Bear-faced Rupert

Rupert Murdoch gave investors at News Corporation's AGM in New York last Friday an interesting explanation for the company^s share price underperformance over the past 12 months. It has been caused by a media bear market, he said. Let^s review the evidence for that statement.
Since News (NWS) re-badged itself a US company in early November 2004, its stock price has fallen nearly 10% in the US, and by more than 12% in Australia (the difference is largely due to currency movements). In Australia over the same period, Publishing and Broadcasting Limited has risen 10%. NWS's legal protagonist Seven Network has increased about a third. Smaller Australian media have experienced a veritable boom, with Rural Press and Village Roadshow up by more than 20%, and Southern Cross and Prime TV up about 10%. The much-maligned Fairfax is flat, as is WA Newspapers. No sign of a bear market in Australian media.

If Murdoch was referring to the US media market, he is partly right. Viacom has fallen 18% in the past year and Disney has dropped about 9%. However, Time Warner is up by more than 4% and major NWS shareholder Liberty Media is flat.

But let's not forget that a major rationale given by the company for the change to a US domicile was to allow better access for US institutions to the ¨unparalleled opportunities~ provided by NWS. To date, it seems, many have declined the offer.

Murdoch failed to mention at the AGM that his shareholders have been experiencing a bear market for not one year, but for more than seven years. I have calculated that if an investor had bought $1000 worth of NWS shares in March 1998, the value of their investment would have grown to $1140 today - even including dividends. The same investor would have been better off putting their money into a bank account yielding 2% a year. Out of a universe of about 25 Australian blue-chip companies, only three returned less than NWS over the last seven and half years, as shown in the following chart.

NWS has not been the worst performer. Telstra, Village (not really a blue chip, but an interesting company) and Lend Lease all returned less. But as I have said before, what is unique about NWS is that almost every broker across two continents failed to notice NWS^s poor performance. Over the past seven and half years, nearly 100% of the broking community, nearly 100% of the time, recommended News Corp to their own clients as a ¨'buy' or ¨'strong buy'!

By contrast, most brokers at some point questioned what was happening at Telstra, Village and Lend Lease. Today there are very few ¨'buy' recommendations on Telstra. To the broking community's credit, this is despite the pending selldown by the Federal Government of its majority share in the company, a selldown that is likely to generate huge investment banking fees. Village Roadshow has been so disappointing that almost all brokers have stopped actively covering it. Yet, by my calculations, a $1000 investment in Village in March 1998 would have returned only $35 less than NWS.

CAPITAL MISALLOCATION

While the brokers were happily recommending NWS, NWS was just as happily tapping the capital markets. I estimate the NWS group raised about $US25 billion from various markets around the globe over the past seven and half years. I have a simple question: would that capital have been handed over if brokers had more accurately anticipated the future - no growth? I suspect not.

But why should we care? Many will say good luck to them. News Corp is happy. The brokers are happy. What harm has been done? Shareholders just need to be a little patient. Why disturb the peace?

The issue here goes to the heart of what capitalism is all about. Capitalism is a wonderful method of allocating capital efficiently. It works best because capital is allocated to performers and denied to non-performers. But, like any system, it is only as good as the information signals that emerge. Now if the signals are wrong, then a capital misallocation occurs. If brokers uniformly and continually recommend a company to their clients that is a continuous non-performer, then a misallocation of capital is likely to follow.

But this raises an additional question for the wider community. How many roads, schools and hospitals were not built or maintained (at a reasonable price) because the NWS group sucked $US25 billion out of the markets and returned less than a bank deposit account yielding 2%. No one can answer that. But it is worth thinking about.

THE SHAREHOLDERS ARE REVOLTING

At the News AGM, all directors seeking re-election were returned unopposed; 16% of shareholders followed the advice of the global corporate governance bodies and withheld support. NWS apparently felt vindicated.

NWS still has to face court action from the corporate governance bodies over whether it misled them in the period leading up to its change of domicile vote last year. I think its likely NWS will win the case, but in my view, whether it wins or loses doesn^t really matter. This is not a ¨he said, she said~ corporate spat with a media rival, fighting over the spoils of war. The corporate governance bodies have no axe to grind. Their only reason for existence is to ensure companies are honest with their shareholders. And they are claiming NWS misled them!

This is a very serious charge for any company. But NWS is no ordinary company. In the Anglo-Saxon world, every day literally hundreds of millions of people rely on NWS to deliver an honest account of what is happening in their world. Based on its reportings, these people are making everyday decisions about their life, including who will govern them. Now to quote Winston Churchill, 'democracy is the worst system of government, except for all the rest'. But like capitalism, democracy only works as well as the information signals that voters get. If voters are fed information that is misleading and wrong, many of their life choices are likely to be wrong as well, including who governs them.

An honest accounting of events is essential. Arguably, NWS is the most influential media organisation in the US and Britain. And it^s right up there in Australia. Its influence is rising in many other countries, if only because of its economic size and presence, such as in Italy and India. Conceivably, NWS is the most influential media organisation in history. And independent corporate governance bodies have charged NWS with misleading them. This charge goes to the very heart of the NWS culture. If independent corporate governance bodies feel misled, what does this say about the credibility of NWS products? Again it^s an issue that^s worth thinking about, particularly for NWS employees.

Let^s look at an example from the field. Around the world, NWS has been a cheerleader for the Iraq war. Now whether you believe the allied invasion was right or wrong at the time, it is now clear there were major miscalculations (WMD, shape of post war Iraq and the insurgency) made both before and after the actual invasion. Countless lives have been lost due to these miscalculations. More questioning and less cheerleading may well have averted tragedy for many.

FUTURE SHARE PRICE PERFORMANCE

The charge brought by the corporate governance bodies are so serious and raise such fundamental questions over NWS^s cultural credibility, that I^m sure Murdoch would like it buried as quickly as possible. He has worked very hard over the decades to promote a perception of trust. A long, drawn-out affair would be very damaging. If the courts won^t dismiss the case (a hearing is set for early November), one way to remove this thorn in his side would be to cut a deal with John Malone of Liberty Media. Having him off the share register would remove the need for a poison pill, which led to this court action. And that would remove the need for a shareholder vote and a drawn-out and highly damaging court case.

The only problem with this scenario is that any deal under these circumstances with Malone is likely to be on Malone^s terms. NWS shareholders could see another wealth transfer from them to Malone. Few shareholders can forget Malone^s sale of Gemstar shares to NWS in 2000. That transaction ended up costing NWS about $US4 billion in write-offs. And that fear is probably the single biggest reason why the NWS share price is unlikely to perform until the whole intrigue is sorted out.

NEWS CORP RIPOST

After my last commentary on NWS (Hardball, Murdoch Style, 14 October) a NWS spokesman was quoted as saying both I and Eureka Report publisher Alan Kohler are well-known critics of NWS. The comment seems to imply some sort of bias in my observations. If the definition of ¨critic~ is an analyst who has had both a ¨buy~ and ¨sell~ recommendation on the company, I^m guilty as charged.

I was also described by the NWS spokesman as having an agenda. I have never discussed a NWS agenda with Alan Kohler. If NWS thinks this is some sort of ¨get NWS~ campaign, they are very wrong. NWS is a $US50 billion global conglomerate. It is ¨the establishment~. I^m a mere analyst in the suburbs. The only agenda I have in regard to NWS is to achieve greater transparency and a better deal for minority shareholders. When NWS can begin to deliver returns to minorities, I^ll be more than delighted to recommend investors buy it as I have in the past. Given that the share price has not performed for more than seven years and no earnings per share growth for more than 18 years, not to mention the current Malone intrigue and the poison pill court case, NWS has a lot of work to do.

The NWS spokesman had plenty to say about me, but he was silent when it came to the points I had raised, such as why there has there been no earnings per share growth since 1987, or why has there been virtually no share price growth since 1998. Nor was there any word about the almost universal backing the company has received throughout this period from the broking community in the face of this appalling performance. It seems you can summarise NWS^s response to ¨no eps growth since 1987 and no share price growth since 1998~ with, ¨He^s just a critic and he has an agenda.~ I think these comments show just how out of touch NWS really is, how uncomfortable it is when the spotlight strays from its strengths.

Speaking of strengths, I have publicly acknowledged NWS^s strengths on many occasions. There are many aspects of the company and Murdoch I admire. There is no doubting the company^s operational expertise and executive talent. It has created some wonderful assets such as BSkyB and Fox. But if you want to understand where the share price is going, ¨that^s not important right now~.

INVESTMENT BANK FEES

I^m pleased to see ASIC will soon be demanding that broker company research will include the level of investment bank fees brokers receive from companies. I think this is a fantastic step forward for better disclosure and a more informed market. Companies will always try and highlight their strengths and hide their weaknesses; that is human nature. Companies will use many techniques to achieve this goal: some will charm; some will be subtle; and some will use sledge hammers. Some might even have such a strong competitive position they can tell it as it is. And a few will use carrots and sticks. But if readers of broker research can easily identify the fees that companies pay their brokers for their various services, it will place research reports in proper context.

Imagine a situation where nine brokers are recommending a company as a ¨buy~ or ¨strong buy~ and each of them is earning significant investment banking fees from that same company. Information about those fees puts some perspective on the broker reports and recommendations. If a 10th broker has a ¨sell~ recommendation on the same company, but is receiving no fees, then the contrast is very illuminating. Once this additional requirement is introduced, I think it will be the most read section of any broker research report.

The author was a News Corp analyst for 15 years. In Australia he was rated amongst the Top 3 News Corp and media analysts over much of that period including 2004.