By
Richard MacDonald
:
The article below details how the News of the World scandal
impacts News Corp.'s (
NWS
) value
.
|
Current Price per share
|
Net debt (cash) per share
|
Current Price + Net Debt=Enterprise Value
|
|
$16.07
|
1.41
|
$17.48
|
Investment Conclusion
Dead Money Until Serious Questions Are
Resolved
For shareholders, no good can come of the utterly unnecessary
self-inflicted wound involving widespread and seemingly
indiscriminate phone hacking at the News of the World (and now
apparently the venerable broadsheet The Sunday Times) of
politicians, celebrities, dead soldiers and murder victims. Without
question, the revelations and subsequent penalties either criminal,
civil or strategic will impair earnings performance, earnings
multiples and asset value for who knows how long.
We do not expect any upside in the shares until the issues
surrounding the News of the World scandal play out--this despite an
announced $3.2 billion increase in a planned share repurchase
program to $5 billion this year. The company has the capacity to
comfortably execute the repurchase program--net debt of $1.41 a
share as of the latest quarter - most of its $15 billion in debt is
in very long maturities and it has $11 billion in cash--but the
size of repurchase program is a concession that the BSkyB
(BSYBF.PK) project is dead. At the same time, the return of $5
billion while beneficial is only likely to cushion a decline in the
shares, not reverse its course.
Still, we feel betrayed by a management who we have followed for
decades with admiration. The good news is we believe the company
can find a way out of this mess and become something quite
different. Aggressive hard hitting journalism has been at the root
of this company's culture since its inception. There is nothing
illegal or immoral about it. However, what happened at News
International went beyond aggressive journalism and was illegal,
immoral and unnecessary to achieving the strategic goals of the
company. And a damn shame!
Why All This Matters
Consequences of the Scandal
Ok, a few people got hacked--why does this matter--aside from
potential criminal liability? Those particular consequences are
completely unpredictable. But the damage there will be in earnings,
loss of strategic opportunity, possible contagion in News' US
businesses and reputation lost.
Penalty to Earnings.
In terms of numbers, it is hard to estimate the impact of the
shut down of the News of the World but it is clearly negative. (In
our view it seems unlikely that The Sunday Times will meet the same
fate.) Presumably there will be redundancy costs for 200 or so
people let go. Then there will be the loss of income for the
closure. Reportedly the Sun--a six day a week tabloid--will launch
on Sunday, and there will be costs associated with that. The other
tabloids in the market will seize, no doubt, the opportunity to
move into the Sunday market. And presumably there will be fierce
cover price discounting which will damage operating income. But
News should prevail, because it is the most financially robust of
the companies in that market.
Strategic Consequences.
NWSA has withdrawn its offer to consolidate the 60% of British
Sky Broadcasting that it does not own. While full ownership of
BSkyB (LON: BSY: GBP 673.88 52 week hi-lo:
663.50 - 850.77 ) would bring cash flow on the income statement, it
would not immediately have boosted asset values or earnings in the
near term. In the long term, consolidating BSkyB was central to the
company's global strategic objectives of owning leading positions
in electronic media worldwide.
Before the scandals, News was in a terrific position to
consolidate BSkyB because of its existing ownership and commitment
to the enterprise. Full ownership would have allowed the company to
further accelerate BSkyB's evolution. Now, as an unconsolidated
sub, the ability of the company to grow BSkyB and to create
benefits across the full portfolio of News' business continues to
be limited.
The Contagion Effect.
Of course, great risk also exists/existed in a possible
contagion effect on News' US Broadcast assets if the scandal widens
or if the OFCOM (the British Media Regulator) had declined to allow
the buyout of BSkyB because of the scandal. If it had deemed the
company no longer a fit person to own a UK broadcast property, then
the FCC might still come under similar pressure to scrutinize News
Corp.'s US activities in its oversight of the broadcast operations.
Fair and balanced had frankly better be the case without any phone
hacking or other illegal or unethical tactics.
Damage to the Company's and Mr. Murdoch's
Reputation.
Finally, the scandal matters because News Corp., and
particularly Mr. Murdoch, has spent the last thirty years trying to
convince the investment community to accept News as a blue chip
diversified media company. For the most part he had succeeded. The
scandal which has now widened to include The Sunday Times (after
further disgusting allegations about fraudulent requests for
information about former prime minister Gordon Brown's accounts at
Abbey National Bank) seems for the moment boundless and to have
undermined practically all of that 30-year effort.
Target Prices.
Enterprise Value of $21.49
We believe that News is still at the top end of its potential
target range even before considering the impact of the scandal on
earnings. We first look at asset values based on long term
projections of free cash flow discounted back to the present,
subtract debt and add back investments.
Based on historic growth in earnings and free cash flow, (and
not factoring in the shutdown of either NOTW or the recent sale of
MySpace) our estimate of the private market value for News at the
mid point for terminal value and discount rate based on publicly
estimated beta is $21.49. It also does not include BSkyB on a
consolidated basis and does not account for its ownership at about
$2 per share at current prices.
Arguably, however, these are still generous multiples given the
mix of the company's business and the decreasing predictably of its
earnings.
|
Enterprise value
|
|
Terminal Value
|
|
|
Discount rate
|
10
|
12.5
|
15
|
|
18.10%
|
$17.71
|
$20.23
|
$22.75
|
|
16.85%
|
$18.77
|
$21.49
|
$24.20
|
|
15.60%
|
$19.92
|
$22.85
|
$25.78
|
At current prices the shares are trading about a 30% discount.
This is an intriguing but not compelling discount. We like to see
somewhere around a 50% discount before getting excited. Moreover,
the Murdoch family clearly intends to retain control of this
company as it has for sixty years.
As we pointed out, the company's substantial cash position and
long term debt with very long term maturities is sufficient to
execute a $5 billion share repurchase plan this year. It is not
enough to take the company private without new debt. It is doubtful
that the family could raise that kind of debt from public markets
under the current cloud of scandal and liability. (If the family
does not tender its shares it will increase its interest and
control of the enterprise in any case without paying a substantial
premium.) Therefore there is no possible strategic event likely to
happen which could realize the full value of this company.
Certainly not at current prices.
Earnings Performance and Multiples.
Historically, News has grown very rapidly, if inconsistently.
Here are the five and ten year compound average growth rates.
|
Period
|
Sales
|
EBIT
|
Depreciation
|
Total Net Income
|
EPS
|
EBITDA
|
|
10 years
|
6.09%
|
NM
|
6.62%
|
16.98%
|
14.99%
|
24.86%
|
|
5 years
|
5.29%
|
-5.48%
|
8.86%
|
-2.02%
|
2.20%
|
-2.74%
|
While the company's television interests around the
globe--particularly the US cable networks--have grown rapidly, the
acquisition of Dow Jones and MySpace have weighed on earnings
during that time. The newspaper publishing business has lagged on a
fundamental basis in both the UK and Australia, but currency
translations have been favorable to earnings.
We projected future earnings based on historical sales growth
and margins. We have not talked to the company about projections
because historic performance seems frankly the best guidance for an
enterprise that has been run by the same management for sixty
years. Our model, by its nature quite mechanical, however seems to
produce estimates close to current consensus estimates by major
Wall Street brokerages as reported on Google. Here are the
projections.
|
EPS
|
Earnings per share current and projected based on
extrapolation of historic sales and margins
|
Consensus EPS
|
Annual estimate based on prior quarter (point or
tangential estimate)
|
|
Prior Year
|
$1.11
|
|
|
|
Current year
|
$1.13
|
$1.12
|
$1.09
|
|
Next year
|
$1.20
|
$1.33
|
$1.48
|
|
|
|
|
|
|
EPS Historic Growth
Rate
|
14.99%
|
|
|
|
EPS Projected 5 year Growth Rate
|
7.21%
|
|
|
Here are the price earnings multiples:
|
P/E
|
based on extrapolation of historic sales and margins
|
based on consensus EPS
|
based on prior quarters (point or tangential estimate)
|
|
Prior Year
|
14.43
|
|
|
|
Current year
|
14.26
|
14.35
|
14.72
|
|
Next year
|
13.37
|
12.08
|
10.83
|
The company's multiple of earnings has been declining since
2005. This reflects the decline in overall equity valuations and a
decline in media valuations because of increased competition from
new media for advertiser dollars and paid entertainment purchases.
To some it may also have reflected the company's determination to
expand rapidly through acquisitions like Dow Jones and BSkyB.
Frankly, this is the way Mr. Murdoch has expanded his business for
sixty years. Investors should not have expectations that he will
proceed any differently in the future.
Target prices based on a median multiple of 18.82 during the
whole period. The median however is higher than than the high end
of the last two years.
Here are the target prices and subsequent returns based on these
projections.
|
Target price
|
based on extrapolation of historic sales and
margins
|
based on consensus EPS
|
based on prior quarter's annualized EPS
|
|
Prior Year
|
$17.46
|
|
|
|
Current year
|
$17.73
|
$17.62
|
$17.18
|
|
Next year
|
$18.91
|
$20.92
|
$23.34
|
|
|
|
|
|
|
Total return from current price
|
|
|
|
|
Prior Year
|
4.25%
|
|
|
|
Current year
|
7.54%
|
6.86%
|
4.23%
|
|
Next year
|
14.55%
|
26.59%
|
41.01%
|
We just don't see further upside from current prices. We think
that consensus earnings estimates for next year are very high and
will be brought down significantly once the impact of the scandal
is incorporated. We also believe that the company's latest earnings
report reflected a number of one-time positives that distorted the
model to the upside and so we do not expect this set of estimates
to be realized. Finally we think that multiples will continue to
remain in a downward trend until the impact of these long standing
and disastrous practices are investigated and resolved.
We do not own stock and don't know if we will even at lower
prices. It's hard to tell how this whole thing will play out.
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours.
See also
21Vianet: Good Margins Along With Risky Outsourcing
Contracts
on seekingalpha.com