Description

We believe that FOX Corporation (FOX/FOXA) is very cheap and that transparency for the first time since the Disney acquisition announcement at the end of 2017 will allow for valuation realization to commence in the next few weeks.

FOX Corporation (FOX/FOXA) has an offering of “must have” networks that are largely immune from being dropped, tiered, or a la carted both by traditional distributors or newer virtual ones. If you don’t believe us then maybe you can trust Netflix, who is at the forefront of video content creation and delivery. Here is what they wrote in their 3Q18 letter to shareholders: “New FOX appears to have a great strategy, which is to focus on large simultaneous-viewing sports and news. These content areas are not transformed by on-demand viewing and personalization in the way that TV series and movies are, so they are more resistant to the rise of the internet.” Out of nowhere, Netflix just decided to talk about FOX’s “great strategy”.

It is our opinion that the purging of weaker hands and event driven shareholders that were “playing” the DIS / FOX situation is largely complete at this point and that the coast is relatively clear to step in – especially ahead of the company’s first Investor Day in a few weeks (May 8th). FOX has largely been silent on any sort of material forward outlook for the last 16 months since Disney announced the acquisition of Twenty-First Century Fox, outside of warning investors of decelerating yr/yr affiliate fee growth in 2H19 just before their stock grant date. Was the timing random? We think not given it had an impact on their $125m+ stock grant. In any event, the Investor Day will be FOX’s first real chance to lay out their unique set of assets, plans for the future, and capital allocation priorities. We think that they have an exciting, differentiated story to share.  

The opportunities for the company can really be boiled down to three major categories: price increases, cost takeout and capital allocation. Pricing is on the cable and broadcast side and cost takeout is from general entertainment programming. For now, we model in share repurchases going forward in order to keep leverage steady at a stock price that grows 10% per year. We think that the combination of these three drivers results in CY21 FCF/sh that is approximately 25% ahead of Street estimates today.

• Pricing

In FOX’s own words: “We create and produce high quality programming that delivers value for our distributor customers, affiliates and viewers, and we intend to receive appropriate value for our content. We are optimistic about our ability to grow revenue from the distribution of our content.”

Cable networks (85% of EBITDA), and in particular FOX News / FOX Business (~three-fourths of total company EBITDA), will continue driving price. FOX News continues its 17-year run as the most-watched network on cable television. We believe that after the comp deceleration in 2H19 off of a difficult comp (large 3Q18 renewal), affiliate fee trends will revert to a high single digit growth rate in FY20. This should contribute roughly $1b of revenue growth through CY21.

FOX Broadcast (15% of EBITDA) has been undermonetized and we expect very high growth in retransmission fees – a doubling in fees per subscriber (from $1.70) wouldn’t be a surprise over the next several years. FOX owns 28 TV stations and also has ~200 affiliates that pay FOX a fixed programming fee. The lack of monetization versus broadcast peers to date and a wider portfolio of sports rights gives FOX strong positioning. This could contribute over $1b of revenue growth through CY21.

• Cost takeout

We have not heard a lot of discussion around this opportunity. Everyone talks about rising costs for sports as their portfolio continues to broaden, but these slots are being consumed in exchange for entertainment programming. Costs for entertainment programming don’t just continue if their slots are being swapped for something else. In the company’s own words, “it makes sense to control our spending – we’ll work to right size what’s going on there.” Things start to get interesting in the Fall when Thursday Night Football (TNF) takes the Thursday slot, WWE on Friday, Saturday / Sunday sports (baseball, college football, college basketball, etc), Sunday animation, so FOX is only left with primetime content spend Monday through Wednesday. We don’t have conviction in a specific dollar amount, but we strongly believe the earnings surprise (vs current Street consensus) from entertainment cost takeout will be to the upside. Again, we will likely receive more clarity at the Investor Day.

• Capital Allocation

There has been no discussion from FOX to date around capital allocation, but FOX’s underleveraged balance sheet and excellent FCF conversion provides immense opportunity. At these prices, we hope that FOX buys back a lot of stock and we would not be surprised to see a dividend and repurchase announcement soon. For now, we model that FOX keeps its balance sheet leveraged sub-2x through CY21. This results in a 26% reduction in share count by the end of CY21.

Tax assets, ROKU, Real Estate

As a result of the separation and the distribution through the Disney transaction, FOX adjusted its asset tax base to fair market value. This will result in approximately $1.5 billion of tax shield per annum over the next 15 years. This equates to a roughly $360 million per year reduction in cash taxes. Utilizing a DCF at a 10% discount rate, this equates to $6.00/sh of value.

FOX also has some other unique assets like a 5% stake in ROKU ($300m value pre-tax) and a studio lot in LA worth well in excess of $1b using CBS’s own studio sale as a comp. The combined value is roughly $2.50/sh.

Valuation

Most people compare FOX Corp to CBS. We understand the logic and it makes sense given the similar mix of cable and broadcast “must have” offerings. Further, Street EBITDA growth estimates are rather similar for the next several years. Comping to CBS also takes into account sports rights competition and TV bundle risks, especially if CBS/Viacom merge. Lastly, we also think that CBS is cheap, but not as cheap as FOX.

However, some material items distinguish FOX from CBS to argue for a higher valuation multiple at FOX:

• Cash conversion. One thing we rarely hear discussed when comparing CBS to FOX is free cash flow conversion. Year after year, there is a very large negative inventory and program rights adjustment at CBS to arrive at true free cash flow. This line item has averaged 24% of EBITDA over the last 3 years versus 7% for FOX. That’s 17% less EBITDA-to-FCF conversion. Benjamin Swinburne at Morgan Stanley is one of the few to call this out. In a CBS note recently he wrote: “We note that continued spending on content will likely continue to weigh on FCF, with the gap between EPS and fully taxed FCF remaining wide.”

• Tax assets. CBS has $1.7b of Federal, State and Local NOLs. FOX has $1.5b of tax shield per annum…for the next 15 years.

• Less leverage. FOX’s leverage is 1.2x less that of CBS at 1.7x, providing for greater capital allocation flexibility, earnings per share growth potential, and margin of safety should an economic downturn occur.

• Viacom. We don’t know what will happen with the CBS / Viacom saga, but we know that Viacom’s assets inside of CBS would most certainly dilute their post-synergy EBITDA multiple given Viacom’s assets are largely not “must have”. Even if synergies are big, the confusion at CBS right now is driving an unquantifiable amount of multiple compression.

Normalizing CBS for consistent outsized inventory working capital adjustments, we estimate that FOXA should currently be valued 25%-30% higher today without giving credit for future capital allocation. We adjust FOX for the high end of its recent 3-year inventory adjustment, while use the 3-year average for CBS. We apply no multiple premium to FOX for lack of a Viacom saga or lower leverage or future cash generation. In this analysis, FOXA should be worth close to $50/sh.

When giving credit for FOXA’s prolific FCF conversion / generation, the upside scenario is stimulated. We use price-to-FCF/sh here to give credit for future FCF generation. We assume that CBS ends the modeled period (CY21) close to FOXA’s CY21 leverage, but still slightly higher by 0.2x. In this analysis, FOXA should be worth close to $60/sh.

Quick 101

Fox Corporation or “New Fox” is comprised primarily of The FOX News Channel, FOX Business Network, FOX Broadcasting Company, FOX Television Stations Group, FS1, FS2, FOX Deportes and Big Ten Network. FOX’s primary revenue comes from affiliate fees for transmission of its content and advertising sales. Affiliate fees primarily include (a) monthly subscriber-based license and retransmission consent fees paid by programming distributors that carry FOX’s cable networks and FOX’s owned and operated television stations and (b) fees received from television stations that are affiliated with the FOX Network. For fiscal 2018, FOX generated revenues of $10.2 billion, of which approximately 48% was generated from affiliate fees, 45% was generated from advertising, and 7% was generated from other operating activities, such as content licensing fees.

Addendum on the Business from FOX’s Form 10:

Brands

FOX News: The top-rated national cable news channel in both primetime and total day viewing. FOX News has held its number one status for 67 consecutive quarters, according to The Nielsen Company (US), LLC and its affiliates, or Nielsen. FOX Nation launched in 2018 as an over-the-top streaming service to deliver premium content complementary to FOX News directly to consumers.

FOX Business: A business news national cable channel. Fiscal 2018 was the highest rated year ever for FOX Business, and, as of September 2018, it has had eight consecutive quarters as the most-watched business network by total business day viewers, according to Nielsen.

FS1: A multi-sport national network featuring over 830 live events during calendar year 2018. FS1 also features FOX Sports Films and opinion shows such as Skip and Shannon: Undisputed, The Herd with Colin Cowherd, First Things First and Speak for Yourself with Cowherd and Whitlock.

FS2: A multi-sport national network featuring approximately 400 live events during calendar year 2018. FS2 programs include the National Association for Stock Car Auto Racing, or NASCAR, college football, college basketball, rugby, Australian rules football, world-class soccer, and motor sports.

Big Ten Network: The Big Ten Network televises approximately 520 live collegiate events annually, studio shows and other original programming associated with the Big Ten Conference. FOX owns an approximate 51% interest in the Big Ten Network.

The FOX Network: A premier national television broadcast network, renowned for disrupting legacy broadcasters with powerful sports programming and appealing primetime entertainment. FOX regularly delivers approximately 15 hours of weekly primetime programming to 208 local market affiliates, reaching approximately 99.9% of all U.S. television households. The FOX Network has ranked among the top two networks in primetime entertainment in the 18 to 34 year old audience for the past 23 years (1995-1996 to 2017-2018 broadcast seasons).

• Sports: The FOX Network had more minutes of live sports event viewership than any other network in 2017, which includes the broadcast of the National Football League, or the NFL, Major League Baseball, or MLB, Fe´de´ration Internationale de Football Association, or FIFA, NASCAR and the United States Golf Association, or USGA, events on FOX. In 2017, the FOX Network produced 22 of the 50 most-watched shows on broadcast television, more than any other network. FOX recently extended its exclusive rights to broadcast certain premier MLB content, including the World Series and All Star Game, through the 2028 MLB season. FOX also expanded its domestic sports rights to include NFL Thursday Night Football, WWE SmackDown Live, and Premier Boxing Champions.

• Entertainment: With such compelling shows as The Simpsons, Empire, and 9-1-1, the FOX Network programs primetime entertainment targeted at the coveted 18 to 49 year old audience. The FOX Network’s primetime entertainment lineup accounted for seven of the 2017-2018 broadcast season’s top 20 new broadcast entertainment series, more than any other network. Empire ranked among the 2017-2018 broadcast season’s top five broadcast dramas in the 18 to 34 year old audience.

FOX Television Stations: FOX owns and operates 28 full power broadcast television stations in the U.S. These include stations located in nine of the top ten largest designated market areas, or DMAs, and duopolies in 11 DMAs, including the three largest DMAs (New York, Los Angeles and Chicago). Of these stations, 17 are affiliated with the FOX Network. In addition to distributing sports, entertainment and syndicated content, FOX’s television stations collectively produce nearly 1,000 hours of local news every week.

Segment Reporting

FOX’s operations are organized into two main reporting segments: Cable Network Programming, which consists of the production and licensing of news and sports programming content, distributed primarily through cable television systems, direct broadcast satellite operators, telecommunication companies and online video distributors primarily in the U.S.; and Television, which is engaged in the operation of broadcasting FOX Television Stations and the acquisition, marketing and distribution of broadcast network programming nationally under the FOX brand. FOX reports the results of other businesses and operations, which will include the FOX Studios lot in Los Angeles, California, in our Other, Corporate and Eliminations segment.

Cable Network Programming

The Cable Network Programming segment produces and licenses news, business news and sports content for distribution primarily through cable television systems, direct broadcast satellite operators, telecommunications companies and online video distributors primarily in the U.S. The businesses in this segment include FOX News, FOX Business, and FOX’s primary cable sports programming networks FS1, FS2 and Big Ten Network.

Television

FOX’s Television segment acquires, produces, markets and distributes broadcast network programming nationally under the FOX brand and the operation of 28 full power broadcast television stations in 17 local markets. The FOX Network regularly delivers approximately 15 hours of primetime programming per week, targeted at the coveted 18 to 49 year old audience. The FOX Network enjoyed more minutes of live sports event viewership than any other network in 2017 with its leading sports slate of NFL, MLB, NCAA and FIFA programming. During the 2017-2018 broadcast season, the FOX Network’s primetime entertainment lineup accounted for seven of the season’s top 20 new broadcast entertainment series, more than any other network, including 9-1-1, The Orville, The Gifted, and The Resident. For several years a mainstay of FOX’s primetime lineup has been FOX’s popular animated series on Sundays with such perennial hits as The Simpsons, Family Guy and Bob’s Burgers. FOX’s programming strategy translates into the youngest median audience age among the four major broadcast networks.

FOX Television Stations owns and operates 28 full power broadcast television stations, which deliver broadcast network content, local news and syndicated programming to viewers in 17 local markets. These include stations located in nine of the top ten largest DMAs and duopolies in 11 DMAs, including the three largest DMAs (New York, Los Angeles and Chicago). Of the 28 full power broadcast television stations, 17 stations are affiliated with the FOX Network. These stations leverage viewer, distributor and advertiser demand for the FOX Network’s national content. In addition, the FOX Network’s strategy to deliver fewer hours of national content than other major broadcasters benefits stations affiliated with the FOX Network, which can utilize the flexibility in scheduling to offer expanded local news and other programming that viewers covet. FOX’s 28 stations collectively produce nearly 1,000 hours of local news every week.

Other Businesses

FOX also owns the FOX Studios lot in Los Angeles, California. The historic lot currently provides over 50 acres of land and 1.5 million square feet of built space for both administration and production services, including 15 sound stages, four scoring and mixing stages, two broadcast studios, theaters, editing bays, and other production facilities. Following the distribution, the FOX Studios lot will provide two revenue streams—the lease of office space to RemainCo and the operation of studio facilities for third party productions, which initially will predominantly be to Disney. The results attributable to the FOX Studios lot will be reported in FOX’s Other, Corporate and Eliminations segment.

Catalyst

• Investor Day May 8
• Buyback / dividend announcement
• Cable affiliate revenue growth
• Broadcast retrans / reverse comp growth
• Entertainment cost takeout