Description

News Corp. (NWSA)

Recommendation:

Buy shares of current News Corp (NWSA) today, and then buy additional shares of “new” News Corp (NWSAV) tomorrow, Wednesday June, 19^th when the shares start when-issued trading assuming that they begin trading in the high teens $/share range as expected, or below.  I believe this strategy allows you to buy 21^st Century Fox right now at an attractive price (~10.5x EBITDA for a high-quality business that is growing nicely, returning cash to shareholders, and could accelerate shareholder returns with more aggressive use of the balance sheet post-spin) and get the “new” News Corp essentially for free, and then to accentuate your returns by adding to the “new” News Corp position when it begins trading cheaply in the when-issued market.

Description:

News Corp is a diversified media business that is currently undergoing a tax-free 100% spin-off of its News & Information Services assets, as well as some Australian diversified media assets.  The result will be two different publicly-traded companies: the remainco, 21^st Century Fox, and the spinco, the “new” News Corp.  The securities start when-issued trading (tickers FOXAV and NWSAV) on June 19^th, and the transaction will be completed on June 28^th, at which time shareholders will receive one share of the spinco, the “new” News Corp, for every four shares of the legacy entity held pre-spin.

21^st Century Fox will consist mainly of the company’s cable networks, film and television production studios, Sky Italia, cash, debt, pension, as well partial stakes in assets like BSkyB, Sky Deutschland, YES Network and Hulu. The main wholly owned properties are cable channels like FOX, Fox News, Fox Sports, National Geographic, and production studios like 20^th Century Fox Film and 20^th Century Fox Television.  When factoring in the non-wholly owned assets, the new entity will not have any net leverage.

The “new” News Corp will consist mainly of the company’s News and Information Services assets, the Book Publishing assets, some Australian diversified media assets, as well stakes in other assets, cash and a small pension liability.  The News and Information Services assets consist mainly of Dow Jones and News International with brands and papers such as The Wall Street Journal, Barrons, The Sunday Times, The Sun, the New York Post and others.  The Book Publishing assets are mainly HarperCollins.  The Australian operations consist mainly of Foxtel, Fox Sports Australia, some Australian print media assets and a digital real estate media asset.  The company will also own 100% of Amplify, an education services company, which I am valuing at zero.  When factoring in the non-wholly owned assets, the new entity will not have any net leverage.

Opportunity:

I think that pattern recognition is key to successful investing; Nick Howley and TransDigm today parallel the strategy and success that Tom Murphy and Capital Cities had in the 70’s-90’s; Liberty Ventures spin last summer from Liberty Interactive paralleled the structure and success of the Liberty spin from TCI in 1991.  I think that the “new” News Corp spin parallels the Starz spin that occurred just this past January.

In early January, Liberty Media completed the spin of Starz.  Similar to the News Spin, the aim of the transaction was to simplify the corporate structure of the combined entity, and the separate the smaller “bad” business from the larger “good” business.  Two things of note happened when when-issued trading began.  First, after the first day of when-issued trading the combined when-issued stocks represented a 3-4% gain vs the consolidated entity the previous day.  Second, the “bad” business began trading cheaply, at ~6x EBITDA.  Over the course of the next several months, another two things happened.  First, the “good” business, the new Liberty Media, saw its shares appreciate to a level above the combined entity pre-spin.  This was despite little appreciate in the shares of SIRI, so largely reflected a narrower discount to NAV, and essentially meant that pre-spin you had bought Starz for free.  Second, the shares of Starz appreciated by ~65% as the multiple expanded (it should be noted that Starz was spun with ~2.5x leverage, while “new” News will be net cash, and thus the equity returns at News are likely to be more muted).  I think the multiple expansion at the “bad” business occurred due to the fact that despite the fact that the business faces some structural challenges, it is still high margin and low capital intensity, and thus throwing off significant cash flow.  The “new” News Corp should also generate a significant amount of cash flow.

To summarize the pattern recognized in the Liberty/Starz transaction, and what I think is occurring at News Corp, pre-spin you could buy the “good” business at a fair price and get the “bad” business for free, and then buy more of the “bad business” again very cheaply in the when-issued market.  Simplification of the corporate structure, and multiple appreciation at the “bad” business drove strong returns for Liberty/Starz investors, and I think will do the same for News Corp investors.

Valuation:

Based on commentary from sell-side research, I expect the shares of FOXAV and NWSAV to start trading in the high twenties and high teens, respectively.

I value FOXAV at ~$31/share, by putting a cable network peer multiple of 11.5x (EBITDA) on their cable networks, a diversified media peer multiple of 9x on their film and television assets, and a DBS peer multiple of 8x on Sky Italia.  I also mark to market the BSkyB, Sky Deutschland and Phoenix Satellite stakes, and use book or estimated values for their YES, Hulu and other investments.

I value NWSAV at ~$24.50 in my bull case.  The difference here relative to where I expect the shares to begin trading, is the multiple ascribed to the news and publishing assets.  While I expect them to begin trading at a ~6x multiple, as was the case with Starz, I think they have the potential to revalue towards ~8x as the markets realize the businesses are more sustainable than previously thought, and are throwing off significant cash flow.

For every dollar to available to invest, I target buying approximately ~$0.60 of NWSA pre-spin, and ~$0.40 of NWSAV post-spin.  This should result in similar-sized FOXAV and NWSAV positions at initial prices, and then deliver a combined return of ~25% based on my valuation expectations.  I think it’s worth noting that those are near-term expected returns, and that FOXAV has strong prospects for compounding at an attractive rate over the coming years.

Risks:

FOXAV:  I think the biggest structural risk to 21^st Century Fox is the potential for content pricing to be disrupted as cable companies transition from a focus on video to a focus on broadband, thus disrupting the current walled-garden / bundling dynamic that seems favorable to content owners.

NWSAV:  I think the biggest structural risk to the “new” News Corp is a faster than expected decline in fundamentals at the print business.

Catalysts:

Capital Structure:  I expect 21^st Century Fox to increase their leverage at some point and use the funds to accelerate share repurchases.  In investor presentations Chase Carey has alluded to the fact that the standalone Fox business is overcapitalized and that they could provide more detailed information regarding future plans at the 21 Century Fox Investor Day in August.

Share Repurchases: I expect management to continue to deploy the same share repurchase strategy at 21^st Century Fox that they have been deploying to-date at the consolidated entity.  I also expect “new” News Corp to repurchase shares, especially if the valuation is cheap post-spin.  “New” News Corp will be spun with a $500m share repurchase authorization.

Minority Stakes:  I expect management to continue to reduce non-strategic minority stakes, and that the reduced complexity will help drive multiple expansion.

Catalyst

Catalysts:

Capital Structure:  I expect 21^st Century Fox to increase their leverage at some point and use the funds to accelerate share repurchases.  In investor presentations Chase Carey has alluded to the fact that the standalone Fox business is overcapitalized and that they could provide more detailed information regarding future plans at the 21 Century Fox Investor Day in August.

Share Repurchases: I expect management to continue to deploy the same share repurchase strategy at 21^st Century Fox that they have been deploying to-date at the consolidated entity.  I also expect “new” News Corp to repurchase shares, especially if the valuation is cheap post-spin.  “New” News Corp will be spun with a $500m share repurchase authorization.

Minority Stakes:  I expect management to continue to reduce non-strategic minority stakes, and that the reduced complexity will help drive multiple expansion.