Investors are often dogmatic when it comes to takeovers; we want to see businesses expand their core business and not pursue size for its own sake; we want the price to be low and the quality of the target to be high.
In short, investors demand a lot – perhaps too much – from takeovers, which is partly why so many ultimately disappoint.
There is one act of corporate cannibalism that makes sense, can be done at a decent price and that involves a high quality target: REA Group, you should take over News Corporation.
It may not appear sensible or obvious at first blush but consider that News owns a 61% stake in REA and is currently trading at an attractive discount to valuation. The resulting purchase could be the equivalent of REA buying back a lot of stock at a hefty discount to market prices.
News Corp is a messy business with a 50% stake in Foxtel, full ownership of Fox Sports, HarperCollins, the Dow Jones businesses and a suite of international newspapers including the Wall St Journal.
Its best asset, however, is a 61% stake in REA Group and ownership of Move, operator of realtor.com, which one day aims to replicate in the US market what REA has done in Australia.
News’ old media businesses may be in obvious decline but they are still lucrative. The news and information business, for example, which houses its newspaper mastheads, still generate about $600m in EBITDA; Fox Sports and the stake in Foxtel generate a further $550m and book publishing another $200m. These may be declining assets (although we can’t say that with certainty) but they still generate healthy cash flows.
On modest multiples, those cash flows should be worth about $5.3bn against a total market capitalisation for News of about $9bn. This implies the real estate businesses are being valued at just $3.7bn.
A current prices, however, News Corp’s stake in REA is worth $5bn alone. If we assume Move is worth zero – an unlikely assumption for the number two real estate listings business in the US – the implied price of REA within News is just $46 a share compared to the market price of $62 a share.
By buying all of News Corp and selling its old media assets, REA could effectively buy back 60% of its stock at a 25% discount.
It would be an acquisition that would please the fussiest of investors; a great asset at a discounted price. With News executives sitting on REA’s board, however, this is all hypothetical and will never happen.
It is an interesting way of highlighting the value on offer at News Corp, however, and illustrates the power of inverting concepts to generate ideas.
Disclosure: The author owns shares in Newscorp.