In the early part of this week NDS said that it has reached agreement with its largest shareholder News Corporation, and private equity group Permira on the exact terms to take NDS private.
The news raises several vital questions about the future of global pay TV services, given that NDS is the global leader in conditional access and also offers middleware and EPG systems, a leadership built upon a strategic relationship with News Corporation.
Does this deal mean that NDS will be squeezed for more profit by Permira? Will the NDS strategy change? And will News Corporation continue to be a loyal customer of NDS after the deal is complete?
Most observation comes from the financial community to date, giving out the same story that the News Corp analyst relations team gave us, which is that it was all done for tax efficiency, in order to extract around $700 million in cash which NDS holds, into the coffers of News Corp, without having to pay tax.
NDS itself told us that the two companies always thought they had a problem with their capital structure and said as far back as September that they were looking for ways to make the capital structure more efficient.
News Corp has a long history of owning less than 100% of a company but by splitting its shares into two classes, holding the voting control. It does this both at the US DTH satellite TV company DirecTV and in the UK with BSkyB. But in NDS, News Corp owned over 80% of the equity while owning 96% of the voting power. So it can afford to be diluted, down to a minority ownership, and still retain effective management control, if that’s what the plan is.
And that’s pretty much what appears to have happened here, though the big remaining question is just what it is that News Corp needs spare cash for,
The three agreed on last week that new companies formed by Permira would acquire all the NDS Series A ordinary shares including those filed as American Depositary Shares traded on NASDAQ, at a price of $63. The only likely way that this deal could be unraveled would be if minority shareholders thought they were not getting enough for their shares, which is unlikely since it is a premium to the stock price.
The overall result would mean NDS stops being a public company and Permira ends up owning 51% and News Corp 49%, with the 67% of Series B shares held by News Corp being cancelled and a mix of 1.5 billion of cash and a $242 million vendor note being paid for the deal. The transaction is expected to close by the end of the year or early 2009.
That’s fairly straightforward, but the question remains is there a fundamental shift in a) the NDS relationship with News Corp, b) the shape of the conditional access markets?
In the past we have raised the question that in the long term, the cost of running conditional access systems which require smart cards is inherently higher than those which run on software alone. This has led us to wonder if at some point in the future News Corp would be unhappy to continue to support NDS and may want an open relationship with multiple suppliers? We don’t think that this is happening right now, and it is likely that this may never happen.
For the greater part the News Corp empire of pay TV is satellite based, and satellite at present shows no sign of coming up with a return path. It is that return path which allows, for instance, IPTV and cable pay TV operators to run multiple, frequent authentications and to ensure that only one set top is using any given authentication at any point in time so that it cannot be cloned. The one way nature of DTH means that it needs the improved security strength which comes from having secure hardware involved, in this case in the smart card. In the long run DTH may be changing, and all satellite set top boxes may one day be attached to broadband lines, and effectively have a return path, even if it is one that they don’t control or own. At that point software only DRM may prove sufficient protection for DTH, but it’s not imminent, and besides that would just put pressure on NDS to provide a cheaper system, not to be replaced as the technology partner. And in the meantime the fairly unbreakable nature of the smart card gives NDS systems that little extra in the way of content protection.
We have seen at rival companies like Irdeto that they can run both smart card and non-smart card systems side by side, and adapt them for each application, so this would not be beyond NDS if ever that was required.
So if there is no fundamental drift from News Corp, and it retains all of its major existing customer relationships, then this will be business as usual for NDS, and can it continue on with its currently strategy?
Prior to DirecTV entering the Liberty Media fold earlier this year, the three largest News Corp controlled pay TV operations represented 68.2% of NDS business last year. Now that DirecTV has gone, the other two, Sky and Sky Italia represent just 41.7% of NDS revenues. Although this is a big drop, it isn’t the entire picture and there are other companies such as Star in China, Foxtel, and Tata Sky in India that will also contribute to an even closer relationship between NDS and News Corp.
The reason that DirecTV contributed so much revenue to NDs was because this includes all of its affiliates DirecTV Latin America, Sky Brasil and Sky Mexico. And it must be remembered that News Corp is increasing its holding with Premiere in Germany, which is already an NDS customer. The chances are that News Corp already realistically represents way over 50% of NDS revenue and that this is only going up, not down, going forwards. And given that the DirecTV just renewed until 2013, that relationship is not going away either even though News Corp no longer controls it.
Yael Fainaro, in analyst relations at NDS told us this week that the company may not expect that Permira would be a shareholder in 10 years time, but it would expect that News Corp would be just as much a customer in 10 years time, and while she agreed that this was not the usual type of private equity deal, could not point us in any particular direction for us to see how Permira will make money from this deal.
Which brings us to the last issue really, which is how will Permira manage its own exit?
Our guess is that Permira will hold the shares for a while and that at some stage NDS will return to the public markets, possibly not the London Stock market, but either one in the US or Asia, to go public once more, and that this is where Permira will get its payout.
That’s not to say that Permira will not interfere with the running of NDS, given that it will have one short of 50% of the board seats once this transaction is compete. NDS has one major issue going forwards, well understood and frequently referred to by its CEO Abe Peled.
The company needs to do less project work, where it re-invents the wheel each time, and produce more products. One of the favorite sayings at NDS is ‘How strong would you like that security?’ and customers often have widely varying needs here. This leads to having to hold more services and integration staff than NDS would like and lower margins on some projects.
Peled has initiated a plan referred to as Fusion, which will see a new generic layer of middleware emerging into products around mid-2009. The idea is that this can be easily customized, with a rapid time to market, but that all of the company’s middleware will come from a single code base. This is said to be expensive with a high investment up front, but it will lead to savings and more customer flexibility in the long run. This is not the type of project that a company like Permira will starve of funds, and as far as we can make out the private equity group can sit tight, wait for the financial markets to be right, and cash out, leaving NDS and News Corp as cozy as ever.
Commenting on the transaction, Abe Peled, Chairman and CEO of NDS said, “With the convergence of broadband and broadcast technology, new frontiers lie ahead for NDS. NDS needs to have the strategic agility and flexibility to enter into any type of value enhancing transactions. The current ownership structure was imposing certain limitations. Therefore News Corp has decided to reduce its ownership position in NDS so that NDS can capitalize on these new opportunities with a more independent structure and the expertise of Permira.”
Our big worry for the future of NDS is that it is tied so permanently to DTH technology. It does have IPTV middleware and it has protected the odd IPTV installation, but with IPTV set to grow by around 50 million seats in the next few years, NDS has too precarious a hold on this market and may need a strategic acquisition of its own in order to benefit from this. Meanwhile although satellite TV is perhaps the most efficient way of reaching a national footprint, it is being attacked by the bundling of cable triple play and telco quad plays, and also by free to air DVB-T broadcasting and free satellite broadcasts ‘ none of which play to NDS strengths. In the end NDS has to decide if its mission is to create new technologies for News Corp or to enter markets which News Corp is not in, but which could make it money.