Carlton cheap, but still no bargain

Canary Wharf; Music Choice Europe Â

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Canary Wharf says it is not a target

It's been an extraordinarily rough ride for investors in Carlton Communications, the number two ITV group.

From a high of 900p in 2000, the stock has plunged to its lowest level since 1992 as the advertising market has gone from healthy to queasy to deathly ill. Results this week from SMG, Aegis, and the French broadcaster TF1 were uniform in their bleak outlooks. Recovery in the fourth quarter, a factor that allowed Carlton shareholders some optimism, is now proving to be a chimera. A growing number of City analysts expect that Carlton's year to September 2002 revenue from television advertising will be lower than the depressed figures for the soon-to-end current fiscal year.

A review of the numbers tells the story. Current fiscal year advertising revenue is expected to see a pro forma decline by around 13 per cent to about £695m. Worryingly, fiscal 2002 is being downgraded by a further 3-6 per cent, suggesting advertising revenue of about £660m.

The high operational gearing means that for every £10m lost in sales about £8m comes off the bottom line. Ouch. Carlton is bringing forward a £25m cost-cutting programme but that offers minimal consolation.

Exacerbating the impact of the downturn are the development costs of ITV Digital, the troubled digital terrestrial television platform, and the start-up costs of ITV Sports. They will cost Carlton about £200m next year and a substantial, if reduced amount, the following year. When the £1.2bn total investment in digital terrestrial television begins to produce a return on investment is anyone's guess. ITV's multichannel strategy is still being formulated and what should be an attractive sports subscription service is unavailable on BSkyB or Telewest, which accounts for 70 per cent of multichannel distribution.

A takeover by, say, TF1, which has close ties to Carlton, could offer investors one way out. But as the French company is only just beginning to feel the pain of the advertising recession, it is likely to think twice before jumping. Indeed, should it or another European broadcaster seek to add assets in the UK market at this cyclically depressed juncture, a more likely target would be Granada.

Though Carlton's stock, down 8.25p at 234.75p, looks appealing, sentiment is set to blacken further before any real recovery. Given that scenario, bargain hunters should keep their powder dry for now.

Canary Wharf

Canary Wharf has tasted failure. It went bankrupt in the early 1990s. But, since its stock market flotation in 1999, at 330p a share, it has been a spectacular success.

The vision is massive: 13.5 million sq ft of office and retail space by 2004, which is now half built. Some 6 million sq ft further has been earmarked for development on new land. The scheme has poached some of the City's biggest occupiers, such as Citibank and Morgan Stanley, and despite the current economic uncertainty, new tenants do not seem to be hard to come by.

It is a remarkable vote of confidence that the market now has in the development, that Canary Wharf has been able to securitise the income from new office blocks before they are even built. This is because the company's exposure to an economic downturn in limited. Its tenants are blue chip, signed up for 20 or 25 year leases.

Canary Wharf only constructs one building at a time which does not have a tenant lined up. Yesterday, even this was halted.

Investors will benefit from the return of at least £2bn over the next three years, as the company completes the original development plan. Canary Wharf shares closed down 5p yesterday at 505p, having come off an all-time high of 574.25p seen at the end of last year. Hold.

Music Choice Europe

Distributing multiple channels of music through digital television offers a business model that gives rights holders and artists an incentive to participate. Consumers, who pay in a low portion of their substantial pay-TV subscriptions, seem to like the service.

Like every new media company in recent years, Music Choice Europe has found the market tough sledding. The shares, which floated at 162p last year, have plunged by 90 per cent. Interim results yesterday give grounds to believe the company will survive. Sales rose 68 per cent to £3.8m with subscriber numbers surpassing 10 million. The net cash outflow minus £1.5m in interest from the group's £34m cash pile was just £3.8m. That should provide sufficient cash until profits are obtained in late 2003.

The shares duly rose 2p to 18.5p, valuing the company at £23m. The powerful shareholders behind MusicChoice – BSkyB, AOL/TimeWarner and Sony – are one reason to back the shares. Another is the growing market share of digital television and bundled products in Britain and overseas.