Fairfax Media does the splits
Recommendation
Fairfax Media would be a shadow of the company it is today without Domain, its real estate division. Between 2014 and 2017, Domain's earnings before interest, tax, depreciation and amortisation (EBITDA) almost doubled from $59m to $113m. Over the same period, EBITDA from Fairfax's publishing businesses fell from $287m to $175m.
So it might seem strange that Fairfax is cutting Domain loose. How will an ailing, ‘old media' business survive without the crutch that has supported it through a time of eroding earnings?
It's a very good question. The simple answer is that Fairfax will retain a 60% stake in Domain once it is demerged and listed on the ASX in mid-November.
Key Points
-
Fairfax demerging 40% of Domain
-
Publishing businesses deteriorating
-
Consider switching into Domain
If Domain continues to grow – something we'll cover in a separate review in a few days' time – then Fairfax will retain an exposure through its shareholding. Our view is that Fairfax will sell down its remaining stake in Domain over time, as it did with Trade Me in 2012. But let's not get ahead of ourselves.
Demergers come with additional costs. As a standalone business, Domain will incur around $12m of corporate costs in 2018. So why split Fairfax in two?
Free agent
Well history indicates that demergers do tend to result in improved business performance. Domain's management can focus on growing the business, unencumbered by any capital constraints imposed by Fairfax's ownership. Separating into two companies will also overcome the cultural mismatch of a rapidly growing online-focused company attached to a fast-eroding publishing business.
Earlier this year we published an article on demergers titled The opportunity in demergers. It's a good summary if you'd like to know more about this type of corporate transasction. |
It will also be easier for Domain to incentivise staff based on its own business performance rather than Fairfax's. And finally, Domain will attract shareholders that prefer high-growth online property assets without a legacy media business attached.
In theory the demerger should benefit Fairfax too. It will no longer be able to access Domain's growing cash flows to offset publishing's decline. So it will be forced to redouble its efforts to come up with a sustainable publishing model without the Domain ‘cushion'.
Deadline for documentation to be received by share registry | 31 Oct |
Scheme meeting | 2 Nov |
Fairfax shares trade ex-entitlement | 16 Nov |
Domain lists on ASX on deferred settlement basis | 16 Nov |
Domain shares trade on normal settlement basis | 23 Nov |
Cost cuts not enough
Whether Fairfax managing director Greg Hywood is able to do that is another question. Having cut $500m of costs from the publishing division over the past five years, he's demonstrably good at expense reduction. At some point that won't be enough any more.
Publishing revenues have fallen from $1.6bn to less than $1.3bn over the past four years. We'd be surprised if the decline doesn't accelerate from here. Advertising revenues in Fairfax's Australian Metro Media division – mainly consisting of The Sydney Morning Herald, The Age, and The Australian Financial Review – fell by 13% in 2016. In 2017 advertising revenues fell by 16%.
It's not pretty. A post-separation Fairfax will need to work extra hard to prove it can survive. Our suspicion is that Fairfax will participate in some type of corporate activity down the track, particularly now that the government's media reforms have passed the Senate.
Vote Yes
Despite the additional costs involved in two separately listed entities, we recommend you vote in favour of the demerger. Each company should be able to focus on its own business better than before. Remember to send your paperwork back so that it arrives by the 31 October deadline (other key dates are in Table 1).
Assuming the demerger proceeds – which it almost certainly will – what does it mean for you as a Fairfax shareholder?
Well you'll soon own two ASX-listed companies rather than one. From 16 November, you'll own one share in a newly listed Domain (ASX code: DHA) for every ten you own in Fairfax. So if you own 10,000 shares in Fairfax now, you'll continue to own those same shares, but you'll also receive 1,000 new shares in Domain as well.
Fairfax before separation | |
Share on issue (m) | 2,299 |
Share price ($) | 0.99 |
Market capitalisation ($m) (A) | 2,276 |
Fairfax post-separation | |
Share on issue (m) | 2,299 |
Estimated share price ($) | 0.66 |
Market capitalisation ($m) (B) | 1,517 |
Domain post-separation | |
Share on issue (m) | 575 |
Estimated share price ($) | 3.30 |
Market capitalisation ($m) (C) | 1,898 |
This doesn't mean you'll be getting something for free – at least in the short term. The Fairfax share price will fall to reflect the value allocation between the two different entities. From 16 November, we estimate that Fairfax's share price will fall to between $0.60 and $0.70.
Exactly what Fairfax's share price falls to, though, will depend on the value the market ascribes to the two companies. In Table 2, you can see an example of how it might work. The current market capitalisation of Fairfax before separation (line A) will be approximately equal to its post-separation market capitalisation (line B) plus 40% of Domain's market capitalisation (line C). This 40% represents the value of Domain that Fairfax is ‘giving away' to its own shareholders via the demerger.
We're expecting Domain to trade somewhere in the range of $2.80 to $3.50 a share immediately after listing based on where the Fairfax share price is today. Based on 575m shares on issue, at $3.50 Domain's market capitalisation would be around $2bn. We'll let you know at what price it might be worth buying Domain in a separate review in the next week or so.
Breaking up: not hard to do
As a Fairfax shareholder, you'll then have another decision to make: do you wish to continue owning shares? While Fairfax will own a 60% stake in Domain, the publishing businesses are structurally challenged (not to mention challenging to value).
While Fairfax's legacy media businesses are still producing free cash flow – we estimate around $50m for the 2017 financial year – this could erode quickly. Revenues continue to fall and, at some point, the publishing businesses are likely to fall into losses. We're particularly concerned about the Australian Community Media division, where earnings have halved over the past four years.
Domain has been the main reason for owning Fairfax shares for many shareholders. If Domain is listed separately, there's an argument for selling out of Fairfax entirely and using the proceeds to buy Domain.
As we said in Fairfax Media: Result 2017, we're likely to cease coverage on Fairfax following the Domain demerger. We've never had a positive recommendation on the stock and we intend to switch coverage to Domain as the superior business. For now our Fairfax recommendation remains HOLD.
Disclosure: The author owns shares in Fairfax Media.