21st Century Fox is a global media conglomerate with strong and in our opinion durable competitive advantage in both content creation (film and TV studios) and content distribution (cable network assets, Hulu stake).
We believe, that despite ongoing shift to online and over-the-top (OTT) services, there remains a place for media companies such as Fox that are investing at scale in producing compelling content that consumers demand. Value, we believe, will continue to accrue to content creators and content distributors in proportion to the quality and value that they bring to the consumer. The relationship is one of competition as well as inter-dependence.
Whilst the networks and cable in the US will see continued subscriber attrition, we believe that attrition will ultimately stability at low single digit number per year, which will largely bet offset by price increases in affiliate fees and advertising. Tobacco companies have shown that profit growth is possible even in declining volume environment. In 2016, FOX continued to experience growth in both affiliate fee revenue and advertising revenue.
Scale continues to matter, Fox broadcast network reaches over 110 million households in the U.S. FOX also has a large international cable channel segment with over 500 channels reaching 1+ billion households in 170+ countries. Pay-television penetration has a long runway left in many emerging countries.
Media is cash rich business with high operating leverage, with low capex requirements, and mid-20% opearing profit margins and excellent profit to cash conversion. The demand for “infotainment”, in our opinion, will continue to rise albeit across a range of TV, online and OTT channels, making it harder to monetize the content.
|Fair Value Estimate||$30-$34|
|Consider Buying Below||$21-$24|
|52 Wk range||$32.60- $23.33|
|Dividend Yield (%)||1.3%|
90% of EBITDA Income From Cable & TV
Present in over 170 Countries
Fox is buying Sky at reasonable multiple of 11.4 EV/EBITDA for 60% shake not already owned. Deal is expected to go through and be cash and EPS accretive in the first year. The deal is expected to make FOX revenue streams more diversified with direct 2 consumer subscription revenue stream making est. 30% of revenue going forward. Fox and its affiliates (Nat geo, Fox, Hulu, Star India, Sky) will have relationship with some 100mln subscribers and active users across their platforms.
We remain comfortable with the Murdoch family’s control of the company, as Murdochs have proven to be shrewd and opportunistic allocators of capital.
FOX has an established track record of successful and award winning production. Creative efforts are by their nature hard to consistently replicate and although there will be inevitable set-backs, over long periods we believe that both TV and film entertainment will prove fruitful and profitable for FOX. The growth of OTT and international syndication increases the value of wholly owning content. Despite the growth of viral and other short-form YouTube video, we expect consumers to continue to consume original long-form content, making the studios that can generate high-quality content increasingly valuable.
With the emergence of “skinny bundles” for cable subscription, FOX remains well positioned with the breath and popularity of the programming and sports (e.g. NFL, college football, MBL) to maintain its position in the bundle with cable operators and indeed grow the affiliate fees and.
FOX reported latest quarter on 10 May, 3rd quarter results showed a slight revenue miss, a small EBITDA beat (+5%) and a good EPS beat (+12%). The proposed Sky bid “remains on track”. FOX is delivering on the ongoing $3.1bn buyback programme (6.0% of market cap). FOX share count is expected to drop from 2.5bln in 2012 to 1.85bln by 2019, a whole 25% less over 7 year time horizon, benefit per share earnings. Share purchases have thus far been done at attractive prices and remain to be value accretive, in our opinion.
The short term risk to earnings is a re-acceleration of the decline in pay TV subscribers.
Feature film and television production and distribution are speculative businesses since the revenues derived from the production and distribution of a feature film or television series depend primarily upon its acceptance by the public, which is difficult to predict. The network ratings play a major role in advertising revenue as is the success of the slate of upcoming movies (Alien Covenant, Planet of the Apes).
Long-term risks include an emerging competition from on-demand players including Netflix and Amazon and strengthened traditional competitors in the wake of consolidating media sector (e.g. AT&T-TimeWarner). On-demand and emergence of “skinny bundles” poses significant thread to the existing business model of a relatively expensive cable bundle subscription. FOX continues to make progress with its own on-demand offering with Hulu, Sky, NatGeo and Fox.
FOX continues to trade on average headline multiples (8.7x 2018 EV/EBITDA, 11.5x P/E), but stripping out the stakes in Sky, Hulu, STAR India and Shine Endemol at a combined valuation of $20bn, “core” FOX trades at just 7.0x 2018 EV/EBITDA, a c30% discount to peers.
Based on 15-17 PE multiple on 2018 EPS ($2.00), we assign fair value estimate of $30-$34 for FOXA shares. For quality of assets that FOX offers, investors are aiming for at least 30% margin of safety against fair value estimate.
Required margin of safety would be reached at prices below $21-$24 a share, some 12% below current price.
- FOX has the breath and depth of popular programming content and sports, strengthening its position in the cable bundle and improving the ability to growth affiliate fees.
- FOX has number of valuable assets globally in the US, Europe and emerging countries such as India. FOX continues to growth its audience and is making progress with on-demand offering.
- Cord cutting and skinny bundles are the future for content consumption, dealing a heavy blow to FOX affiliate fee business model.
- Advertisers are shifting advertising money online, which will hurt FOX profitability given high margin of advertising fees.
- FOX is facing steep cost increases in securing the rights to exclusive content (e.g. sports), and will suffer lower profitability if it’s not able to pass on the increased content costs to cable distributors.
|Income Statement (USD, mln)|
|Reported Net Profit||3,150.68||3,703.50||4,254.66||4,528.33||4,459.00||4,459.00|
|Reported Pre-tax Profit||4,962.81||5,930.21||6,661.38||7,068.67||6,814.00||6,814.00|
|Per Share Data (USD)|
|EPS – Fully Reported||1.72||2.05||2.41||2.61||2.85||2.85|
|Dividend per Share||0.39||0.42||0.45||0.55||NA||NA|
|Per Share Data|
|Cash Flow per Share||2.30||2.38||2.85||NA||NA||NA|
|Free Cash Flow per Share||1.68||1.91||2.38||2.53||3.00||3.00|
|Balance Sheet (USD, mln)|
|Net Asset Value||15,922.55||18,844.72||19,170.17||19,651.67||17,495.00||17,495.00|
|Per Share Data (USD)|
|Book Value per Share||8.43||9.53||10.58|
|Tangible Book Value per Share||(0.23)||(1.13)||(0.68)|
|Enterprise Value (USD, mln)||61,307.13||59,506.35||57,076.90||41,890.00||37,729.00||37,729.00|
|No.||Owner’s checklist criteria||Assessment||Comments|
|1||Is the business simple and understandable?||Yes||FOX business centers on video content creation, distribution and monetization. The key sources of revenue are affiliate fees, advertising, film and TV production, and going forward direct to consumer subscription (Sky).
Costs are primarily content acquisition rights and production costs.
Competitive differentiators are quality of content impacting popularity ratings, depth and breath of content driving stickiness of consumers and cable distributors, and scale to maintain competitive costs.
|2||Does the business have a consistent operating history?||Yes||FOX has been consistently profitable, experienced relatively consistent growth of revenues and profits, driven by FOX network and movie business.|
|3||Does the business have a favorable long term prospect?||Yes||We believe that demand for infotainment will continue to increase, and quality of content will remain a key differentiator. Business will evolve with the digitization of distribution channels and emergence of number of new on-demand competitors (Amazon, Netflix)|
|4||Is management rational in capital allocation decisions?||Yes||Management has skillfully deployed capital and allocated resources including spinning off publishing business, opportunistic Sky acquisition, opportunistic offer for TimeWarner, and creation of number of affiliates (Hulu, Star India)|
|5||Is management candid with its shareholders?||Mostly yes||Management has been relatively transparent on the challenges facing the business and forthright in the acknowledging the problems (Fox News, movie production business).|
|6||Does management resist the institutional imperative?||Mostly yes||Management has remained disciplined in pursuing opportunities that fit well with company’s core competence in content creation and distribution, with bolt-on opportunistic acquisitions.|
|7||Focus on Return on Equity not Earnings per share||Yes||5 year return on equity has consistently exceeded 20% annually.|
|8||Calculates”owner earnings”||High||FOX generates high owner earnings since it generates high levels of cash with over $3bln of CFFO and has limited capital investment needs with some $0.3bln p.a. invested in propetly plant and equipment annually.|
|9||Does the company have high profit margins||Yes||FOX has operating profit of over 20%.|
|10||For every dollar retained, create at least one dollar of the market value||Yes||Yes, management has increased value of the franchise with smart M&A as well as shareholder friendly buy back programme.|
|11||What is the value of the business?||Depth and breath of TV programming, sports and movie content, and large distribution network over which its monetized (affiliate fees, advertising, box office, and direct to consumer subscription).|
|12||Can the business be purchased at a significant discount to its real value. (DCF)||Yes||Yes, FOX is worth $30-355 per share, and currently selling at $27.45, a discount of 10-20% to fair value estimate.|