Description

Recommendation: Long “Core” News Corp (created by shorting 0.138 shares of REA AU per share of NWS or NWSA)

Overview: As described in eremita’s March 2015 write-up, News Corp (“NWSA”) is an assortment of media assets (predominantly located in the US, Australia, and UK) created through a spin-off transaction in June 2013.  NWSA’s largest single asset is its 61.6% stake in REA Group, an Australian publicly traded real estate property portal.  While NWSA has traded down a modest 12% since the spin, REA’s robust share price performance (up 97% over the same time frame) has driven “Core” News Corp’s price down 35%.  Given REA’s demanding valuation (19x EV/NTM consensus EBITDA) and our concerns regarding the health of the Australian residential real estate market, we recommend shorting 0.138 shares of REA AU per share of NWS to create “Core” News Corp (“CNWS” or “the Company”).  While some of the businesses within CNWS face challenges, we think News Corp’s compelling valuation more than discounts these.  In an environment of broadly elevated valuations, we believe the Company represents compelling absolute and relative value trading at 2.5x EV/EBITDA and 0.8x tangible book, with potential catalysts to help narrow the discount to fair value.

We believe that the Company’s operating businesses trade at roughly 35 cents on the dollar vs. intrinsic value (over 60% of the CNWS’ current value is cash and investments, including Move at cost), with greater upside to their private market valuations.  

The remainder of this write-up will focus on addressing a few common investor misconceptions we've encountered regarding the Company, developments since eremita’s write-up (we refer readers to that write-up for more discussion of the various businesses), and potential catalysts.

Investor Misconception #1: “Isn’t News Corp just a newspaper business?”

While investors commonly view News Corp as a dying newspaper business, the reality today is very different, with the vast majority of the Company’s value represented by attractive global media and digital assets, supported by several mature, highly cash-flow generative legacy franchises.  In fact, the high-profile US, UK and Australian tabloid papers that often receive the most media and analyst attention represent an irrelevant 2% of News Corp’s overall value (while many of these papers are breakeven or lossmaking, we’d note that the largest papers in both the UK and Australia and the NY Post are all likely to have substantial private market value), while the Dow Jones / Wall Street Journal segment is a significantly more attractive franchise with growing EBITDA.

Instead, the majority of the Company’s value is comprised of its cash balance and operating businesses with much more attractive prospects and cash flows:

We’d note that the private market value of the CNWS’ assets likely approaches $25 per share (over 300% upside), driven by valuation upside at the WSJ, other papers and Move.  The FT, which is ~20% the size of the WSJ from a circulation perspective, recently sold for $1.2 billion or 31x EBIT.

This headline stigma of exposure to newspapers is leading the higher quality businesses at CNWS to be valued well below where even pure-play legacy newspaper assets trade, much less more appropriately comparable media assets accorded significantly higher multiples.

We can discuss individual valuation assumptions for each business line in the questions section but we believe the aggregate discount is unwarranted.

Investor Misconception #2: “Isn’t this just undervalued because of Rupert Murdoch’s involvement? Murdoch entities always trade at big discounts…”

While Rupert Murdoch’s control at News Corp is often cited as a qualitative reason by investors to ignore the name, in actuality, the discount being applied by the market to News Corp today is dislocated in comparison to the company’s history, other Murdoch entities, as well as holding company structures in general (often with far worse governance and track records).

Before News Corp separated out its Fox assets several years ago, it had a far more complex asset base and more opaque governance structure, yet still traded on average at a percent discount to its net asset value in the 20’s, far less than CNWS’ implied ~45% discount today.

Following the improving governance and capital allocation demonstrated by the announced separation of News Corp and Fox, that discount almost entirely disappeared.

Old News Corp EV / EBITDA Discount Versus Peers

Another interesting comparable to put News Corp’s discounted valuation into perspective is looking at publicly listed family holding companies.  Despite News Corp being better situated from a governance and capital allocation standpoint than most, family holding companies currently trade at an average percentage discount to net asset value in the high-teens, far less than the current discount at News Corp. In fact, looking back historically, the last period of time when family holding companies approached the current discount at News Corp was at the height of the financial crisis, obviously a very different market environment.

Investor Misconception #3: “It sounds extremely undervalued, but won’t it just stay that way?”

The most significant near-term catalyst is the potential restructuring and public listing of CNWS’ Australian media assets, which has been reported on in the Australian press. CNWS jointly owns its Foxtel pay TV subsidiary with Australia telecom company Telstra through a JV (so Foxtel’s significant operating profit is not consolidated into News Corp’s headline results).  With Telstra looking for liquidity in a non-core segment, and News Corp seeking to better highlight the value of its media assets, the two companies have been exploring a transaction that would merge Foxtel and News Corp’s sports network business, and then list the combined entity on the Australian exchange.  Similar the current REA structure, we think this combining and listing would align these attractive assets with the Australian investor base most suited to properly valuing them.  Press reports suggest that the listing could occur as early as Q1 2017 with initial price discussions contemplating values for this asset alone that are in excess of AUD $9 billion.  With the majority of this value accruing to News Corp, a Foxtel IPO would be highly significant in highlighting asset value at CNWS, which has a market cap of USD $4.7 billion ($1.5 billion excluding cash, investments and Move).

Since eremita’s write-up, News Corp has demonstrated its willingness to exit underperforming businesses by winding down its Amplify education content subsidiary.  We also see opportunities for the company to monetize additional non-core assets, in particular the News America Marketing segment. While this segment had been tied up in a lawsuit for several years, the case was settled earlier this year, allowing the unit to be potentially divested.  With the only competitor in the space taken private in an LBO a few years ago, we think this business would be an excellent candidate for private equity.

There are also significant operational catalysts, particularly at News Corp’s Move online real-estate segment. News Corp acquired Move at a valuation of approximately $950 million in 2014. The segment initially undertook significant growth investment (as a result growing traffic approximately 60% and taking share from Zillow), and as revenue has scaled is now inflecting into profitability (including stock compensation as an expense, unlike most internet peers).  As this becomes apparent in headline financials, we believe investors will begin to ascribe more value to this segment.  Incidentally, both Zillow’s current market valuation and the price at which it acquired Trulia would imply a valuation for Move approaching $3 billion versus the negligible value implied by the current CNWS stock price.

We also see a potential upcoming catalyst from currency impacts.  While the depreciation of the Australian Dollar last year had a negative impact on the company’s headline revenue growth, creating modeling complexity and reinforcing investors’ misplaced biases about the business, given the recent stabilization and positive inflection in the currency this has now become a tailwind for headline growth.

Investor misconceptions have led “Core” News Corp to trade at a significant discount to the fundamental value of its attractive asset base, and with a number of catalysts approaching, we believe the security presents a compelling risk-reward.

Risks:

Increasing competitive intensity in the Australian pay-TV market

Inherent cyclicality of advertising spending

Foreign exchange – the company has a significant percentage of its assets denominated in AUD or GBP; this can be easily hedged

Catalyst

Potential Foxtel/FoxSports transaction

Non-core asset divestitures

Ongoing profitability mix shift from challenged newspapers to higher multiple publishing and digital assets

More aggressive capital return