News Corporation is cheap but it requires a leap of faith. Quite a big leap, in fact. You’re betting that Rupert Murdoch and the intelligent people he employs are right, and that the market is wrong.
So far the market is winning. Since we upgraded the stock in The not-so-bad News a year ago, it has fallen 21%. The decline would have been worse had the share price of its largest investment, the 62%-owned REA Group, not risen 42% over the same period.
The Digital Real Estate division, which includes REA and Move, is the only division that isn’t troubled. Here we’ll concentrate on the ones that are, but remember that digital real estate accounts for almost US$4.4bn of value in our base case valuation (see Table 1). Not only is it News Corp’s best asset, it’s worth a truckload.
Digital real estate a wonderful business
Other assets facing challenges
Trouble or nothing?
News and Information Services (NIS) is perhaps the most troubled of all. It’s a vast, global business, with revenues of more than US$5bn. It includes all News’ Australian, British and American mastheads, the News America Marketing insert and coupon business and Dow Jones, which contains the Wall Street Journal and a suite of professional and market information products.
NIS is suffering as advertising revenues shift away from old media. In the most recent quarter, advertising revenues declined 11%. Continuing weakness means we’re expecting divisional earnings before interest, tax, depreciation and amortisation (EBITDA) of around US$470m for 2016, down 50% since 2012. That’s certainly worse than expected, so it’s little wonder the stock has been weak.
But NIS’s management isn’t forsaking old media. Quite the contrary; it’s actually making acquisitions. NIS recently acquired APN News and Media’s regional newspaper business for US$27m, or just two times EBITDA. The recent US$290m takeover of UK radio group Wireless Group plc is harder to fathom on a seemingly pricey 19 times EBITDA, although earnings will grow as recently launched stations mature.
|Division||2016E EBITDA for valuation (US$m)||Multiples: Low /Base /High||Low value (US$m)||Base case (US$m)||High value (US$m)|
|News and Information Services||469||3/5/7||1,407||2,345||3,283|
|Foxtel (50% share)||290||4/6/8||1,160||1,740||2,320|
|Cable Network Prog. (Fox Sports)||124||4/6/8||496||744||992|
|Digital Real Estate Services|
|REA Group stake||$A40/$60/$70||2,402||3,603||4,203|
|Business value after corp. costs||4,635||8,694||12,028|
|Less share of Foxtel debt||(860)||(860)||(860)|
|Less other liabilities||(330)||(330)||(330)|
|Average per NWS share ($US)||9.38||16.37||22.11|
|Average per NWS share ($A)||12.68||22.12||29.88|
Acquiring APN and Wireless Group might seem incongruous but they do fit within News Corp’s strategy. Management will presumably cut costs at APN but, more importantly, these days community and regional newspapers are becoming vehicles for real estate advertising. Wireless Group has the radio rights to the Premier League and owns talkSPORT, the leading sports radio network in the UK, which NIS can cross-promote in The Sun. Both real estate advertising and sports broadcasting are core markets for News Corp.
NIS management certainly isn’t ignoring the shift to digital. At Dow Jones, digital revenues account for more than 50% of the total, and 45% of Wall Street Journal subscribers are digital-only. Over the past year the division has acquired digital coupon company Checkout 51 and video distribution platform Unruly. Both will help make its existing marketing and media businesses stronger.
Our base case in Table 1 suggests NIS is worth US$2.3bn but in a break-up it would be significantly more. Dow Jones might fetch that much alone.
Like NIS, Foxtel and Fox Sports are similarly challenged as customers seek out content elsewhere. For our purposes we’ll consider them as one business because they’re inextricably linked. Indeed, rumours persist that Foxtel and Fox Sports will be merged ahead of a combined 2017 public float.
Overseas, sports network ESPN – owned by the Walt Disney Company – is struggling. Subscriber numbers peaked at 100m in 2011 and are expected to slide to 88m by the end of 2016. However, Foxtel’s decision to unbundle its subscription options mean it is gaining subscribers (albeit slowly).
Foxtel and Fox Sports remain very profitable businesses. Together they will generate more than US$400m in EBITDA for News in 2016*. Yes there’s uncertainty, not least of which is how Foxtel/Fox Sports will recoup the US$1.6bn it will pay to the NRL and ARL for broadcasting rights over the 2017-2022 period. As we said in News Corp on the Move, though, Rupert Murdoch didn’t acquire the rights to lose money.
In our base case valuation, we’ve allowed for Foxtel and Fox Sports to be worth a combined US$2.5bn. In the event of a public float they should be worth at least that much (consistent with other valuations we’ve seen).
Book Publishing is less structurally challenged than the other divisions. People are still reading printed books and e-book sales are much more profitable than print in any case (see Old Murdoch, new News).
In 2016 Book Publishing should generate around US$165m in EBITDA, down 25%. That’s mainly a function of the strong publishing year that was 2015 and what is likely to be a temporary industry-wide downturn in e-book sales. We’ve allowed US$1.3bn for the Book Publishing division but, when you consider News Corp paid US$414m for romance publisher Harlequin alone, it’s probably on the low side.
See you in court
Ignoring but not forgetting Digital Real Estate, as we mentioned earlier, News Corp’s dwindling cash pile is also causing market concern. Litigation isn’t helping, with the company winning a US$117m legal settlement from Zillow but paying out US$280m to settle litigation at News America Marketing.
We’ve deducted the latter in our valuation but the US$290m acquisition of Wireless Group will reduce the ‘Cash’ figure again. The market remains sceptical about the various acquisitions because the long-term benefits are being obscured by their absorption into much larger divisions.
The sum-of-the-parts valuation in Table 1 is derived from earnings. So as those earnings have come down, so have the valuations that drop out the bottom (compared with the table in News Corp on the Move). For that reason we're adjusting our price guide numbers down slightly.
Do not be unduly concerned. A break-up or asset-based valuation would produce higher figures. And management will not stand idly by while earnings erode to zero.
Even if it did, we can afford for one or even two divisions to be worth nothing without this recommendation being a complete disaster. If NIS was worth zero in our base case, our valuation would be $16.70 a share. If Foxtel and Fox Sports were also worth zero, our valuation would be $12.90. A wipe-out of all three divisions is difficult to imagine and yet, even in that dire scenario, the valuation would be only 20% underwater from the current share price.
News Corporation’s wonderful Digital Real Estate business, together with its cash, effectively justifies more than 80% of the company’s market capitalisation. You get the remaining businesses – with revenues of around US$7bn – for not much more than US$1bn.
Yes, buying structurally challenged businesses is difficult. But there’s clear value in this unusual conglomerate. Yes, there’s a risk if earnings continue to plummet. But that will likely force some type of corporate restructure. And yes, we’ve been harping on about News Corporation for a while. But at less than $16 this is a compelling opportunity. BUY.
*Note that Foxtel is 50% owned, so News has no direct interest in its cash flow.
Note: The Intelligent Investor Growth and Equity Income portfolios own shares in News Corporation. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.