News Corp: Interim result 2015

As usual, Friday's interim result from News Corp was a seething mass of segmental results, one-off charges, currency adjustments and litigation payments – but you don't need to scratch too far below the surface for some value to emerge.

Here's how it stacks up. The company has a market capitalisation of US$9.4bn and at 31 December it had net cash of US$1.9bn, giving an enterprise value of US$7.5bn. Now if you plug in the current share price (around $49) for News's 62% stake in REA Group, you get about US$3.1bn, leaving a value for the rest of just US$4.4bn. And while that rest includes the Australian newspaper business that we'll say, charitably, is worth nothing, it also includes the Wall Street Journal, Dow Jones, the HarperCollins book publishing business, The Times and The Sun in the UK, Fox Sports and half of Foxtel, the US's third-largest online real estate portal (Move, acquired in November) and an infant US education publishing business.

Between them, those businesses made earnings before interest, tax, depreciation and amortisation of about US$1bn in calendar 2014, after accounting for corporate costs and losses in the education start-up, putting them on an enterprise value (EV) to EBITDA multiple of around 4.4.

Doubts

So, is it time to back up the truck? Not quite. It's possible to poke holes in each of the elements of this valuation. First and foremost, you're taking REA's valuation on a forecast price-earnings ratio of more than 30. Of course it's a fine business and could be worth more (see our review of REA Group's 2015 interim result), but if you really think that it might be best to buy shares in it rather than News Corp.

The cash might also not be worth US$1.9bn after Murdoch has deployed it. Of course he's got more right than wrong over the years and who's to say it also won't end up being worth more, but it introduces further risk.

The biggest doubts, however, surround the earnings contributed by News's biggest divisions, News and Information Services (NIS) and the 50% stake in Foxtel, which generated 37% and 24%, respectively, of EBITDA in the first half (excluding digital education losses and corporate costs).

News and Information Services, despite its high-profile titles, is in obvious decline, with segmental EBITDA shrinking in eight of the last ten quarters, at an average year-on-year rate of 16%. The story was the same in the December quarter, with EBITDA falling 15% due largely to weak advertising revenues in the UK and Australia, compounded by the stronger US dollar. So how highly (or rather lowly) do you value earnings that are falling at this kind of rate? The answer depends on when you think the decline might end and it would be a brave call to draw a line in the sand for this business. Certainly, an EV to EBITDA multiple of 4.4 doesn't look particularly conservative.

Foxtel faces its own existential threats as people increasingly 'cut the cord' with their cable/satellite TV providers to access content online through services like Netflix (which is due to arrive on these shores (officially) in March this year). In 2013, the largest US cable companies (with about 94% of the market) saw subscriber numbers fall for the first time ever. The fall only represented 0.1% of the overall subscriber base, but we've learnt from newspapers how quickly these small shifts can escalate.

Foxtel showed a handy 5% increase in subscriber numbers over the year to December, to 2.7m, helped by its November price cuts and a reduction in churn from 12.8% to 11.8%. In Australian dollar terms, second-quarter revenue was flat and EBITDA grew 2%, although EBITDA fell 6% when translated into US dollars.

Smart TV

Who's to say how the battle for viewers will play out, but we'll make a few tentative predictions. First of all, the distinction between different delivery mechanisms – such as online, cable and satellite – will soon become meaningless, which is a problem, particularly, for the large cable incumbents. Second, there will still be a need for some kind of aggregator. Viewers value convenience and they'll want to be able to access multiple channels in one place with similar recording and other controls. One of the more (shall we say) 'innovative' projections for TV is that it will follow us around the house, from bathroom mirror, to tablet, to fridge door, to living room – perhaps suggesting an appropriate range of content for each location (something relaxing in the bath and a news show on the fridge).

To achieve this kind of thing effectively will surely require some kind of content distributor. Foxtel is already venturing online with its Foxtel Play and Foxtel Go products and, with its 2.7m subscribers, is as well placed as anyone to make a go of this kind of thing. But so is Netflix and so are a bunch of others. At worst, Foxtel could be frozen out entirely and at best it'll be one of a number of providers in a much more competitive market. So there are opportunities in all of this, but the threats look bigger.

The news is better in Book Publishing, which has been growing quickly, with the internet actually providing a boost due to the higher margins on e-books. In the December quarter the division was up against a very strong prior period, but still managed to increase EBITDA 6%, excluding Harlequin Enterprises (acquired for US$414m in August).

There's also some option value in the newly acquired US real estate portal, Move, which is performing well in terms of metrics if not profit (with traffic up 37% in January from a year earlier), and the US digital education business, which has been making losses as it invests in digital curriculum content, but which could end up being worth the $1bn or so that's been poured into it.

All up, News Corp's ragbag of businesses still looks cheap, but it is a ragbag and we're not inclined to chase it any higher. So, with the stock up 11% since News, REA make Move on US real estate on 1 Oct 14 (Speculative Buy – $18.62) and now above our buy price, we're downgrading to Hold. With the risk slightly higher, due to the conversion of US$750m cash into Move and the increased reliance on REA's valuation, we're also nudging our maximum recommended portfolio weighting down from 5% to 4%. HOLD.

Note: Our model Growth Portfolio owns shares in News Corp.

Disclosure: The author owns shares in News Corp.