Rupert Murdoch is not in the habit of losing money. (Except when it’s necessary to run his treasured but loss-making newspaper The Australian, but that’s another story.)
Witness News Corporation’s decision to pull the plug on digital education business Amplify four months ago. Amplify burnt through $200m in cash in the 2015 financial year. With poor take-up by schools and ill-conceived proprietary hardware, Murdoch realised News Corp had stuffed up. Amplify was sold on 30 September.
So what does Murdoch’s loss aversion mean for News Corp’s two most important businesses: pay television and digital real estate? That’s what we’ll explore in this review, before concluding with an update to the sum-of-the-parts valuation outlined in The not-so-bad News from 24 Feb 15 (Buy – $19.84)?
Foxtel penetration improving slowly
Move's performance exceeding expectations
Diversification and Aussie dollar helping
There’s no doubt pay television provider Foxtel – of which News owns 50% - faces structural challenges. Netflix and other subscription television services – with plans from around $10 a month – have forced Foxtel to unbundle its packages. Foxtel’s average revenue per user was $93 a month in 2015 but that figure looks destined to fall.
Foxtel’s management needs household penetration to rise. At around 30%, pay TV penetration is much lower in Australia than the US, where it stands at 83% of households. Foxtel grew subscribers from 2.7m to 2.9m over the nine months to 30 September 2015 by unbundling its packages, which now start at $25 a month (plus installation).
Where Foxtel has a significant competitive advantage over other subscription television services is in sport broadcasting (the minimum charge for Foxtel’s ‘sports combo’ is now $50 a month). Although Australia’s anti-siphoning laws mean free-to-air networks have priority when bidding for sports broadcasting rights, Foxtel has the widest range and best coverage of sport.
To keep people subscribing, there are some sports Foxtel absolutely must broadcast. That’s why Fox Sports – News Corp’s ‘Cable Network Programming’ division – recently bid a combined $2.2bn for the AFL and NRL pay TV rights until the end of the 2022 seasons. The AFL called the deal ‘colossal’.
Some say News Corp overpaid, with the AFL rights for the 2017-2022 seasons costing 67% more than the rights to the 2012-2016 seasons. But broadcasting rights have generally soared over time everywhere, including internationally. The prior three five-year AFL seasons saw rights jump by 150%, 50% and 67% respectively.
It’s impossible to forecast exactly how much money News Corp will make from its $2.2bn investment. What you can be sure of is that Murdoch didn’t sign these deals to lose money. If sport fans want to watch sport it will cost them, whether it’s through watching advertising or paying subscription fees.
|Division||2015 EBITDA for valuation (US)||Multiples: Low /Medium /High||Low value (US)||Medium value (US)||High value (US)|
|News and Information Services||603||3/5/7||1,809||3,015||4,221|
|Foxtel (50% share)||380||4/6/8||1,520||2,280||3,040|
|Cable Network Prog. (Fox Sports)||135||4/6/8||540||810||1,080|
|Digital Real Estate Services|
|REA Group stake||/$50/$60||2,045||2,840||3,408|
|Business value after corp. costs||5,090||9,325||13,209|
|Less share of Foxtel debt||(813)||(813)||(813)|
|Less other liabilities||(357)||(357)||(357)|
|Average per NWS share ()||10.53||17.82||24.51|
|Average per NWS share ()||15.05||25.46||35.01|
News Corp isn’t infallible of course. Fox Sports recently lost the broadcasting rights to the English Premier League to Optus. While News Corp management downplayed the loss, Foxtel will probably lose subscribers from the 2016/17 season because of it.
In the first quarter of 2016, Foxtel’s Australian dollar EBITDA fell 21% (38% in US dollars). News Corp’s management attributed most of this to one-off factors and is still (a little too?) confident that Foxtel’s earnings will rise this financial year.
To reflect the structural challenges and rising cost of broadcasting rights, we’ve decided to reduce the low, medium and high multiples for Foxtel and Fox Sports in our sum-of-the-parts valuation (see Table 1). One fact remains: dedicated sport fans will need a Foxtel subscription for the foreseeable future.
Digital real estate
While News Corporation’s pay television businesses are arguably weakening, its digital real estate businesses are doing just the opposite. The 62%-owned REA Group is without question the jewel in News Corp’s crown. Further analysis suggests we’ve been under-estimating REA’s ability to keep lifting prices and over-estimating the effect of a possible downturn in listing volumes.
REA’s share price surge to more than $50 reflects the quality of the business but takes it further away from an upgrade. Our $36 buy price now looks too optimistic. We’ve revised our low, medium and high values for News’ stake in REA upwards to reflect share prices of $36, $50, and $60 a share respectively.
In time, though, Move – which operates realtor.com in the US – could be even more important to News Corp’s valuation. Management is extremely pleased with the performance of Move since its 2014 acquisition, with 2016 first quarter revenue rising 33%. Compare that to Zillow, the US number one real estate website, where revenue rose 13% in the same period.
The improvement in Move’s performance reflects its reinvigoration under News Corp’s ownership. The realtor.com home page has been revamped (does anyone else think it looks suspiciously like domain.com.au?) and there’s a new focus on editorial content. Importantly, as management forecast at the time of acquisition, the company is driving traffic to the website from its collection of premium media sites.
Move’s ultimate business model isn’t yet clear. The US real estate listings market is different from Australia but one thing is clear. Realtors in the US are generally unhappy with market leader Zillow, so Move’s relationship with the National Association of Realtors could be a source of competitive advantage.
Management expects Move to become EBITDA positive in 2016, with further improvement in 2017. We’ve maintained the same values for Move in our sum-of-the-parts valuation, but there’s certainly long-term upside here.
Same but different
Let’s turn to the remaining divisions in our sum-of-the-parts valuation. We’ve converted everything to US dollars, News Corp’s reporting currency, before converting back to a per-share Australian dollar valuation at the end. Remember this if you’re comparing it to the sum-of-the-parts valuations produced previously.
We’ve maintained the same multiples for the News and Information Services division as before, although we reiterate that revenues and earnings from this division are likely to continue declining over time. We have however reduced the medium and high multiples for the Book Publishing division, primarily to reflect the strong year that was 2015.
|News and Information Services||83||105||(20)|
|Foxtel (50% share)||140||225||(38)|
|Cable Network Prog. (Fox Sports)||28||32||(13)|
|Digital Real Estate Services||57||57||N/a|
The net effect is that the valuations per share are largely unchanged. In fact, the low valuation has increased slightly because Amplify has been sold. So why has News Corporation’s share price fallen 7% since The not-so-bad News from 27 Jul 15 (Buy – $19.84)?
It’s probably because the market expects earnings to fall in 2016. All divisions except digital real estate reported lower first quarter earnings (see Table 2). The market remains concerned about how the structural issues in pay television will play out while, in the book publishing division, there seems to have been an industry-wide downturn in e-book sales.
You should expect News Corp’s earnings to swing about, which is why it’s better to analyse the company on a sum-of-the-parts basis. Some divisions are facing structural challenges, it’s true, but News Corporation is a very diversified business. Don’t under-estimate management’s ability to use the company’s media properties to increase – or at least protect – the value of its other businesses.
Management thinks the stock is underpriced, with the company buying back more than three million shares since the buyback commenced in May last year. We agree, and the fact the share price has fallen 5% since News Corp: Result 2015 from 13 Aug 15 (Buy – 19.59) at the same time as the Aussie dollar has fallen improves the value on offer. The recommendation remains BUY.