News Corp: The juice in the split

You didn't have to even read the entire article to get a feel for why we upgraded News Corp on 25 Oct 10. The initial premise in Breaking news: There's value in News Corp (Long Term Buy  - $14.61) was neatly summed up in the precede: 'Investors are currently getting a chance to buy News Corp on the cheap. And the fact that Murdoch won’t be around forever need not hold you back. It may even be a good thing.'

Murdoch hasn't resigned and may well attempt to manage this business from beyond the grave, once he's cryogenically frozen at the age of 114. But there are plans for the next best thing. Yesterday, a simple, one-sentence press release to the Australian market said, ‘News Corporation confirmed today that it is considering a restructuring to separate its business into two distinct publicly traded companies.’

A special board meeting, to be held around the time of this review, looks set to explore or vote on the issue of separating News Corp’s film, cable programming and television assets from the newspaper and other assets. If it’s already discussed in a press release, though, it’s probably a fait accompli. We don’t know exactly what will fall where in the split, but strongly support the general idea.

Newspapers are a dying business. For News Corp, they have in recent years delivered Murdoch political power but not much in the way of profits. The stench of the phone hacking scandal, the prosecutions, the manipulation of politicians and the bribery of police has done much to reduce that influence. Murdoch and the board now look likely to succumb to commonsense and set these devalued, troubled assets free.

That may well lead to someone else, seduced by ink and influence, to lose large sums of money before an eventual collapse. For current shareholders, that's a welcome outcome. Murdoch's love of newspapers has cost shareholders plenty of late. In essence, this plan offers a possible escape route from the poor businesses and a revaluation of the good ones. 

In News Corp’s midtown Manhattan headquarters, other plans have emerged over the past few weeks. The company made a proposal to acquire Consolidated Media Holdings in an all-cash offer of $3.50 per share. The deal, set to be supported by Consolidated Media’s board (including James Packer, who has been interested in selling for a while) in the absence of a better offer, will increase News Corp’s stake in Foxtel to 50%, making it equal partners with Telstra. It will also deliver 100% ownership of Fox Sports Australia.

The offer has a few hurdles to clear, including the intentions of Consolidated’s 24.4% shareholder Seven Group Holdings and also regulatory approval. The $2bn price tag looks like a big deal, but it’s small change compared with News Corp’s $51bn market capitalisation and US$9bn of cash in the bank.

Conglomerate discount

Despite the share price rise over the past year, there remains the possibility of a conglomerate discount in the current price. In a perfectly efficient market, demergers wouldn’t add anything to underlying value. But in the real world—a world of conglomerate management inefficiency, commitment bias and sloppy investment analysis—they often do. A good, recent example is that of the Foster’s Group demerger.

A News Corp split in particular would shine a light on the more valuable parts of the empire, especially Cable Network Programming, and perhaps allow a more complete recovery from the phone tapping scandal.

With the class A shares up 50% since our initial upgrade in Breaking news: There's value in News Corp of 25 Oct 10 (Long Term Buy – $14.61) over a time when the All Ords Accumulation Index has fallen nearly 10%, this has been one of our more successful blue chip recommendations of late. But a demerger may well help us crystallise better value more quickly.

The shares are up 15% since News Corp: Scandal 2.0 (Hold – $19.16) and remain a HOLD.

Note: The Growth portfolio owns News Corp non-voting A-class shares.

Note: Not long after this review was published, News Corp confirmed that the demerger had been approved. Detailed plans won’t emerge for some time, and the separation is likely to take 12 months to execute. Obviously, we’ll follow further announcements closely.