Abi Watson +44 (0)20 7851 0902 STV [email protected] Jamie McGowan Stuart Pulling the levers for growth +44 (0)20 7851 0906 [email protected] Thomas Thomson • STV now has a clear pathway to reduce its reliance on +44 207 851 0903 [email protected] linear advertising by investing in production, while pushing the transition to digital forward with a UK- Gill Hind +44 (0)20 7851 0913 wide footprint [email protected] Tom Harrington • To that end, STV Player has some momentum and +44 (0)20 7851 0918 recent production company acquisitions, increasing [email protected] external commissions and PSB Out of London quotas should ensure STV Studios returns to growth in 2021 14 October 2020 • Such development is imperative: COVID-19 has accelerated structural change in viewing habits meaning now that content must not only be great, but available widely and immersed in a smooth user experience just to have a chance Figure 1: Viewer mins to STV-produced shows* and STV channel (bn) Related reports: ITV H1 2020 results: Clawing out of the 70 65.6 63.6 61.9 60.6 ravine [2020-082] 59.6 60.1 59.9 60 TV set viewing trends: 2020 lockdown and 50 full year 2019 [2020-073] 40 Broadcast television: Troubling trends in 28.1 30 lockdown [2020-058] 24.3 20.0 17.8 18.6 16.7 20 14.0 COVID-19 TV impact: Permanent change without intervention [2020-037] 10 19.4 20.7 14.0 17.8 18.6 16.5 18.4 0 Media consumption: the ‘surprising’ 2013 2014 2015 2016 2017 2018 2019 endurance of broadcast media [2020-014] Repeats of Antiques Road Trip on Really STV-produced shows* (UK viewing) *Excludes STV-only programmes. STV channel (ITV Scotland region) [Source: Enders Analysis, BARB/AdvantEdge] If your company is an Enders Analysis subscriber and you would like to receive our research directly to your inbox, let us know at www.endersanalysis.com/subscribers STV holds the two Scotland regional Channel 3 licences—the only ones outside ITV’s ownership. Nevertheless, the two are closely linked: the vast majority of STV’s broadcast schedule is comprised of Channel 3 networked programming, while ITV sells all STV’s national linear airtime and sponsorship. This relationship presents STV with two clear advantages: • Access to a network programme budget of over £800 million at a cost we estimate of c. £40 million • The arrangement whereby in any advertising downturn, STV’s programming payment to ITV declines, while programming costs can only increase when advertising revenues do. At a time of general content cost inflation, and a difficult advertising market, the upshot for STV is material, amounting to a £3.5 million saving in H1 2020 But while STV’s fortunes are inextricably bound to the efficacy of ITV, there is still room for maneuverability and strategy through its Scottish programming, stakeholder relationships, regional advertising, production capability and control of the digital transformation of the company. In January 2018 Simon Pitts took the helm as STV’s CEO, and five months later the company announced its new three-year growth strategy aiming “to establish the integrated producer-broadcaster as Scotland’s home of news and entertainment”. This was to be delivered through three strategic objectives: • Maximising the value of the broadcast business by delivering high quality, cost-effective news and entertainment • Driving digital growth through the STV Player by creating an ‘STV for Everyone’ • Building a world class production business If an existing business did not fit into the new strategy, it would no longer be supported. The loss-making local TV venture, STV2, was sold in June 2018 to That’s Media, while STV ELM—which provides operational services to the charitable Scottish Children’s Lottery which launched in 2016—is to be divested. Considering the symbiotic relationship between STV and ITV, it is perhaps unsurprising that at a high level the two share similar overarching strategies. Both aim to become less reliant on linear advertising revenues by developing their production businesses along with an emphasis on the transition to digital. Of course the same structural viewing shifts that affect all broadcasters—accelerated by the pandemic— make STV’s strategic realignment all the more urgent. In this report we will consider each of the three core objectives and the extent to which they are being realised, before covering the impact of COVID-19 on the company. We will show that its consistent commitment to regional news, investment in internal sales teams and the launch of the STV Growth Fund to widen the television advertising base in Scotland has further cemented its already strong relationships with viewers and businesses in its home country, thereby reinforcing its status as the leading commercial broadcaster. Online, the broadcaster seems finally to be kicking into gear with the STV Player now available on the majority of connected TVs in Scotland. Moreover, its content strategy of licensing third-party content takes the Player—minus any Channel 3 catch-up content—beyond STV’s borders. As STV sells all its Player inventory we will see significant upside in digital revenues over the next few years. Additionally, STV’s burgeoning production business—with a new management team and indie acquisitions—stands to benefit from the increasing nations and regions commitments for PSBs, which favour STV. STV: Pulling the levers for growth [2020-099] 2 | 14 Overview of the STV business Linear spot advertising and sponsorship remains the bedrock of STV’s business, forming 75% of its total revenues in 2019. National advertising has been broadly flat since 2017, with revenues increasing at a CAGR of just under 0.1% (v. 2.5% on a UK-wide basis). As Figure 2 shows the two main drivers of STV’s revenue growth have been its regional advertising and the STV Player (‘Digital’), which we discuss in detail later in this report. Figure 2: STV revenues, 2020 H1, 2019 v. 2017 (£m) 2020 H1 2019 2017 CAGR (%) Broadcast 35.0 92.3 92.0 0.1% National 28.0 75.3 74.3 - Regional 6.0 14.9 11.0 - Other 1.0 2.1 2.0 - Sponsorship - - 5.7 - Digital 5.9 13.0 8.2 16.6% Productions 1.6 13.7 10.2 10.2% ELM 2.2 4.8 6.6 6.6% Total revenues 44.7 123.8 120.4 1.9% The revenue streams STV reports have changed over the last three years—sponsorship revenues are now bundled into National and Regional revenues. Where it is not possible to identify the correct comparatives zero (-) has been entered. [Source: company reports, Enders Analysis] STV’s digital revenues have grown rapidly (albeit from a small base), at a CAGR of 17% since 2017— although we note that, on an absolute basis, STV Player is still a relatively small proportion of total revenues, c. 11% as of 2019 year-end. Far more significant is its impact on the bottom line—digital revenues have a margin of c. 50%—meaning that they contribute roughly one-third of total operating profit. STV’s operating margins have grown commensurately, up 2.1 ppts. Figure 3: STV adjusted costs, EBITDA, and other financials, 2019 v. 2017 (£m) 2019 2017 CAGR (%) Total costs 101.2 98.0 (1.1%) Broadcast 72.4 76.7 1.9% Digital 5.7 4.5 (8.2%) Production 13.8 10.2 (10.6%) EBITDA 27.7 21.5 8.8% Operating profit 22.6 19.0 6.0% Operating profit % 18.3% 16.2% - Free cash flow* 21.0 12.2 19.8% *2017 free cash flow was impacted by the timing of NAA/ASA offsets, as payments were received in August. Where costs have increased, CAGR has been denoted with brackets, as costs are a negative line item [Source: company reports, Enders Analysis] STV: Pulling the levers for growth [2020-099] 3 | 14 STV’s 2020 diversification target of one third of operating profit being non-broadcast earnings has been thrown off track by COVID-19—revenues from content sales have dwindled given the freeze on most television production (see Broadcast television: Troubling trends in lockdown [2020-058])—but over the remainder of the report we discuss the developments being made along this path up until the pandemic, and how the company has reacted to the current situation. Maximising broadcast with enhanced viewer and business engagement Traditional TV viewing will continue its decline, but we believe that significant value will remain within STV’s broadcast business: pivotally, ITV is a reliable deliverer of a wide array of UK-originated programming that covers many genres and is of widespread, mainstream appeal. That being said, with regard to their broadcast businesses, STV and ITV have slightly differing objectives and capabilities. ITV’s objective is couched in terms of “transforming” its broadcast business, which encompasses commissioning programmes (to reach lighter viewers and increase reach), digital investment in ITV Hub and addressable advertising, as well as developing deeper strategic and creative partnerships with advertisers (see Silver linings for TV [2020-073]). STV is only responsible for commissioning its programming for Scotland and does not have the same relationships with national advertisers as ITV. As it can neither influence the majority of its schedule nor controls most of its ad revenues, its broadcast objective relates to areas where it effectively retains autonomy. Thus, STV is seeking to “maximise” the value of the broadcast business, which it aims to do in two main ways: 1. Investing in a distinctive future-facing news organisation 2.