Sky was right to buy ITV stake despite losses

WHEN BSkyB bought a 17.9 per cent stake in ITV for £940m in 2006, Rupert Murdoch was hailed a genius. For it was Rupert – not son James – who masterminded the move, even if the latter took public credit for it. In one foul swoop, the mogul blocked the newly merged NTL / Telewest and Richard Branson’s Virgin Group from taking over ITV, a move that could have created a formidable competitor in the pay TV space.

Yesterday, the Court of Appeal ruled that Sky would have to reduce its stake to below 7.5 per cent, agreeing with earlier judgements by the Competition Commission and the Competition Appeal Tribunal.

The masterstroke hasn’t come cheap. Sky bought into ITV at 135p a share and the stock finished at 58.15p yesterday, meaning that Sky is sitting on paper losses totalling around £550m. Then there are the legal costs: Sky must pay the fees of every single one of the ten barristers that worked on the case, six of them QCs.

That said, Sky would be in a more precarious position if it hadn’t ambushed the Branson-led takeover. Combining ITV with what would soon become Virgin Media would have created a giant company with interests in telecoms, broadband, pay-TV and free-to-air broadcasting; this is exactly the kind of company that Sky was about to become, having just launched its own phone and internet offering.

Having defused the threat, it is unlikely to return. Virgin Media is now geared to the hilt, and few analysts think it would try to launch another bid. Others that have expressed interest in ITV, such as RTL owner Bertelsmann and Italy’s Mediaset, have little interest in British telecoms and pay TV and are therefore less of a threat to Sky.

So strategically at least, Sky has done well. Its shares were virtually flat yesterday, as the market has priced the paper losses in after Sky wrote down its investment in ITV last year. Having played a good hand thus far, the question is what the pay-TV giant does next.

It is currently in discussions about selling the entire block of shares to a firm interested in launching a takeover, a move that would allow it to determine ITV’s future. Alternatively, it could hang on to the stake and lodge an appeal with the Supreme Court. Few expect it to win, but by waiting it out Sky could reduce its losses. Sentiment appears to be on ITV’s side and earnings upgrades look likely as advertising revenues rise and some regulation is loosened.

Even it does end up losing over half-a-billion pounds, investors should remember that doing nothing in 2006 could have cost the firm much more.