap with ITV: ITV trades on a c16x 2015E PE and c13x EV/EBITDA. This is at a near 40% premium to STV. If STV were to trade on 17x, it would imply fair value at 670p.

Table 6: UK FTA spot multiples Source: Company accounts, Peel Hunt estimates Share price Equity Debt / (cash) EV ex pension EV/Sales EV/EBITDA PE Yield PH Target price ITV 267 10728 233 10961 3.4 12.5 17.1 2.1 330 STV 485 191 23 214 1.8 9.9 12.3 2.1 650 UTV 172 165 54 219 1.8 17.5 24.9 4.4 195

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Industry transaction multiples: UTV’s TV assets have been acquired for £110m, which is an 11x EV/EBITDA exit multiple (excluding UTV Ireland). This is a 10% premium to the current, undisturbed STV multiple. In short, STV is in far better shape than UTV ‘as is’, and would offer comparable synergies.

Media sector multiples: Overall, Media sector multiples are a little misleading for STV, in our view. Why? Business models and returns are very different across the sub-sectors. The thrust of our argument here is that the broadcast sector/production sector is also in vogue, STV (and ITV) are scarce assets.

Table 7: UK Media sector multiples: By subsector Source: Peel Hunt PER Historic PER +1 PER +2 PER +3 EV/EBITDA Historic EV/EBITDA +1 EV/EBITDA +2 EV/EBITDA +3 Digital 48.4x 31.4x 27.0x 24.0x 26.2x 23.3x 20.2x 18.1x Marcom 15.2x 14.3x 13.0x 11.9x 10.4x 9.5x 8.7x 8.1x B2B 14.9 13.7 14.3 12.4 11.1x 10.1x 10.7x 9.5x B2C 7.4x 7.4x 6.9x 6.5x 7.0x 6.8x 6.6x 6.4x Broadcast/Production 17.6x 17.4x 15.5x 9.7x 14.3x 12.7x 10.9x 9.6x

Option value in new initiatives?: We would not ascribe separate values to City licences at this stage, which are loss making, or Production or Digital. The latter should remain comfortably profitable through the forecast period, whilst the others have decent profit potential further down the line and at present depress returns. STV is also reviewing alternative airtime sales channels, which could have upside potential.

Peak-trough analysis: Broadcast stocks are ordinarily seen as Media cyclicals. For cyclical stocks, we would typically adjust valuation for average earnings, taking into account profit fluctuations. However, we have explained that STV is much less operationally geared now, as result of structural cost action. Hence, trough multiple * peak earnings are not valid in this case.

DCF: We prefer not to set target prices on DCF. However, it is an interesting valuation support tool. We calculate STV’s cost of capital at 9%. Based on our unlevered cash flow forecasts and a 2% terminal growth rate, we derive an EV of £326m. Backing out debt and pension, we derive equity fair value of 738p. This is far ahead of our 650p target price.

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Table 8: STV: Discounted cash flow valuation Source: Peel Hunt estimates Dec-15E Dec-16E Dec-17E Dec-18E Dec-19E Dec-20E Dec-21E Dec-22E Dec-23E Dec-24E Terminal FY FY FY FY FY FY FY FY FY FY EBIT £20.6 £22.2 £24.2 £26.7 £28.8 £32.0 £34.4 £36.2 £38.2 £40.0 less cash tax £0.0 (£2.7) (£3.2) (£3.7) (£5.8) (£6.4) (£7.0) (£7.4) (£7.8) (£8.2) NOPAT £20.6 £19.5 £21.0 £23.0 £23.1 £25.6 £27.4 £28.9 £30.4 £31.8 plus depreciation £2.2 £2.2 £2.2 £2.2 £2.2 £2.2 £2.2 £2.2 £2.2 £2.2 less cap ex (£3.0) (£3.0) (£2.5) (£2.5) (£2.5) (£2.5) (£2.5) (£2.5) (£2.5) (£2.5) Change in working capital (£1.0) (£1.7) (£1.6) (£1.8) (£1.4) (£1.7) (£1.7) (£1.8) (£1.8) (£1.5) Free cash flow before interest £18.8 £17.0 £19.2 £20.9 £21.3 £23.6 £25.4 £26.8 £28.3 £30.0 £436.1

Discount factor 0.917 0.841 0.772 0.708 0.649 0.596 0.546 0.501 0.460 0.422 0.422

Discounted cash flow £17.5 £14.3 £14.8 £14.8 £13.8 £14.0 £13.9 £13.4 £13.0 £12.7 £183.9

Debt Equity EV Debt Equity Cost of capital. EV split 9.0% 23 190 213 11% 90% Terminal growth rate 2.0% 5% 9%

Enterprise value 326.2 less minorities 0.0 less deferred consideration 0.0 less pref 0.0 less pension deficit -14.9 less net debt/(cash) -23.2

Value of equity 288.1 Number of shares in issue 39.1

Implied share price 736

Spot multiples (selected) do not reflect pension: In our view, this is a valid point. Like many traditional media stocks, STV has meaningful liabilities (see the next section on cash generation and balance sheet for more details). Taking the historic FY 14 IAS deficit of £15m, this is c35p per STV share. EV multiples are adjusted for pension deficit.

This is best reflected in the free cash flow yield, which is after pension deficit recovery funding. On this basis, the shares yield 3.4% and 5.9%.

Table 9: STV: Pension analysis (£m) Source: Company accounts, Peel Hunt estimates H1 2015 FY 14 FY 13 Assets 326 307 297 Liabilities -333 -321 -296 Deficit -7 -15 1

Discount rate 3.70% 3.60% 4.55% Inflation 3.10% 2.90% 3.30%

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Chart 5: UK Media IAS pension deficits (most recent data) Source: Peel Hunt

4000 3500 3000 2500 2000 1500 1000 500 0 ITV STV UTV DMGT TNI JPR

IAS deficit Gross liabilities

Dividend: At the market price, STV yields 2% on the ordinary dividend. However, we assume > 10% CAGR in dividend going forward. STV cash generation and balance sheet

Best balance sheet for many years STV has its best balance sheet position for many years, as depicted below, as a result of years of deleveraging.

Chart 6: STV: Falling liabilities Source: Company accounts, Peel Hunt estimates

2010 2011 2012 2013 2014

90 80 70 60 50 40 £m 30 20 10 0 -10 Net debt IAS pension Total

FY 2015 net debt, £23m. We forecast net debt/EBITDA of 1x at 2015 year-end. Even grossing up for the IAS pension deficit (£7m, as at H1 2015), this ratio is 1.3x. Capex will remain slightly ‘above trend’ in the near term, on the back of licence renewals and some refurbishment. In general, STV is ‘capital light’ and cash conversion should be c90% on a trend basis. Our cash flow forecasts, shown below, take full account of STV’s near £8m pension contributions. This in fact is the main cash draw on the group.

Rising bond yields the main In the valuation section, we have already touched upon the pension. Rising real sensitivity interest rates – and corporate bond yields – are the main sensitivity on it, not just for STV but for all companies with a deficit.

Actuarial vs IAS deficit However, as a reminder there is a significant difference between the IAS 19 deficit and the actuarial funding deficit based on the different discount rate used in each methodology to discount the liabilities.

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Recap on pension The last actuarial valuation was in 2012, an £83m deficit (hence, 11 year recovery plan @ >£7m p.a). This is clearly far ahead of the IAS deficit. The latest actuarial valuation is due to be completed in Q1 2016. It is on this last calculation that the cash pension funding is determined. Our working assumption is that there will be no change.

Dividend expectations Our ordinary dividend assumptions follow the company’s guidance: namely, 10p FY 2015, growing to 12p FY2015-16. The cash cost of this is £3.4m, rising to £4.1m in FY 2016.

What to do with surplus cash flow? On this basis, STV should generate c£6m surplus free cash flow annually going forward. The question, therefore, is what will STV do with this cash generation?

Table 10: STV: Cash flow forecasts Source: Peel Hunt estimates Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15E Dec-16E Dec-17E Dec-18EE FY FY FY FY FY FY FY FY FY Operating profit "normalised" £14.4 £15.0 £17.1 £18.0 £19.5 £20.6 £22.2 £24.2 £26.7 Depreciation £2.5 £2.4 £2.4 £2.1 £2.0 £2.2 £2.2 £2.2 £2.2 Intangibles (proper costs) £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Share option costs £0.0 £0.0 £0.0 £0.0 £0.3 £0.3 £0.3 £0.3 £0.3 EBITDA £16.9 £17.4 £19.5 £20.1 £21.8 £23.1 £24.7 £26.7 £29.2 Working capital £3.6 £0.2 (£1.4) (£1.2) (£0.9) (£1.0) (£1.7) (£1.6) (£1.8) Pension deficit recovery plan (£3.7) (£4.2) (£4.3) (£4.2) (£5.5) (£7.8) (£7.8) (£7.8) (£7.8) Other cash movements £0.0 £0.1 (£0.7) £0.0 £0.0 £0.0 (£2.0) £0.0 £0.0 Cash associated with discontinued (£9.5) £1.5 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Operating cash flow £7.3£7.3£7.3 £15.0£15.0£15.0 £13.1£13.1£13.1 £14.7£14.7£14.7 £15.4£15.4£15.4 £14.3£14.3£14.3 £13.1£13.1£13.1 £17.4£17.4£17.4 £19.6£19.6£19.6

Interest (£3.2) (£2.8) (£1.6) (£2.5) (£1.8) (£1.3) (£1.1) (£0.9) (£0.7) Dividend received £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Tax £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 (£2.7) (£3.1) (£3.6) Capex (£0.8) (£1.6) (£1.0) (£1.4) (£5.0) (£3.0) (£3.0) (£2.5) (£2.5) Deferred consideration £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Free cashFree cash ffflowflowlowlow £3.3£3.3£3.3 £10.6£10.6£10.6 £10.5£10.5£10.5 £10.8£10.8£10.8 £8.6£8.6£8.6 £10.0£10.0£10.0 £6.4£6.4£6.4 £10.9£10.9£10.9 £12.7£12.7£12.7

Ordinary dividend £0.0 £0.0 £0.0 £0.0 (£1.6) (£3.4) (£4.0) (£4.8) (£5.5) Exceptionals (£4.7) (£12.9) (£6.3) £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Acquisitions £0.0 £0.0 £0.0 (£0.9) (£0.3) £0.0 £0.0 £0.0 £0.0 Shares issued £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Net cash flow (£1.4) (£2.3) £4.2 £9.9 £6.7 £6.6 £2.3 £6.1 £7.3

Opening debt (£49.4) (£52.2) (£54.5) (£45.3) (£35.7) (£29.4) (£23.2) (£20.8) (£14.7) Net cashNet cash flowflowflow (£1.4)(£1.4)(£1.4) (£2.3)(£2.3)(£2.3) £4.2£4.2£4.2 £9.9£9.9£9.9 £6.7£6.7£6.7 £6.6£6.6£6.6 £2.3£2.3£2.3 £6.1£6.1£6.1 £7.3£7.3£7.3 Net dNet debtdebt reclassified --- notional acquisition costs) (£1.4)(£1.4)(£1.4) £0.0£0.0£0.0 £5.0£5.0£5.0 (£0.3)(£0.3)(£0.3) (£0.4)(£0.4)(£0.4) (£0.4)(£0.4)(£0.4) £0.0£0.0£0.0 £0.0£0.0£0.0 £0.0£0.0£0.0 Currency £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Closing dClosing debtdebtebtebt (£52.2)(£52.2)(£52.2) (£54.5)(£54.5)(£54.5) (£45.3)(£45.3)(£45.3) (£35.7)(£35.7)(£35.7) (£29.4)(£29.4)(£29.4) (£23.2)(£23.2)(£23.2) (£20.8)(£20.8)(£20.8) (£14.7)(£14.7)(£14.7) (£7.5)(£7.5)(£7.5)

Nosh 38,000 38,800 39,050 39,100 39,100 39,400 39,100 39,100 39,100 FCF/share 8.7p 27.3p 26.9p 27.6p 22.0p 25.5p 16.3p 27.8p 32.6p

Net debt / EBITDA 3.09 3.13 2.32 1.78 1.35 1.00 0.84 0.55 0.26 IAS pension -22.9 -30.9 0 -23 1.3 -14.9 -14.9 -14.9 -14.9 0 -14.9 Grossed up net debt -75.1 -85.4 -68.3 -34.4 -44.3 -38.1 -35.7 -29.6 -22.4 Net debt / EBITDA 4.4 4.9 3.5 1.7 2.0 1.6 1.4 1.1 0.8

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We make the following points:

• Comfortably geared: Interest cover is > 15x (the cost of debt is low). Leverage ratios continue to fall. STV could operate at 1.5x-2x net debt/EBITDA, in our view (vs 1x now). Implicitly, this is £10m-£25m of headroom • Resumption of cash tax: Effective FY 2016, we assume STV will once again pay cash tax. This has not been the case for a number of years. • Increased payout ratio?: STV has prescribed dividend expectations for FY 2015 and FY 2016. On our EPS forecasts, this implies a payout ratio of 25%, increasing to 27% (in other words, DPS growth ahead of EPS). Taking the pension into account, it is likely to be more accurate to look at cash dividend cover, which is lower than EPS (see below) but even then the current projected cover is > 2x. Table 11: STV dividend under EPS and free cash flow – current Source: Company accounts, Peel Hunt estimates 2014 2015E 2016E 2017E 2018E DPS 8.0 10.0 12.0 14.0 15.4 EPS 37.6 39.3 43.1 47.7 53.2 Div cover (1) 4.7 4.0 3.7 3.5 3.4 Cash divi 1.6 3.4 4.0 4.8 5.5 FCF post pension 8.6 10.0 8.5 10.9 12.7 Div cover (2) 5.4 3.0 2.4 2.3 2.7

Payout ratio (1) 21% 25% 27% 29% 30%

• Share buyback?: On a PE of c12x, and with low funding costs, STV could usefully buyback shares, resulting in some EPS accretion. • Special dividend?: STV does not have the cash pile ITV had when it instituted special dividends. UTV’s capital return, likewise, is the product of an asset sale. At the same time a proportion of surplus cash could be returned, mindful of the pension fund. • Enhanced transfer value: This exercise allows STV to partially de-risk the group balance sheet. ETV exercises incentivize deferred members to transfer scheme benefits to another pension. At this stage, precise details are not available but we would envisage a reduction in overall scheme liabilities, and an improved funding position in the future. • M&A: STV’s growth is entirely organic and self-funded. In Production, where STV is arguably sub-scale, there could be a case for acquisition activity. Overall, however, STV management have been consistent in rejecting acquisition activity.

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ITV background: The Network; performance trends and implications for STV of the UTV deal

The ITV network

ITV – free-to-air network, ITV is a commercial FTA broadcast network, also known as Channel 3 (the established in 1955, Channel 3 position on the EPG). It provides the Channel 3 service in England, Wales, the service Borders region, the Channel Islands and the national breakfast service; STV covers northern and central Scotland; and UTV serves viewers in Northern Ireland. Last year Ofcom, the industry regulator, renewed the license terms for 10 years duration, effective from 1 January 2015.

STV – a Channel 3 licensee As a Channel 3 licensee, STV is one of the UK PSBs (Public Service Broadcasters) and is tightly regulated. In effect, licensees benefit from spectrum allocation, and access to the EPG, in exchange for certain Public service obligations, related mainly to original production, news and local interest programming.

ITV network not the same as ITV Plc The ITV network is not the same as ITV Plc. However, as a result of long-term sector consolidation, ITV Plc now has de facto control of the ITV network. The table below depicts the status quo, by region.

Table 12: ITV Plc and network consolidation Source: Company accounts, Peel Hunt estimates Licence Service area Licence holder Parent co On Air name Service name Comments Northern Scotland STV North Ltd STV Group STV STV North Grampian acquired by SMG for £105m, in 1997 Central Scotland STV Central Ltd STV Group STV STV Central Northern Ireland UTV Ltd UTV / Now ITV UTV Ulster TV Acquired for £100m by ITV in 2015 Channel Islands Channel TV ITV Plc ITV Channel TV Acquired for £10m in 2011 Border (Eng/Scot) ITV Broadcasting Ltd ITV Plc ITV Border Acquired by Granada for £51m NE England ITV Broadcasting Ltd ITV Plc ITV Tyne Tees Yorks, Lincs/Nth Norfolk ITV Broadcasting Ltd ITV Plc ITV Yorkshire NW Eng/IoM ITV Broadcasting Ltd ITV Plc ITV Granada Wales/West of England ITV Broadcasting Ltd ITV Plc ITV Wales / West Old HTV/UNM: Sold to Carlton for £181m Midlands ITV Broadcasting Ltd ITV Plc ITV Central East of England ITV Broadcasting Ltd ITV Plc ITV Anglia Old UNM: Sold to Granada London ITV Broadcasting Ltd ITV Plc ITV London South / SE Eng ITV Broadcasting Ltd ITV Plc ITV Meridian Old UNM: Sold to Granada SW England ITV Broadcasting Ltd ITV Plc ITV Westcountry

ITV Plc created over 10 years ago The original ITV Plc deal was back in 2004, when Granada and Carlton merged, uniting all England/Wales regional franchises under one parent company for the first time. Before that, there was a period of consolidation across the regional licensees, also involving the then United News &Media. STV itself was also a player in this process, acquiring Grampian TV in 1997. This whole process is ongoing with the recent UTV transaction.

£1bn ITV network schedule: ITV Plc commissions and funds the annual £1bn ITV family schedule, which is Programming loaded towards core ITV 1. STV and UTV are affiliates, in effect meaning that STV pays fees to broadcast ITV programme content. This STV fee is < £40m annually (see below), or 5-6% of the total cost. STV’s own payment is variable with national airtime revenue performance.

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Chart 7: ITV Network Programme Budget Source: Company accounts, Peel Hunt estimates

1200

1000

800

600 £m 400

200

0

-200 2008 2009 2010 2011 2012 2013 2014

Absolute (£m) YoY chg (£m) Core ITV ex new channels (£m) YoY chg (£m)

Progamme budget should be TV is a leisure activity and ultimately we would expect consumers to be drawn competitive advantage to the best content. In this context, the size of the ITV programme budget is, of course, impressive and an important competitive advantage for STV (and ITV Plc too). Similarly, there has not been much actual growth in the budget in absolute terms.

Share of viewing of ITV 1 on As can be seen below, in this context, ITV 1’s share of viewing has actually been declining trend declining in recent years. This was < 15% (down YoY) at the end of H1. At the Family level, this is offset by an increase in the viewing share in the suite of ITV portfolio channels (ITV 2/3/4 etc). The Family share of viewing was 21% in H1 2015. Declining share should be intuitive given the vast choice available to viewers in multi-channel homes. The BBC has, however, been much steadier in share than ITV, with the main channel alone, BBC 1, at c20%.

Chart 8: Share of total TV viewing by channel Source: Company accounts, Peel Hunt estimates

30 25 20 15 10

% viewing share viewing% 5 0 BBC1 BBC2 ITV Channel Channel BBC ITV Channel Channel All other 4 5 portfolio portfolio 4 5 portfolio portfolio

2008 2009 2010 2011 2012 2013 2014

Still delivers majority of mass The falling share of viewing is a legitimate investor criticism of ITV. However, market viewing in commercial sector ITV is still the best place for an advertiser to reach a mass market, based on the threshold premise of 5m viewers. As a reminder, the BBC is licence fee-funded and, hence, unable to deliver the same sort of commercial mass market as ITV.

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The major ratings success of recent times has been the Great British Bake Off, broadcast on BBC. ITV’s own recent programme performance has been more mixed. I’m a Celebrity is currently the most popular show on ITV 1, with <8m viewers.

Table 13: UK TV programme ratings: November 2015 Source: Mediatique BBC1 BBC2 ITV1 C4 C5 Strictly 11.6m Masterchef 3.6m Im a Celebrity 7.6m Gogglebox 3.8m Disney Little Mermaid 1.5m Countryfile 7.4m Uni Challenge 3.2m Coronation St 7.0m Guy Martin 2.8m Cant pay: We'll take it away 1.4m EastEnders 7.0m Lost Kingdom 2.6m X Factor 5.8m Secret Life of 4/5/6 yrs old 2.2m Deck the Halls 1.3m Apprentice 6.7m Simply Nigella 2.5m Emmerdale 5.7m SuperVet 2.2m Loch Lomond 1.3m Dr Who 6.2m Abu Dhabi GP 2.2m Paul O Grady 3.7m Isis: British Women supporters 1.8m Ben Fogle 1.3m

Ratings on key soaps are ITV has lost the Champions League rights this year, which will be having an disappointing impact in H2 2015. In addition, we flag that the ITV 1 – and STV- core audience demographic is mature. Over time, the performance of the soaps in particular has therefore been a cause for concern. Coronation Street peaked in 1990 with c20m viewers. At present, the soap attracts < 7m viewers.

Chart 9: Declining Coronation St viewers Source: Ofcom

25.0

20.0

15.0

10.0 (m) of viewers viewers of(m) 5.0

0.0 1980 1985 1990 1995 2000 2005 2010 2015

STV has strong commercial market As we highlight later, STV retains a very strong market share advantage over share advantage, north of the border other commercial rivals north of the border. STV also maintains an opt-out, primarily for local content. On average, we estimate that c94% of overall programming on STV is identical to the ITV network.

Chart 10: Scottish commercial market share Source: Company accounts, Peel Hunt estimates

35 30 25 20 15

market) 10 5 0

% viewing share (commercial share viewing% STV CH 4 CH 5 E 4 ITV 3 ITV 2 Film 4 5 USA More 4 ITV 4

Series1

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STV relationship with ITV ITV is a one-time shareholder in STV.

2 of the 3 Scottish licenses owned STV now controls 2 of the 15 Channel 3 licenses. There is no STV South as by STV Southern Scotland is part of the ITV Border region (Border being owned by ITV Plc) and programmes there are presented under the ITV Border brand.

Covers vast majority of Scotland STV has a distinct identity of its own, and the only mention of the ITV brand occurs during ITV Breakfast and national bulletins. Within STV, Scotland is split into two regions and four sub-regions. STV still has opt-outs in terms of the ITV schedule. Within the regions, there are further opt-outs for local news and commercials. In effect, STV covers 90% of the Scottish population.

STV/ITV: once a troubled Historically STV has had a sometimes fractious and litigious relationship with relationship, now much better ITV, in part over the ‘opt-outs’ that STV employed in Scotland. However, the commercial relationship with ITV, in particular, has evolved considerably in recent years.

Terms of relationship: NAA Since 2012, the commercial relationship between ITV and STV/UTV – eg the other C3 licence holders – has been governed by a new network agreement, whereby STV and UTV are affiliates.

STV is hybrid Broadcaster: Producer For its own reporting purposes, STV breaks out Consumer and Production as separate divisions. STV’s largest Consumer cost is then the network affiliate fee, c£40m, which is then pegged to the top-line performance of national airtime sales. This also introduces some variability into the cost base.

Chart 11: STV costs - ex Production Source: Company accounts, Peel Hunt estimates

11% Network affiliate fee 6% ITV Sales 3% 43% Regional programming Staff costs 17% Transmission costs Facilities Overheads 11% 9%

National airtime, key STV revenue National airtime advertising is then easily STV’s largest revenue stream, 64% of stream group revenue. The currency of airtime sales is audience performance itself, with a specific bias to peak time dayparts.

ITV markets this airtime, for a ITV sales houses market the national airtime sales for the network as a whole. margin This is reflected in the commission costs, highlighted in the cost breakdown. Earlier this year, STV hinted at reviewing its national sales operations, but there is nothing concrete to report at this stage. ITV clearly is the incumbent and other major players in ad sales include Sky Media and Channel 4. Given the margin ‘paid way’ to ITV, there could be upside to STV in the event of a change.

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Strong STV audience share: Core STV consistently outperforms ITV in terms of peak-time audience share, and this ITV, plus Regional value-added is also a group KPI. Unlike ITV, STV does not operate a bouquet of small portfolio channels (eg ITV 2,3,4). The main STV company-specific lever on outperformance is the combination of network programming, regional news and Scottish content and ‘internal’ marketing through the wider suite of STV Consumer services. Advertising: Family NAR vs STV Another important point of difference between the two operators is in advertising. ITV Family NAR (net advertising revenue, in aggregate) is only a loose proxy for STV national airtime sales. As can be seen, the performance trend is directionally similar, but rarely coincides exactly. In H1 2015, ITV Family NAR was + 5% YoY, STV national airtime sales + 3%. Again this partly reflects the aggregation of the ITV portfolio channels at the Family level, which is not a benefit to STV. Chart 12: ITV Family NAR vs STV National airtime sales YoY Source: Company accounts, Peel Hunt estimates

25% 20% 15% 10% 5%

Growth YoY Growth 0% -5% -10% ITV Family NAR STV National Variance

2010 2011 2012 2013 2014 H1 15

Falling ITV 1 viewing share has not The declining ITV 1 audience share has not affected ITV – or STV – advertising been matched by falling advertising performance to date. This must reflect the fact that Contract rights renewal (CRR) is not at all dampening advertiser demand for the sort of mass market audience that ITV – and STV – can still deliver. At the outset of the Granada/Carlton merger, CRR was intended specifically to give advertisers the right to reduce adspend in line with falling audience share. In reality, we suspect three factors have influenced ongoing strong ITV ad sales performance, in spite of falling SOCI (share of commercial impacts): • the buy-side – eg the ad agencies – have consolidated, with Group M in particular now responsible for c40% of all buying. ITV is its key counterpart in broadcast; • ITV – including STV/UTV - can still deliver mass markets in an era of fragmented viewing habits; and • ITV Family offers agencies/advertisers an aggregate audience (including complementary demographics), where the share of viewing is more secure than ITV 1 alone. STV: Regional airtime revenues, In our opinion, STV is a net beneficiary of these trends too. Away from ITV with City licenses now launching however, it should be noted that STV also has a material Regional advertising revenue stream, £13m PA. This is sold by STV’s own salesforce, independent of ITV. STV’s organic growth initiatives (eg City TV, Digital and stv.tv) are also sold by STV itself.

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The future of ITV Plc Long term Buyers of ITV We have been Buyers of ITV for many years, and remain so today. Our current target price is 330p (vs the current share price of 267p). Whilst the ITV investment case has changed over time, it is worth reiterating the fundamentals: • EPS recovery from the trough in 2009, 1.8p; • growing international Studios business; • cash returns to shareholders (including special dividends); • very strong balance sheet, net debt £525m at the last reporting date; • management premium (e.g Norman, Crozier, Griffiths); and • bid premium. ITV and STV: Parallels and In terms of the business mix there are, of course, parallels between ITV and STV. differences Both perform best in terms of viewing share on DTT platforms. Similar to STV, ITV has also been trying gradually to diversify away from FTA broadcast (advertising). ITV has a small but growing Pay business, based on the likes of ITV Encore and supplying HD variants of ITV channels to platforms. Both have been expanding profitably in VOD. ITV Studios: internal and external However, as most investors will be aware, ITV is a producer-broadcaster and supply operates a very significant Studios business. Studios supply >60% of ITV network programming, which is in effect internal supply. The thrust of expansion is external supply, eg to third-party broadcasters predominantly in English- language markets. Chart 13: ITV Revenue/EBIT by segment Chart 14: ITV Studios revenue breakdown Source: Company accounts, Peel Hunt estimates Source: Company accounts, Peel Hunt estimates

22%

39% Broadcast External Studios Internal 61%

78%

Content – a growing part of the Content/production is an important aspect of the ITV equity story overall, and story/business mix the Plc has been acquisitive in the last two years. Major deals include Leftfield and Talpa, strengthening ITV’s overseas capabilities. As we will see, STV’s own Production division has been built organically. ITV – a successful turnaround story The ITV turnaround story has been a huge success under almost any analysis but it was originally framed by management in terms of a 5-year journey and this is now approaching its end. Comcast bid rumours In the lead-up to Christmas, Comcast had been heavily linked with a bid for ITV Plc. There has been no RNS from either party. Assuming ‘there is no smoke without fire’ this opens up the prospect for a bidding war over ITV in 2016. Currently Liberty Global owns 9.9% of the ITV equity (acquired in two tranches).

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Liberty: Already a shareholder Liberty is perhaps best known in the UK for its Virgin Media brand. Most recently it has also been active in the Republic, taking over TV3 for €80m consideration. Ironically, this is a competitive threat in the FTA space to UTV Ireland, now owned by ITV.

Vertical integration What Liberty lacks is meaningful content, which ITV would, of course, bring in a deal that would be a good example of vertical integration.

Liberty: CWC deal too However, Liberty is also in the process of acquiring CWC for £3.5bn (c12x EBITDA). And as the largest international cable company in the world, this is a good example of horizontal integration as CWC has a strong footprint in the Caribbean. The land grab in ‘broadcast’ is far reaching. Liberty is also linked with Vodafone. In the UK, BT is also commonly linked with ITV.

International broadcast: Game of In short, we see broadcast as a ‘game of Russian dolls’, with an increasing Russian dolls international dimension, clear-scale economies and follow-on commercial activity. The value of the largest companies in this sector, spanning all of TMT, is very impressive. STV, which capitalised at < £200m, is small in this context.

Chart 15: Global TMT stocks by market cap (£bn) Source: Company accounts, Peel Hunt estimates

100.0 90.0 80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0 Comcast Vodafone Viacom Liberty Global ITV

Lots of overseas buyers apparent There are a multitude of international buyers. In the UK, for example, Viacom has already been active, acquiring Channel 5 for £450m in 2014. C5 is a regulated PSB like the C3 licensees. In turn, this has led to Sky winning the C5 ad sales business in addition to Sky-own advertising and other third-party business.

Logic for a takeover ITV offers both a mass market distribution platform in the UK and one of the largest production companies outside the US. At a time of weakness in its nearest rival, the BBC, we identify ITV as the main strategic asset in the UK Media sector overall. In terms of its network platform, it now lacks only the two STV licences.

Cannot extricate STV from ITV In summary, the future of ITV Plc has major implications for STV itself. Recent sector newsflow, involving Comcast as a possible bidder for ITV, should not be discounted. Having then explored the ‘big picture’ in terms of international TV sector consolidation, we now look at the recent ITV/UTV transaction and what it means for STV.

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Acquisition of UTV and implications for STV ITV £110mdeal for UTV In October, ITV Plc announced a £100m recommended cash deal for UTV Media TV assets, comprising UTV Northern Ireland (‘UTV N.I’) and UTV Ireland, in the Republic. After deductions, this Class 1 transaction was to generate c£98m cash proceeds for UTV Media. Special return pending to The UTV share price has responded well and we speculate that a 55p-60p return shareholders to shareholders is on the cards (either B share, or Special). After the deal completes, UTV Media comprises solely of commercial radio assets, in the UK and Ireland, and the Plc will almost certainly have a new name. There will be a much reduced connection to Ireland and no connection to Northern Ireland. UTV deal no surprise in context The ITV deal in itself was then no surprise to us, following the significant underperformance of UTV Ireland, relative to pre launch expectations. Throughout H1 we were downgrading our UTV Media forecasts on the back of revised TV expectations, and the UTV share price fell accordingly. In breach of covenants Originally, UTV Media forecast £3m losses for the new channel in its first full year of operations, 2015. In H1 2015 alone, the new channel generated operating losses of £7.5m. As a result, H1 net debt/EBITDA ballooned out to 3.4x (net debt, £46.9m). UTV Media sought, and gained, a relaxation of its banking covenants. UTV Ireland: Losses for new channel FY 2015 losses for UTV Ireland have most recently been pitched at c£13m, with c£13m no clarity over a break-even timetable. For a small public Media company, the adverts-funded UTV Ireland venture has proved too difficult to execute. White knight approach In this deal scenario we see ITV as the ‘white knight’ for UTV, and almost the only plausible bidder. However, without dwelling on UTV misfortunes, it is worth outlining ITV’s stated motives for the acquisition: ‘The deal further strengthens ITV's free to air business and enables it to run a more efficient network. On completion of the acquisition ITV will own 13 of the 15 regional licences for the Channel 3 network and the combined business will benefit from ITV's continued investment in content, its advertising sales team and broadcast infrastructure’ (ITV, 19 October 2015).

Some option value in UTV Ireland Beyond the ITV network consolidation angle, we suspect an additional motive was the ‘option value’ in UTV Ireland, given the economic growth profile of the Republic, ITV’s familiarity with the marketplace and the own-supply of key programming. That said, ITV has been fairly tight-lipped about the future of the channel. Pension liabilities included in UTV In addition to the upfront £100m cash consideration, ITV also takes on the UTV deal Media pension liabilities. This means UTV Media (or newco) will no longer have to fund the Scheme. On an IAS accounting basis, the value of this deficit is c£3m, or £10m on an actuarial basis. This is an adjustment to the transaction EV, hence, £110m fully loaded. Deal multiples As can be seen in the table below, the implied exit multiple on UTV NI was 2.8x historic sales, or 11x historic EBITDA. It remains to be seen whether the £100m consideration imputed any value to the loss-making UTV Ireland. Even the mature channel, operated from Belfast, has run into some local difficulties this year.

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Table 14: UTV exit multiples: TV assets Source: Peel Hunt, UTV Ireland is the new channel launched in Jan 15 UTV N.I: Historic UTV N.I UTV Ireland Group TV Inc UTV Ireland Revenue EBITDA Revenue EBITDA Revenue EBITDA Revenue EBITDA Equity 100 39.0 9.5 40.0 10.0 9.0 -13.0 49.0 NA Liabilities 10 EV: Multiples 110 2.8 11.6 2.8 11.0 12.2 -8.5 2.2 NA

On our estimates, STV trades on 1.9x EV/revenue and 9.9x EV/EBITDA. This is based on a fully-loaded EV, comprising IAS deficit.

Taking all of this into account, what does it mean for STV Plc? We make the following points.

• Based on our analysis above, UTV Media was a ‘distressed seller’ under any definition. We doubt UTV had much negotiating power with ITV. On the other hand, STV is clearly in rude health with a well-articulated growth path. • The general thrust of the ITV Plc strategy under Adam Crozier has, in fact, been diversification away from free-to-air TV advertising, mainly in favour of Production. The UTV Media deal actually goes against this and in our opinion should be seen as opportunistic. • ITV has already been a shareholder of STV but chose to exit it. In 2013, ITV sold its 6.8% stake for 285p per share (eg £7.6m). • At the same, ITV is still in a very strong financial position and STV would really be no more than a ‘big bolt-on’. According to the Q3 trading update, net debt is c£0.5bn (vs a market value of > £10bn). Even grossing up for pension, ITV’s liabilities are only >£1bn. We estimate ITV derives >£0.6bn FCF p.a, before dividend. • There would be ITV deal synergies: STV’s costs ex-Production are £85m. Some of these are Plc-related. Historically, ITV has reduced the production footprint through consolidation of acquired licensees. • STV alone now operates the two remaining licences: Northern and Central and this should warrant a strategic premium, in our view. ITV network consolidation, not a new feature of the UK Media landscape, is approaching its denouement. • CMA has not stepped in: At the time of writing, the CMA has not affected the UTV/ITV deal from being consummated, so competition concerns over such deals should be allayed. At the same time, STV is a ‘national asset’, in the context of heightened political sensitivity in Scotland. In summary, STV has no direct control itself over >60% of the company’s revenues, or the quality of the majority of programming output that it shows. At the same time, STV’s own contribution to the ITV network programme schedule is c£40m only. Tangible progress has been made in ‘Non-ITV’ revenues, diversifying STV business exposure. ITV’s consolidation of UTV leaves STV as ‘last man standing’.

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Importance of Television and the changing Media and technology landscape in the UK

Impact of technology on household From a household technology perspective, the UK’s TMT market is increasingly media consumption characterised by the following, according to Ofcom. Superfast broadband rollout: 83% penetration in the UK now. 4G rollout: 86% penetration now. Smartphone penetration: 71% of all adults have a smartphone and this device is now the most common method of accessing the internet.

Sales of Smart TVs: 28% of all new TV sales in the UK are now smart TVs, with inbuilt internet connectivity.

Growth in short-form video content: 32% of all Ofcom survey respondents state they watch YouTube daily. New technologies are having profound impact on operating models in television, as per the diagram below. This is relevant to ITV and STV, and provides sector context too.

Chart 16: TV operating models: Old vs New Source: Peel Hunt, Mediatique

Future of TV: Key starting point Clearly, a major part of the investment debate over any quoted broadcaster is then the outlook for Television itself as a medium. Is TV relevant to households, and is it to relevant to advertisers? US investors particularly bearish on Certainly when we have been marketing the Media sector, for example in the mainstream linear TV US, much of the pushback we get from investors is ‘structural’ in nature. This relates to new market entrants in broadcast and changing consumer viewing patterns. Traditional US broadcasters have also been de-rated in terms of stock market multiples. UK: DTT platform is key However, we are keen to highlight that every international broadcast market is distinct in terms of the role of the State and, of course, delivery platforms. In the

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UK, for example, pure IP delivery is in its infancy and DTT is very well established. On the other hand, cable is the dominant platform in the US and DTT is less relevant. This also has implications for retransmission fees, which is a key theme for companies such as ITV/STV. Chart 17: International comparison: TV homes by platform Source: Peel Hunt

70% 60% 50% 40% 30% 20% 10%

% of TV homes per platform per homes TV of % 0% Satellite Cable IPTV DTT

France Germany Italy Sweden UK USA

UK TV viewing Analogue switch-off now ancient Freeview has existed since 2002 and the final analogue switch-off took place in 2012. history STV has carriage across all platforms: DTT, cable and satellite, hence, the debate in the UK broadcast sector should now centre on ongoing consumption patterns, the impact of TV alternatives (largely online streaming) and free vs pay TV. Consumption patterns Average Brit still watches 220 mins According to our analysis, based on data sourced largely from Ofcom, the of TV a day average person in the UK consumes c220 minutes of TV every day and this volume has not changed substantially since 2004. However linear TV in slow decline However, based on our analysis there is a modest decline underway in the UK in linear TV viewing. Key developments include • VOD: There are many variations in VOD but, in essence, the term describes non-linear or non-live TV viewing. Of the 220 minutes of TV viewing per day, approximately 27 minutes (or > 10%) is now time-shifted. This was almost zero a decade ago. Broadcaster VOD, eg iPlayer, STV Player, does, of course, capture some of this shift. This is ad funded in the case of the commercial broadcasters. Likewise, +1 channels are well established for time- shifted viewing. Chart 18: Live vs time shifted viewing in the UK Source: Ofcoms, Peel Hunt estimates

300 250 200 150 100 50 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 Average daily minutes viewing

Live Time shifted Total

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• OTT – eg the emergence of companies such as Netflix, Amazon Prime and Now TV: The emergence of many new market entrants in the ‘over the top’ space is a feature of the UK marketplace too. These operators have business strategies spanning Free and Pay. Chart 19: New market entrants: TMT sector Source: Peel Hunt, Mediatique

• The chart below depicts subscription based OTT from a number of household names. Again, this is ‘on demand’ but is based around internet streaming in this instance. In the UK, Sky is the broadcaster that has perhaps best captured some of this market with its Now product. Chart 20: Growth in subscription OTT in the UK Source:Ofcom, Peel Hunt estimates

7.000

6.000

5.000

4.000

3.000 subscribers ('000s) subscribers 2.000

1.000

0.000 Q1 14 Q2 14 Q3 14 Q4 14 Q1 15

Netflix Amazon Prime Now TV Total

• Demographic factors: Unsurprisingly, adults over 65 years of age consume far more TV than other age groups; even more in 2014 than they did 10 years ago. With an ageing UK population, this is a comforting thought for traditional broadcasters. Children, on the other hand, consume 26 minutes less TV daily than they did 10 years ago.

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Chart 21: Average daily minutes viewing per person - across age groups Source: Company accounts, Peel Hunt estimates

400 350 300 250 200 150 100 Minutes per day day per Minutes 50 0 All invids Children Adults 16- Adults 25- Adults 35- Adults 45- Adults 55- Adults 65 24 34 44 54 64 +

2004 2014

Scotland consumes most TV in UK Interestingly, by region, it is clear that Scotland consumes more TV daily than any other regions, 239 minutes daily (eg 4 hours). London and Meridian are the regions that consume the least TV daily. From the peak in 2010, there is an evident decline in Scots daily viewing. However, as a ‘pure play’ on Scotland, we consider this UK regional trend is positive overall for STV.

Chart 22: Daily viewing by region (minutes per day per person) Source: Ofcom,, Peel Hunt estimates

300 250 200 150 100

Minutes per dayper Minutes 50 0 Network NW Meridian NE London Scotland SW

2006 2007 2008 2009 2010 2011 2012 2013 2014

Increase in time-shifted viewing. Declining ‘live’ TV consumption overall seems likely from the current c90% VOD is a driver levels. This, however, is likely to bring VOD even further into play.

VOD additive to overall top-line The economics of broadcaster VOD appear quite attractive at this stage. This is growth positive for both ITV and STV (eg high margins, low marginal cost as programming is already embedded in the cost base). Compounding high VOD top-line growth rates also adds to aggregate, divisional Broadcast growth.

Attractive CPT rates CPT rates (cost per thousand) are higher in online than mainstream TV. This is illustrated below, with ITV1 – the channel – at a blended £6. We assume that the STV Player is at a lower rate than either ITV or Channel 4 due to their ability to bundle audience more easily.

Broadcaster VOD limitations The limitations for the ‘old’ broadcaster in terms of VOD are twofold, in our view.

• Programming: In the case of the C3/PSBs, the core demographic is older. There will be finite interest amongst the young in watching Coronation Street online.

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• Inventory: eg the volume of ads that can be served through the player relative to mainstream TV. This is an issue for all VOD operators, not just broadcasters. Users of online players are likely to consume a below-average amount of advertising. Chart 23: Comparing CPT rates for VOD and normal TV (£) Source: Peel Hunt

30 25 20 15 10 5 0 ITV Player C4 Player STV Player ITV 1 Cost per thousand impressions: £

Importance of VOD Beyond broadcaster VOD there are a number of variations in the business model, involving both Free and Pay. New market entrants include the major internet/social media players, such as Facebook and Google/YouTube.

YouTube – targets > 20% of TV ad Last year, it was reported that Google/YouTube was advising UK/Ireland brand budgets advertisers to spend > 20% of their TV ad budgets on YouTube. This was on the back of research that found that YouTube was the most effective medium for reaching 16-34 year olds.

Social media complementary Overall, we see Broadcaster VOD as a very effective response so far to changing viewing patterns. Likewise, the rise of social media in general has not disintermediated TV. In fact, they interact quite favourably. There is a raft of anecdotal evidence that suggests, for example, that twitter feeds are disproportionately focused on TV shows (eg X Factor, Strictly) and/or TV celebrities. The ‘second screen’ phenomenon is familiar to any UK household, with the tablet and/or smartphone being used simultaneously with the TV.

Shift from Free to Pay over time Instead, the long-run structural development in TV to be aware of is the shift to Pay-TV, or convergence, and the implications for free and PSB broadcast models.

Free vs Pay

Number of Free-only homes The growth of Pay-TV is one of the main features of the Consumer Media declining environment in the UK, in our opinion. Already more than 50% of UK homes are Pay, in terms of the main ‘family’ TV set, predominantly Sky. Some projections suggest this Pay penetration could go to > 70% by 2024, displacing Free.

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Chart 24: Free vs Pay TV Homes in UK: 2014 Chart 25: Free vs Pay TV Homes in UK 2024 Source: Mediatique Source: Ofcom

27%

44% Free only Free only Pay Pay 56%

73%

Pay TV originally driven by live sport The original drivers of Pay TV were simply subscription access to live exclusive and movies sport, and an ‘early look’ at films from the major US studios. Since then, platform operators have greatly enhanced their offerings. This includes HD, bundling of telephony and broadband and PVRs (Quadplay, in general). We expect this innovation to continue going forward.

Bundling evident As can be seen in the vast array of monthly packages available to UK TV consumers, the options in multi-channel TV/quadplay are complicated. Until now, the starting point has been the licence fee itself. At the upper end, this can now easily reach > £100 pcm. Consumers are increasingly used to paying for entertainment (‘the home cocoon’).

Chart 26: Monthly TV packages (cost options) Source: Peel Hunt, Mediatique

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What does this mean for the PSBs, including STV? Linear vs Pay TV matrix In industry jargon, this spectrum of choice also extends from Linear/Free to Non linear/Pay (see below). Homes can have more than one TV platform, and pay platforms then also integrate Free and Pay channels. A further complicating factor is the growth in IP-based based delivery (through desktop/tablet or Smart TV), specifically for on-demand services. This is important because of Viewing share is much lower for PSBs on platforms other than Freeview. At this audience fragmentation stage, this is not a material concern for us and indeed a key pillar of retransmission fees is based on PSB share of all-viewing. However, if viewing share accelerates towards Pay platforms (and/or IP platforms), it could have long- run implications. Growth in YouView From a technology standpoint, the main variable for the PSBs is, therefore, the platform evolution of Freeview to YouView. This service provides both free-to- air channels, and on demand services through a set top box. Interestingly, BT and TalkTalk have partnership arrangements with YouView, which enhances the broadband/ISP option. Chart 27: Linear/non linear and Pay vs Free Source: Peel Hunt, Mediatique

Diversifying away from FTA It is still somewhat hard to generalise over the PSBs given some are commercial and some are not, eg the BBC. The commercial PSBs, including STV, have fine- tuned their own strategies to include:

• less exposure to FTA advertising overall; • pay revenues, where possible;

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• monetising user data, collected through registration, for personalised advertising; and • additional services, including VOD/players (which are free at the point of use). In considering all of these factors, we conclude that the decline in linear TV viewing is far underway but at a surprisingly modest rate overall, and with major variations by UK region. The traditional broadcasters have also moved adroitly in terms of catch-up/VOD services. This is ad funded and proving lucrative so far, as it is premium content with low-marginal cost.

Issues could arise further down the line if: (1) younger age groups bypass traditional VOD; and (2) traditional broadcasters are unable to open up more inventory. Other possible concerns, namely Pay vs Free, are more long run in nature but should not be ignored. TV advertising in an industry context TV = above the line advertising To use industry jargon, TV advertising is ‘above the line’ advertising. It is also paid media in an era when the marketing mix includes paid, earned and owned media.

• Paid (leveraging the brand externally): Display advertising on a third-party channel; paid content promotion; pay per click. • Earned (customers are the channel): Word of mouth recommendations; organic SEO; positive blogs. • Owned (company in control): Company website; company You Tube channel; company Facebook page. Print still under pressure Based on WPP’s analysis below, which we have abbreviated, print continues to ‘over-index’ in terms of its share of adspend, relative to consumption. Mobile and internet (eg digital in total) are both under-indexing, which is intuitive. Viewability and ad blocking are concerns in the internet space.

TV: Well matched in share of TV, on the other hand, is in equilibrium at least for the time being. TV accounts adspend for c40% of time spent in terms of Media consumption and c40% of all adspend. TV is proving remarkably resilient to new technology devices and remains perhaps the key medium for attracting a mass audience.

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Chart 28: Share of adspend by Media Source: Peel Hunt, WPP

45% 40% 35% 30% 25% 20% 15% 10% % Total Media consumption Media Total% 5% 0% Print Radio TV Internet Mobile Medium

Time spent Adspend

Major ad categories on C3 The major ad categories on the C3 network are as follows: retail; finance; food. Category spending can vary around major sports events (eg the Rugby World Cup in Q3 2015).

Appointment viewing: eg major In our view, ‘appointment viewing’, such as major sports events, is likely to sports, still very healthy ratings remain a key driver of near-term viewing trends on linear TV. Eg, overall viewing was in fact firm around 2010-2012, benefiting from the World Cup and Olympics, both of which were on mainstream terrestrial TV.

Reach and impact Effective advertising is all about reach and impact and this is most likely to remain with the ‘free’ PSBs. More specifically, investors should be aware that ‘TV’ is also a catch-all term for linear and VOD-based advertising, where the PSBs are proving adept.

Print ad updates have been poor UK print advertising trends have deteriorated through 2015 with little mitigation from so-called digital revenues. In recent weeks, we have had very poor trading updates from the likes of Trinity Mirror (TNI) and Johnston Press (JPR). We sense a ‘tipping point’ in print ad revenue, which is again likely to favour TV and digital media.

Market share opportunity for STV Scotland has a long and proud newspaper history: The Scotsman (JPR), the given plight of Scottish newspapers Daily Record (TNI) and the Herald (Newsquest). However, the heart of the STV strategy is providing media services to local markets. Hence, weakened competition in the print sector is a plus for STV, specifically in terms of the revenue potential of City TV licences, and regional airtime.

Fall in publisher ad revenues due to As can be seen in the chart below, these publishers have seen classified ad sharp decline in classifieds revenues diminish significantly over time and display ads have grown in importance. This is mainly because online search (e.g Google) and dedicated online sites (e.g Rightmove and AutoTrader) have displaced traditional print classifieds in verticals such as jobs, property and motors.

Using JPR as an example, the UK’s largest Regional publisher, we can see that classified advertising revenue has fallen precipitously since 2005, -70%. Display as a category has also fallen for them over the same period but by a significantly reduced amount. As a result, display is c40% of overall advertising.

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Chart 29: Johnston Press: Changing mix of advertising Source: Company accounts, Peel Hunt estimates

400 350 300 250 200 150 100

£m advertising revenue advertising £m 50 0 2005 2014

Classfied Display Total

‘Local’ advertising Interest from publishers in display Publishers are thus more focused on display and also on the potential of ‘hyper advertising, and ‘hyper local’ local’ advertising’. At the margin, this could become a competitive issue for broadcasters (who are also display-focused), particularly given the video capabilities of most newspaper websites now.

JPR/Sky Adsmart Johnston Press, for example, partnered Sky in the sale of hyper-local and contextualised advertising for many of its UK SME clients (Sky Adsmart). This is brand advertising on national channels but to relevant household audiences (households are selected on factors such as age, location and life style). The data is derived from a combination of Sky’s own customer data and information from consumer profiler experts such as Experian.

Overlap of commercial activities in Some of these SME clients will be in Scotland, given the footprint of JPR’s Scotland activities. However, to date, there has been no meaningful data on the success of the initiative and we are a little cynical of the likely success rate.

More data on consumers, more In the case of STV, we will see that its business strategy has been responsive to targeted advertising changing times with, for example, increased data collection and the launch of the City services. Local TV like this is also ad or sponsorship-funded, but the entry price point is much lower than national TV of course and the clients are likely to be local businesses/institutions.

Local market: Radio; newspapers; At present, the local advertising/sponsorship market is supported by local online; and now TV newspapers, local radio and online search. Local TV models have worked in the markets like the US, but not really so far in Europe.

The advertising world is changing fast. TV remains highly attractive to display advertisers and continues to deliver mass-market audiences. Classified advertising, the mainstay of publishers has, in effect, been vaporised. Print still ‘over indexes’. Hence, print media is looking for an alternative model, eg contextualised advertising. ‘Local TV’ also has ad potential, addressing communities on a hyper-local basis.

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Regulatory environment: Scottish independence, Retransmission fees, the future of the BBC

TV – closely regulated TV is a closely-regulated environment, specifically PSBs. And the regulatory and political backdrop remains an important consideration in the STV investment case. In our view, it is now more of a clear-cut positive than arguably was the case two years ago in 2014.

Less of a drag factor on STV now Then STV faced the renewal (by Ofcom) of its licences, together with the than 2 years ago uncertainty surrounding the outcome of the Scottish Referendum (which took place in Q3 2014). In terms of investor sentiment, we recall the Referendum was a temporary drag in 2014.

Referendum last year. Medium term In the end, there was a 55:45 margin in favour of the Union. Subsequently, the clarity on political future SNP won 56 of the 59 seats at the Westminster General Election in May 2015. And, looking ahead, it seems likely that the SNP Manifesto for the Holyrood 2016 Election is likely to contain a new timetable for another referendum.

Licence renewed However, STV now has certainty over the licence renewal, and clarity at least in the short term over the political backdrop. New developments In our view, the regulatory backdrop has in fact moved on in a number of ways:

• Retransmission fees. • The BBC Charter renewal. • Securing EPG prominence for City TV channels. • Qualifying status as an independent producer.

Retrans fees: a catalyst on sector We identified retransmission fees as a potential stock catalyst for STV/ITV well share price performance over a year ago, on the back of the growing importance of such fees in the US broadcast sector. CBS, for example, derives c$2bn retransmission fees annually.

DCMS review In Q2 2015, the DCMS started a consultation period ‘options for deregulation’, aimed at looking at the existing balance of payments between platform operators and PSBs (public service broadcasters). This will entail the removal of Section 73 of the Copyrights, Design and Patents Act (1988), which is the key legislation relevant to retransmission at present. An additional policy objective would be to support ongoing investment in content by PSBs.

Ofcom: ‘Complicated’ to implement Subsequently, there has been ‘ebb and flow’ in the wider industry debate, such fees Ofcom, for example, is on record as saying implementing retransmission fees would be ‘complicated’.

Major Bill possible, H1 2016 We now expect a more broad-based Digital Bill to be announced in H1 2016, with one possible objective being the introduction of retransmission fees. Assuming this passes through the legislative hoops, a commercial negotiation is likely (behind closed doors), in our view. What would happen next?

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Retransmission fees arguments: For and against Transfer of value, from platform to In brief, the argument behind retransmission fees now is for the transfer of value broadcaster from pay operators/platforms – eg the likes of Sky, Virgin Media – to PSBs/content providers, eg the likes of ITV/C3, BBC, C4 and C5. This in effect is a reversal of the situation a few years ago, whereby the PSBs paid the platforms in exchange for carriage.

Must offer, must carry PSBs operate under legal ‘must offer’ stipulations, being universally available across DTT platforms, as well as cable and satellite. ‘Must carry’ is a more nuanced condition for platforms. The table below depicts the status quo.

Table 15: Summary of current platform/PSB model Source: Peel Hunt, Mediatique, DCMS Platform PSBs: Platforms: Copyright Other comments Must offer Must carry ? Cable Yes N/A No Pay model. Cable is an electronic communications network. Cable is exempt from the Copyright Act Satellite Yes No Yes Pay model. Technical platform services regime for Sky. Satellite platforms not legally required to carry PSBs DTT Yes Yes Yes Free model. Spectrum gifted to PSBs (Terrestrial)

Major platforms are significant In a fully digital world, TV platforms – satellite and cable – now comprise more players than half of all UK TV homes (eg 15m out of 25m total households). The balance relates to Freeview, or terrestrial alternatives/DTT. Share of viewing of PSBs is highest, as you would expect, on DTT.

No payments made at present Under the current regime, the platforms make no payment to the PSBs for the retransmission of the PSB channels. This is in spite of the fact the main channels- ITV/STV, BBC1/2, C4 and C5- also account for > 40% of TV viewing even in sophisticated multi-channel pay homes (cable/satellite platforms).

Chart 30: Viewing share of PSBs on each TV platform Source: Peel Hunt

70 60 50 40 30 20 10 0 % of viewing time by platformby time viewing of % BBC 1 BBC 2 ITV C4 C5 Total PSB

DTT Cable Satellite

Other channel suppliers already paid Pay platforms already pay carriage fees to other channel suppliers (eg Disney, Discovery and Turner). Platforms also benefit from including the well-watched PSB channels on the EPG, which in turn lowers their platform churn (and subscriber marketing costs). Carriage fees are also paid to the likes of ITV 2/3/4.

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Content spend from PSBs subsidy to The PSBs also invest c£3bn in programming annually, with ITV clearly one of platforms? the main players in content origination. ITV is also at the forefront of the industry drive for retransmission fees, with STV in the vanguard.

Platform operators: Are the US and The counter argument from the platform operators is that the UK and the US TV UK markets really comparable? markets are not comparable, and that PSBs in the UK already have important regulatory privileges (e.g EPG prominence). The main point of the platforms is access to premium ‘paid for’ content and not PSB content. Elsewhere, the likes of Sky are also active themselves in content spend and the PSBs should not merit special treatment.

Pass through cost, in our view For the platform operators, in this context, we would also see retransmission fees as a ‘pass through cost’.

Other key points Beyond the competing arguments, we make a number of other important points to make on retransmission fees.

• We understand there is broad-based political support in the UK for retransmission fees. However, an act of legislation will still be necessary for their introduction. • Complications may yet arise from the ‘state owned’ nature of the BBC and Channel 4 (in the case of the BBC, when the licence fee is already under downside pressure). • We seriously doubt any new retransmission fees would be ‘backdated’. • ‘Must offer’ is the key feature of current PSB regulation. In the US, the ultimate sanction of the ‘local’ broadcaster is to withdraw content from the platform operator. This gives rises to occasional blackouts. This is unlikely to be permitted in the UK. • Shareholder benefits for the PSBs should be clear but it should be underlined that the regulator is unlikely to look favourably at major special dividends. • According to Virgin Media, a quid-pro-quo for consumers would be a reduction in the amount of advertising minutage on commercial channels. • Retransmission fees would be another leg to the UK TV revenue pool, alongside advertising and subscription (pay). • Ofcom has suggested alternatives to retrans fees in terms of PSB funding remedies : E.g, more advertising minutes; levies on pay-TV operators; contestable funding Worked example on benefit to ITV/STV Worked example Bringing all this back to the equity story on STV, we then highlight a worked example below. We take the number of subscribers across the two main platforms, Sky and VMED (15m in aggregate), and then apply a monthly fee per household (£1.50 pcm).

Basis of commercial negotiation This price point seems reasonable to us, benchmarked against US retransmission fees. In reality it would be negotiated or regulated, and the consumer is likely to face an increased bill from their platform operator.

£270m overall benefit for PSBs, in This arithmetic generates c£270m of total annual retransmission fees for all PSBs, our example not just C3. The size of retransmission fees is a sliding function of the monthly

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levy. In our crude example, ITV/C3 derives 40% of this total benefit, or £108m. This is pure gross profit in effect, as there is no cost.

Reinvestment of some of We assume 30% reinvestment of this annual ‘windfall’, as one of the stated incremental gross profit DCMS policy objectives is to maintain and grow investment in programme content. Hence, the net benefit to ITV/C3 in this example is £76m. STV’s share of this is c6%, in line with the contribution to the network programme schedule.

Growing perpetuity In terms of the valuation impact, we treat these fees as a growing perpetuity. On this basis, the value per share for ITV is 27p, and 165p for STV. Clearly this is material in the context of the current valuation of either company, as well as respective EBIT.

Table 16: Retransmission fees: Worked example Source: Company accounts, Peel Hunt estimates Sky Virgin Total

No TV subs 10.0 5.0 15.0

Charge per household pcm 1.50 1.50 Annually 18.00 18.00

£m fees: Total 180 90 270

ITV/C3 40% 72 36 108 BBC 40% 72 36 108 Other 20% 36 18 54

Net benefit to ITV after re investment at 30% (£m) 76 Net benefit to STV (6% of £76m) 4.5

ITV: Growing perpetuity formula (£m) 1080 Undiscounted value per ITV share (p) 27 Undiscounted value per STV share (p) 165

Leading Media execs suggest Leading media executives, such as David Abraham at Channel 4, have also cited c£200m value for commercial PSBs a total value of £200m for retransmission fees for commercial PSBs (eg excluding the BBC). However, if we were to re-run the above analysis for a 50p pcm value, the per share value would fall to 9p for ITV and 55p for STV.

Table 17: Retransmission fees potential in context Source: Peel Hunt FY 16 EBIT (1) PH retrans fees pre tax (2) Total (1+2) Retrans as % of total ITV 922 102 1030 11% STV 21 6 27 22%

Finally, we would discount the retransmission ‘dividend’ to reflect probability, tax and execution risk. Even so, it could be a material catalyst through 2016.

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The BBC Royal Charter renewal 2016 In brief, the Royal Charter renewal process is now underway, with an outcome likely by the end of 2016. Myriad outcomes are possible but, on balance, our clear sense is of a reduced BBC going forward, with fewer services across TV, Radio and Online. The early-stage Green paper also appears to rule out any role for advertising revenues on the BBC.

More opportunity for commercial This backdrop can also only be helpful to UK commercial media in general, in media terms of audience share opportunity and weakened competition. It should be noted, however, that it would not affect commercial viewing market share.

Cooperative proposals – shared In our view, the BBC has been detrimental to the development of commercial journalism media over the last decade or so. A more reciprocal relationship is possible going forward. As an interim measure, the BBC has already proposed shared local staffing going forward (with commercial media), together with the BBC Corporation working more in partnership with hyperlocal websites and bloggers to support their journalism.

BBC Scotland As it stands, BBC Scotland employs > 1200 staff in both Radio and TV. Ironically, BBC Scotland is almost co-located on Pacific Quay in Glasgow, alongside STV. Both the main BBC TV channels already have opt-outs in terms of the UK network feed. There is also a Gaelic language channel, Alba.

BBC – trust deficit with viewers in According to the BBC Trust itself, only 48% of Scots believe the BBC reflects Scotland their lives. There is also an apparent deficit between the BBC licence fee collected in Scotland and local content spend. This is an opportunity for STV, and local commercial media.

New news service In this context the recent enhanced news initiative announced by STV should help cement the group’s position in Scotland, specifically in digital news and current affairs.

EPG (Electronic Programme Guide)

EPG opportunity for STV On a related note, BBC 3 is shortly to cease being a linear TV service (and become online only). This will free-up position 7 on the Freeview EPG, which is a prominent setting for viewers. In England and Northern Ireland, City services are allocated to the EPG 8 position. At present, STV’s City licences are listed at 23 on EPG, which is a disadvantage. An elevated position would be a positive for the services.

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STV: New business initiatives and Production Overview Scotland 5m population Outwith Production, STV serves one marketplace, namely Scotland. The estimated population of Scotland in 2014 was c5.3m, a slight increase on the previous year.

Chart 31: Scottish population over time Chart 32: STV reach and coverage by product Source: STV Source: STV

Scottish macro On most economic indicators, Scotland is similar to other regions in the UK. There are, however, two key industrial drivers of the Scottish economy that distinguish it from the rest of the UK: Financial services; Oil and Gas. There could be some downside risk to the Regional economy from ongoing weakness in the latter sector.

More market share sought, through STV seeks an enlarged share of advertising and consumer discretionary spend in new products/platforms Scotland across a range of free-to-use services. TV is, of course, still the main distribution platform for this.

National airtime: Like a cash cow Taking a step back, STV has reasonable visibility on its core business cash flow, the C3 licence and highly profitable VOD, which is worth c£20m p.a. In our view, STV’s business strategy in recent years has then very sensibly focused on low-risk diversification away from national airtime, which in the past was also a source of operating leverage. This has required very modest investment only.

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Figure 2: STV Family suite of services Source: STV

Half of all Consumer growth in Today national airtime sales accounts for c64% of STV group revenue. Other recent years, from new revenue revenue streams include regional airtime, digital, sponsorship and City TV. In streams 2011, Digital (growth) revenue was < £2m. On our revised FY 2015 forecasts, Digital and City combined will be > £9m revenue. Just under half of overall Consumer revenue growth has come from these new revenue streams.

Chart 33: STV revenue by segment (a) Chart 34: STV revenue by segment (b) Source: Company accounts, Peel Hunt estimates Source: Company accounts, Peel Hunt estimates

11% National 5% 1% Regional 4% 36% Digital 4% National Sponsorship All other City TV 11% 64% 64% Other Productions

UTV: High risk approach to We have already seen how UTV Media, another listed Media small-cap, sought diversification to diversify away from its UK C3 licence; firstly into commercial radio and then into FTA TV in the Republic. Ultimately, this significantly increased the UTV risk profile and threatened to erode shareholder value in 2015.

STV: Low risk Many years ago, STV (e.g ‘old SMG’) itself was a fairly active Media sector consolidator. However, under CEO Rob Woodward, STV has been clearly focused on TV and TV production. Non-core assets have long since been divested.

Improved reach Instead, STV’s approach to new business initiatives has been organic, eschewing acquisitions. This is low risk, and is proving successful. The table below highlights the breadth of the reach across the complementary services.

Table 18: STV: Consumer Reach Source: Company accounts, Peel Hunt estimates TV audience STV Player City TV City Digital STv.TV Total 2013 3.6 0.5 0.2 3.0 7.3 2014 3.6 0.7 0.6 0.4 3.6 8.9 2015 H1 3.6 0.6 0.9 0.8 4.8 10.7 2015 F 3.6 1.0 1.0 1.0 3.6 10.2

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Data opportunity Accessing consumers across multiple platforms also gives STV a significant ‘data capture’ opportunity. We expect this to be an ongoing corporate focus, alive to the opportunity in targeted advertising. Customers have to register to use the STV Player and City TV apps. There has been impressive growth in registrations for the STV Player since 2012. Chart 35: STV Player: Growth in registrations (millions) Source: Company accounts, Peel Hunt estimates

H1 2015

2014

2013

2012

0 0.2 0.4 0.6 0.8 1 1.2 1.4

STV Player STV Player – free, of course – is accessible through the STV website, as well as being available on a variety of set-top boxes and Smart TVs. Current programmes are available for 30 main days after original transmission, together with extensive archive programming. As stated already, the economics of the STV Player are very attractive. City licences Local TV opportunity STV has embraced the Local TV opportunity and will eventually be running five local City licences in total: Glasgow (launched), Edinburgh (launched), Aberdeen, Dundee and Ayr. These are fully costed in our forecasts and the start- up costs are most evident in 2015-16, before target break even in 2017. Logically, there should be economies in running multiple licences, utilising the existing STV newsgathering capability, as well airtime/sponsorship teams. DTT platform output, not IP Comux (Caris Media) operates the Local multiplex, under Ofcom, and 34 licences have been granted overall. The licences have been granted by Ofcom for a 12-year period. Local TV is often derided south of the border due to adverse newspaper headlines on the likes of Mustard (Norwich) and London Live. Few of the licensees are well-established broadcasters. In our opinion, the main drawback of the offering is that it is not IP based, relying instead on platform carriage. Early STV performance trends good In the case of STV, programming consists mainly of local current affairs, old soaps and other archive material. We expect live broadcast to be focused around peaktime (eg 6-10pm). However, it is important to note that audiences for City services are already healthy and the services are being run in partnership with local educational institutions. This conveys a cost advantage, as well as fulfilling a community dimension.

Deepens engagement In terms of strategy, it can be seen that these licences, in conjunction with the City Apps, deepen STV’s engagement in the communities it already serves. The commercial potential lies in the ability to sell ‘cheaper’ advertising to small-scale, or local advertisers. STV’s improved data capabilities can also be complimentary to local VOD advertising.

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Production Forecasts cut As we noted in the Forecasts subsection, we have downgraded our STV FY 2015 revenue/EBIT forecasts. This partly reflects adverse phasing, which we expect to reverse this year.

Underperformance vs KPIs At the same time, Production continues to disappoint in terms of performance against group KPIs. In effect, STV has left c£1m of EBIT ‘on the table’ from underperformance against own KPIs.

Table 19: Production 2015: Latest Forecast vs original KPI Source: Peel Hunt Revenue (£m) EBIT (£m) Latest 10 Latest 0.2 Projected: KPI 20 Projected: KPI 1.2

Not easy to model accurately Frankly, this division is difficult to model with accuracy (this is not unique to STV, investors should be familiar with Entertainment One). Importantly, STV Production has never lost money at the divisional level and it has never been a material contributor to group profits.

Chart 36: STV Productions: Performance 2010-2014 inc Source: Company accounts, Peel Hunt estimates

16 14 12 10 8 £m 6 4 2 0 Revenue EBIT 2010 2011 2012 2013 2014

Returning series can be very A short-hand approach would be to model the number of hours commission at a profitable given unit price. In reality, different Production genres have varying economics. As a rule of thumb, return series are disproportionately profitable – particularly drama – as most of the upfront development cost is sunk. Margin is also, of course, a product of a growing revenue base overall.

As far as we understand, the main returning series for STV are still programmes such as Catchphrase and Antiques Roadtrip. Even then, the rights/IP to shows can vary by region. This can again make a difference to profit outcome.

Top 10 UK Indies all > £50m The UK independent production sector is valued at £2.8bn. Growth in recent revenue years has been achieved in spite of declining net PSB spend. The growth has come from overseas. Structurally, looking at the top-10 UK Indies (independent producers), where the cut-off revenue is > £50m, STV Production is clearly sub- scale.

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Table 20: UK: Top 10 TV Producers Source: Peel Hunt, Televisuel Rank Producer Turnover (£m) Comments 1 IMG 162 Part of William Morris, sports production bias 2 Avalon 87 Owned by Avalon Entertainment 3 Thames 85 Owned by Freemantle 4 Tiger Aspect 66 Owned by Shine 5 Lime 61 Owned by All 3 Media 6 Two Four 57 Owned by ITV 7 Sunset + Vine 56 Owned by Tinopolis 8 Left Bank 55 Owned by Sony 9 Neal Street 53 Owned by All 3 Media 10 Studio Lambert 50 Owned by All 3 Media

STV: Organic path so far Production is important to STV and features notably in the group KPIs. To date, the strategy has been entirely organic. Within the wider sector, however, there has been a lot of dealflow in the last 12 months. ITV and All 3 Media have been particularly active in terms of bolt-ons. All3 Media itself was acquired for £550m by Liberty Global/Discovery in 2014. Key thoughts In this context, we would also make a number of points on Production: • Solid long-term track record in content: Across genres, STV is behind the following: Catchphrase; Fake Reaction; The Link; Club Reps; Perez Hilton- Superfan; Safeword; Antiques Roadtrip; Taggart; and Rebus. • Number of recent senior creative hires: In a people business, STV places store on the possible impact of new hires, well-known producers such as Sarah Brown (Drama) and Dan Korn (Factual). This also frees up senior management time from running the division. • Strategic relationship with Group M: Lately, STV has partnered Group M Entertainment, which should bear fruit in 2016 and beyond. The model is co- investment and co-production and, hence, from STV’s perspective addresses some of the scale concerns. The two businesses already collaborate on programmes such as Safeword and The Poison Tree. • ITV – internal supply potential?: It would be a mistake to assume that STV is in any way privileged by its status as an affiliate. The ITV network budget is significant but commissioning is highly competitive. • Netflix and other new would-be customers: Beyond ITV and the UK broadcasters, there are a number of new customers out there with deep pockets. • Reclassify STV Productions as Qualifying Independent Producer: STV could usefully have independent status, which would allow it to benefit from quotas and improved terms of trade in the UK broadcast sector. • One or two major commissions can make a major difference: High-end TV production is expensive (we recall Spartacus, c$2m per episode). However, the sale value of successful international series can also be very high. • Saleable asset?: STV Production looks too small to be a divestiture candidate and the group is in a comfortable balance sheet position anyway. • Opportunity cost: Ultimately, most investors we speak to about STV think of Production as ‘free option value’. There is no obvious opportunity cost and other growth initiatives across the group are still being funded.

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Financial statements

Table 21: STV: P&L forecasts Source: Peel Hunt estimates Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15E Dec-16E Dec-17E Dec-18E FY FY FY FY FY FY FY FY FY Consumer £95.0 £93.6 £92.5 £98.6 £107.1 £113.3 £119.3 £125.6 £131.8 Production £9.8 £8.4 £10.2 £13.5 £13.3 £9.5 £13.0 £15.2 £19.0 RevenueRevenueRevenue £104.8£104.8£104.8 £102.0£102.0£102.0 £102.7£102.7£102.7 £112.1£112.1£112.1 £120.4£120.4£120.4 £12£12£122£12222.8.8.8.8 £13£13£132£13222.3.3.3.3 £140£140£140.8£140.8.8.8 £15£15£150£15000.8.8.8.8

EBITDA --- totaltotaltotal £16.9£16.9£16.9 £17.4£17.4£17.4 £19.5£19.5£19.5 £20.1£20.1£20.1 £21.8£21.8£21.8 £23.1£23.1£23.1 £24.7£24.7£24.7 £26.7£26.7£26.7 £29.2£29.2£29.2

Non cash costs Depreciation - total (£2.5) (£2.4) (£2.4) (£2.1) (£2.0) (£2.2) (£2.2) (£2.2) (£2.2) Software £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Share option costs £0.0 £0.0 £0.0 £0.0 (£0.3) (£0.3) (£0.3) (£0.3) (£0.3)

Consumer £13.4 £14.5 £16.9 £17.6 £19.1 £20.5 £21.6 £23.5 £25.5 Production £1.0 £0.5 £0.2 £0.4 £0.4 £0.2 £0.5 £0.8 £1.1 Clean operating profit - total £14.4 £15.0 £17.1 £18.0 £19.5 £20.6 £22.2 £24.2 £26.7

Other income JV's £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Dividend income £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0

EBIT £14.4 £15.0 £17.1 £18.0 £19.5 £20.6 £22.2 £24.2 £26.7 margin 13.74% 14.71% 16.65% 16.06% 16.20% 16.68% 16.62% 17.09% 17.58% Net interest (£2.3) (£2.3) (£4.0) (£2.8) (£2.2) (£1.3) (£1.1) (£0.9) (£0.7) PBT nPBT normalisednormalisedormalisedormalised £12.1£12.1£12.1 £12.7£12.7£12.7 £13.1£13.1£13.1 £15.2£15.2£15.2 £17.3£17.3£17.3 £19.3£19.3£19.3 £21.1£21.1£21.1 £23.3£23.3£23.3 £26.0£26.0£26.0

IAS 19 £0.4 £1.3 (£1.5) (£0.9) £0.0 £0.0 £0.0 £0.0 £0.0 Goodwill £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Exceptions (£8.6) (£14.9) (£5.3) £0.0 £0.0 £0.0 £0.0 £0.0 £0.0

PBT reported £3.9 (£0.9) £6.3 £14.3 £17.3 £19.3 £21.1 £23.3 £26.0

Normalised tax charge £0.0 £0.0 (£1.7) (£2.2) (£2.6) (£3.9) (£4.2) (£4.7) (£5.2) Effective tax rate 0% 0% -13% -14% -15% -20% -20% -20% -20% Tax on exceptionals and goodwill £1.4 £1.5 £0.3 £0.1 £0.0 £0.0 £0.0 £0.0 £0.0

PAT normalised £12.1 £12.7 £11.4 £13.0 £14.7 £15.5 £16.8 £18.7 £20.8 discontinued £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 PAT reported £5.3 £0.6 £4.9 £12.2 £14.7 £15.5 £16.8 £18.7 £20.8

Minority £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Preference £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0

Attributable profit normalised £12.1 £12.7 £11.4 £13.0 £14.7 £15.5 £16.8 £18.7 £20.8 Attributable profit normalised diluted £12.1 £12.7 £11.4 £13.0 £14.7 £15.5 £16.8 £18.7 £20.8 Attributable profit reported £5.3 £0.6 £4.9 £12.2 £14.7 £15.5 £16.8 £18.7 £20.8

WANS basic 36,400 36,800 37,650 37,800 38,000 38,300 38,300 38,600 38,600 WANS diluted 38,000 38,800 39,050 39,100 39,100 39,400 39,100 39,100 39,100

Normalised EPS basic 33.2p 34.5p 30.3p 34.4p 38.7p 40.4p 44.0p 48.4p 53.9p Normalised EPS diluted 31.8p 32.7p 29.2p 33.2p 37.6p 39.3p 43.1p 47.7p 53.2p Reported EPS basic 14.6p 1.6p 13.1p 32.3p 38.7p 40.4p 44.0p 48.4p 53.9p Reported EPS diluted 13.9p 1.5p 12.6p 31.2p 37.6p 39.3p 43.1p 47.7p 53.2p Dividend declared in the year 0.00p 0.00p 0.00p 2.00p 8.00p 10.00p 12.00p 14.00p 15.40p dividend paid in the year 0.00p 0.00p 0.00p 0.00p 4.00p 9.00p 10.60p 12.60p 14.42p

Dividend cost in year £0.0 £0.0 £0.0 £0.0 (£1.5) (£3.4) (£4.0) (£4.8) (£5.5) Retained profit £5.3 £0.6 £4.9 £12.2 £13.2 £12.1 £12.8 £13.9 £15.3 Consumer margin 14.1% 15.5% 18.3% 17.8% 17.8% 17.9% 18.0% 18.5% 19.2% Production margin 10.2% 6.0% 2.0% 3.0% 3.0% 2.0% 4.0% 5.0% 6.0%

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Cash flow table

Table 22: STV: Cash flow forecasts Source: Peel Hunt estimates Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15E Dec-16E Dec-17E Dec-18E FY FY FY FY FY FY FY FY FY Operating profit "normalised" £14.4 £15.0 £17.1 £18.0 £19.5 £20.6 £22.2 £24.2 £26.7 Depreciation £2.5 £2.4 £2.4 £2.1 £2.0 £2.2 £2.2 £2.2 £2.2 Intangibles ( proper costs) £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Share option costs £0.0 £0.0 £0.0 £0.0 £0.3 £0.3 £0.3 £0.3 £0.3 EBITDA £16.9 £17.4 £19.5 £20.1 £21.8 £23.1 £24.7 £26.7 £29.2 Working capital £3.6 £0.2 (£1.4) (£1.2) (£0.9) (£1.0) (£1.7) (£1.6) (£1.8) Pension deficit recovery plan (£3.7) (£4.2) (£4.3) (£4.2) (£5.5) (£7.8) (£7.8) (£7.8) (£7.8) Other cash movements £0.0 £0.1 (£0.7) £0.0 £0.0 £0.0 (£2.0) £0.0 £0.0 Cash associated with discontinued (£9.5) £1.5 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Operating cash flow £7.3£7.3£7.3 £15.0£15.0£15.0 £13.1£13.1£13.1 £14.7£14.7£14.7 £15.4£15.4£15.4 £14.3£14.3£14.3 £13.1£13.1£13.1 £17.4£17.4£17.4 £19.6£19.6£19.6

Interest (£3.2) (£2.8) (£1.6) (£2.5) (£1.8) (£1.3) (£1.1) (£0.9) (£0.7) Dividend received £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Tax £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 (£2.7) (£3.1) (£3.6) Capex (£0.8) (£1.6) (£1.0) (£1.4) (£5.0) (£3.0) (£3.0) (£2.5) (£2.5) Deferred consideration £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Free cashFree cash ffflowflowlowlow £3.3£3.3£3.3 £10.6£10.6£10.6 £10.5£10.5£10.5 £10.8£10.8£10.8 £8.6£8.6£8.6 £10.0£10.0£10.0 £6.4£6.4£6.4 £10.9£10.9£10.9 £12.7£12.7£12.7

Ordinary dividend £0.0 £0.0 £0.0 £0.0 (£1.6) (£3.4) (£4.0) (£4.8) (£5.5) Exceptionals (£4.7) (£12.9) (£6.3) £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Acquisitions £0.0 £0.0 £0.0 (£0.9) (£0.3) £0.0 £0.0 £0.0 £0.0 Shares issued £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 NeNeNetNet casht cash flowflowflow (£1.4)(£1.4)(£1.4) (£2.3)(£2.3)(£2.3) £4.2£4.2£4.2 £9.9£9.9£9.9 £6.7£6.7£6.7 £6.6£6.6£6.6 £2.3£2.3£2.3 £6.1£6.1£6.1 £7.3£7.3£7.3

Opening debt (£49.4) (£52.2) (£54.5) (£45.3) (£35.7) (£29.4) (£23.2) (£20.8) (£14.7) Net cash flow (£1.4) (£2.3) £4.2 £9.9 £6.7 £6.6 £2.3 £6.1 £7.3 Net debt reclassified - notional (£1.4) £0.0 £5.0 (£0.3) (£0.4) (£0.4) £0.0 £0.0 £0.0 acquisition costs) Currency £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Closing dClosing debtdebtebtebt (£52.2)(£52.2)(£52.2) (£54.5)(£54.5)(£54.5) (£45.3)(£45.3)(£45.3) (£35.7)(£35.7)(£35.7) (£29.4)(£29.4)(£29.4) (£23.2)(£23.2)(£23.2) (£20.8)(£20.8)(£20.8) (£14.7)(£14.7)(£14.7) (£7.5)(£7.5)(£7.5)

Nosh 38,000 38,800 39,050 39,100 39,100 39,400 39,100 39,100 39,100 FCF/share 8.7p # 27.3p # 26.9p # 27.6p # 22.0p # 25.5p # 16.3p # 27.8p # 32.6p

Net debt / EBITDA 3.09 3.13 2.32 1.78 1.35 1.00 0.84 0.55 0.26

IAS pension -22.9 -30.9 0 -23 1.3 -14.9 -14.9 -14.9 -14.9 0 -14.9

Grossed up net debt -75.1 -85.4 -68.3 -34.4 -44.3 -38.1 -35.7 -29.6 -22.4

Net debt / EBITDA 4.4 4.9 3.5 1.7 2.0 1.6 1.4 1.1 0.8

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Balance sheet table

Table 23: STV: Balance sheet forecasts Source: Peel Hunt estimtes Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15E Dec-16E Dec-17E Dec-18E FY FY FY FY FY FY FY FY FY Goodwill £7.9 £7.9 £7.9 £7.9 £7.9 £7.9 £7.9 £7.9 £7.9 Other intangibles £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Intangibles £7.9 £7.9 £7.9 £7.9 £7.9 £7.9 £7.9 £7.9 £7.9 Tangible fixed assets £10.1 £9.5 £8.2 £7.4 £10.4 £11.2 £12.0 £12.3 £12.6

Stocks £35.8 £29.1 £18.5 £17.6 £18.3 £18.8 £20.3 £21.6 £23.1 Receivables £26.4 £24.2 £19.5 £21.4 £22.9 £23.5 £25.3 £26.9 £28.8 Payables (£26.3) (£24.2) (£13.8) (£16.9) (£19.4) (£19.8) (£21.3) (£22.7) (£24.3) Trading working capital £35.9 £29.1 £24.2 £22.1 £21.8 £22.5 £24.3 £25.8 £27.6 Non trading current assets/liabilites £0.0 £0.0 (£0.2) £0.0 (£1.5) (£1.7) £0.7 £1.7 £22.2 Net working capital £35.9 £29.1 £24.0 £22.1 £20.3 £20.8 £25.0 £27.5 £49.9

Net debt (£52.2)(£52.2)(£52.2) (£54.5)(£54.5)(£54.5) (£45.3)(£45.3)(£45.3) (£35.7)(£35.7)(£35.7) (£29.4)(£29.4)(£29.4) (£23.2)(£23.2)(£23.2) (£20.8)(£20.8)(£20.8) (£14.7)(£14.7)(£14.7) (£7.5)(£7.5)(£7.5)

Investment £0.0 £0.0 £0.0 £0.9 £1.2 £1.2 £1.2 £1.2 £0.0 Tax asset/liability £5.9 £13.4 £8.9 £5.1 £7.4 £8.0 £9.0 £10.0 (£3.1) Provisions for onerous lease & change (£4.5) (£4.2) (£1.6) (£1.4) £0.6 (£0.5) £0.0 £0.0 £0.0 Minority £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 £0.0 Pension deficit (£22.9) (£30.9) (£23.0) £1.3 (£14.9) (£14.9) (£14.9) (£14.9) (£14.9)

Net aNet assetsassetsssetsssets (£19.8)(£19.8)(£19.8) (£29.7)(£29.7)(£29.7) (£20.9)(£20.9)(£20.9) £7.6£7.6£7.6 £3.5£3.5£3.5 £10.5£10.5£10.5 £19.4£19.4£19.4 £29.2£29.2£29.2 £44.9£44.9£44.9

47 This report is prepared solely for the use of Alex DeGroote Peel Hunt STV Group# 18 January 2016

Appendix: Risks

Risks to our STV investment case include the following:

Advertising – cyclical: STV derives c90% of group revenue from advertising. UK TV advertising is now > 5 years into an ‘up cycle’, with growth rates rebounding after the financial crisis. Nevertheless, a declining UK macro – or a succession of interest rate rises – could affect advertising projections. STV has taken measures to reduce operational gearing but it is still a downside risk.

Advertising – structural: TV has proved remarkably resilient as an advertising medium in spite of changing consumer habits. The emergence of social media and many new digital platforms feel complementary so far to TV. VOD has also been incremental and not substitutional to date. The health of advertising is critical for free-to-air broadcasters. However, there could be a drift out of TV ad budgets over time, impacting STV.

Viewing patterns – structural: On average, Brits still consume > 200 minutes a day of TV. Scotland ranks highly in terms of TV consumption per capita. In this context, STV is comfortably the commercial market leader. Nevertheless, the amount of linear TV viewing is declining over time. Time-shifted viewing is also increasing in popularity, particularly amongst younger age groups. This could weigh upon the attractiveness of TV as an advertising medium, as well as the rate card.

ITV performance: STV delivers its own content (mainly news and local interest). However, ITV has de-facto control of overall network output. If ITV’s programming performance is below par, specifically in peak-time, there could be a fall in share of viewing. The ITV network programme budget has not shown much growth in absolute terms, and share of viewing for ITV 1 has been under pressure in recent years.

Regulatory (1): STV’s TV businesses operate under licences that are granted by Ofcom. These licences are valid out to 2024. STV has certain public service broadcaster obligations that it must fulfil. Nevertheless, the UK regulatory framework is not static and investors should be aware of this. If, for example, retransmission fees come to nought, it could be taken adversely.

Regulatory (2): Much of the rhetoric from the SNP in terms of Media policy ideas has been around a more federal BBC, taking into account specific Scottish concerns. In general, we doubt that the DCMS (or Ofcom) would be duplicated in the event of an independent Scotland. Nevertheless, it is hard to call regulatory/regime risk to STV, further out.

New initiatives: One of STV’s KPIs is the diversification of group EBIT away from traditional broadcast, towards digital and production. The target is 33%. If new business streams fail to perform as expected and/or core national airtime remains robust, STV will not deliver on this KPI of diversification. Production has not delivered in 2015.

48 This report is prepared solely for the use of Alex DeGroote Peel Hunt STV Group# 18 January 2016

Appendix: STV KPIs

1. Non broadcast EBIT share: 33% by 2015

2. Peak-time audience re ITV Network: Aim to exceed in all years

3. Consumer division margin: 17.5% target, 2015

4. Consumer reach: Various targets

5. Consumer engagement: Various targets

6. Consumer insights: 1.6m, 2015

7. Long form video stream: 18.0m, 2015

8. Digital revenues, £7.7m target, 2015

9. Digital margin, 45% in 2015

10. Production revenue, £20m target, 2015

11. Production margin, 6%, 2015

49 This report is prepared solely for the use of Alex DeGroote Peel Hunt STV Group# 18 January 2016

Appendix: STV Board and Management

Rob Woodward (CEO)

George Watt (CFO)

Margaret Ford (Chair)

David Shearer (SID)

Other non execs

Michael Jackson

Genevieve Shore

Christian Woolfenden

Anne Marie Cannon

Ian Steele

Management

Helen Arnot (Head of Legal and Regulatory affairs)

Alistair Brown (Chief Technology and Platforms Officer)

Suzanne Burns (HR and Communications Director)

Alan Clements (Director of Content)

Bobby Hain (Director of Channels)

Elizabeth Partyka (Deputy Director of Channels)

Peter Reilly (Commercial Director)

Steven Walker (Director of Corporate Development)

50 This report is prepared solely for the use of Alex DeGroote Peel Hunt STV Group# 18 January 2016

Recommendation structure and distribution

Recommendation distribution at 18 January 2016 Corporate No Corporate % Total No Total % Buy 76 80% 162 54% Add 9 9% 35 12% Hold 8 8% 86 29% Reduce 1 1% 6 2% Sell 0 0% 8 3% Under Review 1 1% 2 1%

Until 7 September 2015, Peel Hunt’s Recommendation Structure was as follows: Since 7 September 2015, Peel Hunt’s Recommendation Structure is as follows: Buy, > +10% expected absolute price performance over 12 months Buy, > +15% expected absolute price performance over 12 months Hold, +/-10% range expected absolute price performance over 12 months Add, +5-15% range expected absolute price performance over 12 months Sell, > -10% expected absolute price performance over 12 months Hold, +/-5% range expected absolute price performance over 12 months Reduce, -5-15% range expected absolute price performance over 12 months Sell, > -15% expected absolute price performance over 12 months Under Review (UR), Recommendation, Target Price and/or Forecasts suspended pending market events/regulation

NB The recommendation is the primary driver for analyst views. The target price may vary from the structure due to market conditions, risk profile of the company and capital returns

Peel Hunt… Shareholding (%) held by during the last 12 months has acted as a has received compensation sponsor/broker/NOMAD/ is broker to from this company for the financial advisor for an offer Company in PH in Company makes a market this provision of investment of securities from this Company Analyst PH (>3%) (>3%) in this company company banking services company STV Group x x x

Recommendation history Company Date Rec Date Rec Date Rec Date Rec STV Group 18 Oct 10 Buy

51 This report is prepared solely for the use of Alex DeGroote Peel Hunt STV Group# 18 January 2016

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