How to profit from the football feeding frenzy - buy BT

Most people think that we are living in an age of austerity. Try telling that to the managements at BSkyB and BT.

Between them, they have agreed to shell out a staggering £3bn to screen live Premier League football matches for three seasons from August 2013.

That's 70% more than the £1.75bn being paid for the current rights.

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It's certainly good news for top football players but they're not the only ones who could profit. Here's why.

How will this affect the finances of football clubs?

Premier League clubs will get a welcome income boost. But while this may be good news for their fortunes on the pitch, if history is anything to go by, most of the extra cash could end up in players' wallets. So it's unlikely that it will lead to Premier League clubs turning their current losses into big profits.

More income, however, should make it easier for clubs to meet UEFA's financial fair play rules, whereby they will have to balance their books (for more on this, read my recent piece on football finances).

Footie fans will have to shell out even more for their fix

But where will the money come from? Sky and BT both need to get a return on their investments. With the live rights costing 70% more than the existing deal, the chances are that viewers are going to have to pay more to watch football.

But how much more? Sky has been quite coy on this issue so far. It talks about offsetting the cost of football rights with cost efficiencies and discretionary spending elsewhere. BT meanwhile, has yet to develop a pricing plan.

However, there's an argument to say that football on TV is currently quite reasonably priced, and there's room for increases.

Before you throw something at your screen, of course I realise that most of us would rather not pay to watch football, and many people either can't afford to, or simply don't want to.

However, let's look at the costs for those who do. A ruling by broadcast regulator OFCOM means that Sky currently has to wholesale its Sky Sports 1 and 2 channels at a fixed price to the likes of BT and Virgin Media. These companies usually re-sell these channels to their customers at cost or a slight loss.

At the moment, a subscriber to BT Vision could have both channels for £18.20 per month. This allows them to watch 115 live matches plus cricket and lots of other sports. Over nine months of the football season that works out at £1.42 per match. A season ticket at Arsenal next season for 19 league and 7 cup matches works out at £37.88 per match. At Wigan it is £15.78 per match.

So if you like your football, then watching on TV looks quite good value it might not be as enjoyable as a live match, but it's an awful lot cheaper. And that suggests that Sky and BT could raise prices a fair bit before people would stop buying.

Is this a bad deal for Sky and BT investors?

The stockmarket this morning seemed unimpressed. Sky shares were marked down 6.7%, with BT's down 2.8%.

Sky's share price slid because it paid a lot more than analysts had hoped. According to the Financial Times, the City was expecting Sky to pay £620m per season rather than the £760m they have agreed to pay, so promptly lowered their profit forecasts.

That said, Sky has still retained 116 matches, which allows it to keep its flagship Sunday and Monday night football programmes. It will also still wholesale these matches to other broadcasters. The key issue could be the price differential between Sky and BT will Sky customers jump ship?

Writing off Sky has been a losing bet and it's not one we're prepared to make now. Its ten million customers indicate that it remains a good business. But if you didn't already realise it, you now know just how critical footballing rights are to Sky's business model. Given these factors, at these levels, we are neither buyers nor sellers of the company.

BT on the other hand, is altogether more interesting. It is now venturing into areas where Setanta and ESPN failed to make hay before them. Can BT succeed?

While the company has been winning lots of new broadband customers, it has realised that it needs a credible TV offer to keep customers happy. Increasingly, customers are looking to buy their phone, broadband and pay-TV packages from the same provider. So far, BT Vision has failed to make a big impact with only 700,000 subscribers.

But BT may do better than people think. Unlike Setanta and ESPN, it has bought some better quality matches than they did. It has agreed to pay £246m per season for 38 matches, 18 of which are so called first-choice matches' involving the top clubs. This means it stands a better chance of attracting viewers. It will set up a dedicated interactive football channel to screen matches over its fibre-optic network, and look to sell its content to others such as Sky.

Also, it's not been reported much in the press, but BT is quietly building a payTV business that will exploit the high bandwidths of its fibre-optic network. This network allows BT to broadcast live channels (known as linear TV) over the internet.

This means that BT will save money as it will no longer have to rent space from Freeview as it does now. It has already signed deals with FX, UKTV and National Geographic to have their live channels. The addition of football and other channels could eventually create a powerful third player in the pay-TV market.

More importantly, with fibre-optic broadband being rolled out to around two-thirds of the country, BT is effectively taking on Virgin Media's cable TV business. Perhaps it is Virgin rather than Sky that has most to fear?

So do the numbers stack up for BT? Time will tell. Profits and cash flow are expected to decline by £100m and £200m respectively in 2013/14 due to football costs.

But by 2014/15, BT is predicting underlying free cash flow of £2.5bn or 32p per share. This gives it an underlying free cash flow yield of 15.8% at the current share price of 203p.

Given a yieldof just over 4%, BT's dividend looks safe and it has the potential for strong growth. With the state of its pension fund looking a lot more healthy and its competitive position getting stronger, we think BT shares are a buy.