News Corp Looking At Yahoo?

News Corporation has sat out this week's rally, falling about 2%. I think the problem is fear over a bid for Yahoo. These fears persist despite very strong denials of interest from Rupert Murdoch and Peter Chernin on the quarterly conference call just ten days ago. The latest rumor is some sort of joint bid whereby News Corp puts Fox Interactive and a pile of cash into a new company that also contains Yahoo and another pile of cash dumped in by a private equity firm. News Corp would own a piece of the new entity, maybe around 20%. The new Yahoo/MySpace entity would outsource search to Google which would provide an immediate bump to operating income given that Google search monetizes at a substantial premium to Yahoo search.

Assuming this is a real deal, an assumption I would not make, and that the Google search deal would pass regulatory muster, another assumption I would not make, I have mixed feelings....

....On the one hand News Corp's value creation in Fox Interactive Media would be realized. Most valuation models for News Corp use EPS or EBITDA multiples. Since Fox Interactive Media, particularly MySpace, is way under earning relative to its private market value, the models are massively undervaluing News Corp.'s web assets. I've seen estimates that the overlooked value could be as much as $4 per share, not exactly small change on a $20 stock.

On the other hand, I have become much more positive about the ability of MySpace to monetize its traffic. The Google search deal is guaranteed for another two plus years. Display advertising is definitely ramping thanks to the new hyper targeting initiatives.

The question is whether MySpace can ever generate enough operating profit to justify the multibillion dollar private market value that exists today. In other words, would you rather have 20% of a larger entity with recognizable value today or 100% of an asset with a potentially significant higher value in five to ten years? Of course, this assumes that Yahoo is worth something significant today and that it will grow in the future.

I'm honestly not sure where I come down. If forced to choose, I'd take 100% of Fox Interactive. One thing I do know is that this is a sideshow to the momentum that exists across News Corp's asset base including the cable networks, SkyItalia, and MySpace. And that momentum is being hidden by heavy investments in the UK newspapers, Eastern European TV, Fox Business News, the Big Network and dilution form the Dow Jones acquisition.

The bottom line is that the Yahoo rumors are giving investors a great shot to buy News Corp cheap. Disney is up 2% on the year. News Corp is down 6%. Opportunity is knocking at News Corp.

Good News Corp

News Corporation reported excellent third quarter beating consensus estimates on EPS, revenue, and operating income. Strength was virtually across the board with every segment beating estimates on the operating income line. Topping off the good news, operating income growth guidance was raised from low teens to mid teens.

On the call management addressed the two most pressing short-term issues for the stock. First, Rupert Murdoch said that NWS is "definitely not making a bid for Yahoo." Just to be extra clear, COO Peter Chernin repeated Rupert's comment. Second, Chernin said that Google should not have been surprised by the profitability of their MySpace deal as it was on target with initial projections.

The only question left for the bulls is that even the higher guidance assumes a significant slowdown in the second half of the company's fiscal year. Halfway through FY08, operating income has grown 24%, yet the upwardly revised guidance is only mid teens. The math suggests that implied growth in 2H08 is upper single digits. Personally, I think they are just being exceptionally conservative in light of the continuing uncertainty about the US economy which seems particularly worrisome to Rupert Murdoch.

The bottom line is that NWS will likely beat and raise again next quarter. The shares deserve to trade much higher and the just reported quarter and commentary should provide an immediate boost. NWS is the best positioned large cap media stock for long side investors over the next year.

In 2Q08, NWS reported adjusted EPS of 32 cents, comfortably ahead of the consensus of 27 cents. Revenues of $8.59 billion beat consensus of $8.24 billion. Operating income grew by 24% vs. expectations of 9% growth. Every segment but Other comfortably beat its operating income estimate. Revenues were better than expected in Cable Networks, SkyItalia, Newspapers, and Other. In Other Fox Interactive Media, which includes MySpace, had revenue growth of 87% and showed an operating profit of $47 million vs. a loss of $11 million a year ago....

....Growth drivers in the quarter included exceptional results in Television where strong ratings and advertising at Fox Network led the profit boost. Filmed Entertainment was down year over year but results were significantly better than expected driven by higher than expected DVD sales which led to favorable shift in margins. SkyItalia continued to show operating leverage inherent in its fixed cost model now that subscriber growth has accelerated. Newspapers got a boost from surprisingly strong 7% advertising growth in Australia. Foreign currency translation also gave the Newspapers a boost such that the segment had 15% operating income growth vs. low single digit consensus expectations.

Looking ahead, management noted that there are several near-term growth drivers. At the studio, the theatrical success of Alvin and the Chipmunks and Juno will drive DVD sales. Both films had low production costs and will be very profitable. TV stations will benefit from political advertising which will really ramp as the November election approach. Newspapers will begin to see the savings of the new plant in the UK in the June quarter. This has been a drag in 1H08. MySpace will continue to ramp thanks to the guaranteed revenues from Google and initial success with hyper targeting of display ads.

It is rare to find a company as diversified as NWS firing on all cylinders while also absorbing significant investment spending. This scenario is great for investors as the investment spending should extend the growth profile of the company. Fox Business Channel, the Big Ten Network, TV stations in Turkey, Poland, and Serbia, Dow Jones, and Fox Interactive are all potential contributors to long-term growth that are a drag on current earnings growth. Nevertheless, operating income growth in 2008 and 2009 should be in at least the upper teens. NWS shares are an exceptional value at current value prices.

News Corp Earnings Preview: Expect Good News

I anticipate a strong quarter from News Corporation after the close on Monday and a positive reaction from the market. The stock jumped 3% on Friday as investors began to look ahead to earnings and considered the impact of the Yahoo-Microsoft deal on MySpace. I think plenty of upside remains in the near-term and long-term and would be long heading into the report as a trade and an investment.

NWS is expected to report 2Q08 results of 27 cents on revenues of $8.24 billion. EPS are expected to grow by 4$ on a 5% increase in revenue. The all important operating income line is expected to grow by 9-10%. This will be the lowest growth of the year for operating income with a substantial acceleration expected in the next two quarters. It is this acceleration which is expected to continue in the company's 2009 fiscal year starting July 1st that attracts me to the shares.

It is always best to analyze the big entertainment conglomerates on a segment basis. Here is a breakdown of expectations with brief highlights for the most important segments. In parentheses is the estimated revenue growth and operating income growth (rev %/op inc %)....

Cable Networks (+19%/+13%): Rising affiliate fees at Fox News and a strong advertising market will drive growth but margins will be pressured by developments costs at Fox Business Channel and the Big Ten Network. Winding down of development costs will lead to accelerating growth in this segment in future quarters.

Newspapers (+7%/-2%): Accelerated depreciation and other expenses related to a new headquarters building in the UK will pressure margins. Currency translation will help. Dow Jones closed with a few weeks left in the quarter and may distort the numbers. Newspapers are poised for accelerating growth as the headquarters impact disappears. I think DJ may prove less dilutive than expected which could also help this segment in 2008.

Other/Fox Interactive (+20%/$24 million profit versus breakeven): My Space should see a significant swing of $50 million in profits which will be partially offset by increased expenses to develop TV stations in Eastern Europe. Google mentioned some issues with social networking sites on its conference call but I am not sure if that flows through to MySpace results or not. My confidence about monetization of MySpace increased over the past few months which is a major reason I decided to purchase NWS.

Filmed Entertainment (-11%/-18%): Tough comparisons in box office and DVD will cause a big drop in this segment that is dragging down the overall growth rate of the company this quarter. Last year, there were two big holiday films vs. just one this year. In DVDS, last year had three strong selling titles versus just one this year. DVD comps are compounded by a weaker and crowded DVD market this year.

Television: (+2%/+65%): Much improved profitability at FOX Network due to strong ratings, a healthy advertising market and the removal of a low margin baseball contract are the reason for the highly favorable operating income comparison. Reduced losses at MyTV will also help. The TV stations face a tough comparison due to political spending a year ago. The impact of the writer's strike is anybody's guess.

Satellite (+20%/ profits vs. losses): Operating leverage is working in favor of SkyItalia now that the business has turned around and sub growth remains strong. Subs should grow by at least 100,000 and losses of $12 million a year ago should turn to profits of $40 million this year. Plenty of upside remains as margins are under 5% this quarter. SkyItalia will be a significant growth drive in 2008 and 2009...

News Corporation December Quarter Preview

I anticipate a strong quarter from News Corporation after the close on Monday and a positive reaction from the market. The stock jumped 3% on Friday as investors began to look ahead to earnings and considered the impact of the Yahoo-Microsoft deal on MySpace. I think plenty of upside remains in the near-term and long-term and would be long heading into the report as a trade and an investment.

NWS is expected to report 2Q08 results of 27 cents on revenues of $8.24 billion. EPS are expected to grow by 4$ on a 5% increase in revenue. The all important operating income line is expected to grow by 9-10%. This will be the lowest growth of the year for operating income with a substantial acceleration expected in the next two quarters. It is this acceleration which is expected to continue in the company's 2009 fiscal year starting July 1st that attracts me to the shares.

It is always best to analyze the big entertainment conglomerates on a segment basis. Here is a breakdown of expectations with brief highlights for the most important segments. In parentheses is the estimated revenue growth and operating income growth (rev %/op inc %)....

....Cable Networks (+19%/+13%): Rising affiliate fees at Fox News and a strong advertising market will drive growth but margins will be pressured by developments costs at Fox Business Channel and the Big Ten Network. Winding down of development costs will lead to accelerating growth in this segment in future quarters.

Newspapers (+7%/-2%): Accelerated depreciation and other expenses related to a new headquarters building in the UK will pressure margins. Currency translation will help. Dow Jones closed with a few weeks left in the quarter and may distort the numbers. Newspapers are poised for accelerating growth as the headquarters impact disappears. I think DJ may prove less dilutive than expected which could also help this segment in 2008.

Other/Fox Interactive (+20%/$24 million profit versus breakeven): My Space should see a significant swing of $50 million in profits which will be partially offset by increased expenses to develop TV stations in Eastern Europe. Google mentioned some issues with social networking sites on its conference call but I am not sure if that flows through to MySpace results or not. My confidence about monetization of MySpace increased over the past few months which is a major reason I decided to purchase NWS.

Filmed Entertainment (-11%/-18%): Tough comparisons in box office and DVD will cause a big drop in this segment that is dragging down the overall growth rate of the company this quarter. Last year, there were two big holiday films vs. just one this year. In DVDS, last year had three strong selling titles versus just one this year. DVD comps are compounded by a weaker and crowded DVD market this year.

Television: (+2%/+65%): Much improved profitability at FOX Network due to strong ratings, a healthy advertising market and the removal of a low margin baseball contract are the reason for the highly favorable operating income comparison. Reduced losses at MyTV will also help. The TV stations face a tough comparison due to political spending a year ago. The impact of the writer's strike is anybody's guess.

Satellite (+20%/ profits vs. losses): Operating leverage is working in favor of SkyItalia now that the business has turned around and sub growth remains strong. Subs should grow by at least 100,000 and losses of $12 million a year ago should turn to profits of $40 million this year. Plenty of upside remains as margins are under 5% this quarter. SkyItalia will be a significant growth drive in 2008 and 2009...

Why I Bought News Corporation

Back in July, I wrote a review of News Corporation for RealMoney.com outlining the bull case. The analysis remains relevant today so in light of the purchase of News Corporation shares for Northlake clients earlier this week, I am reproducing the article so you can learn more about this new holding….

I like News Corporation because it offers the fastest earnings growth among the mega cap media stocks but trades at the same P-E multiple as its peers on 2008 earnings. Furthermore, the company is active in M&A with a decent chance for a major transaction that would unlock value in MySpace. Since the Dow Jones (DJ) deal was announced, the shares have sat out the rally giving back gains made earlier this year. I think the weakness in the shares, down 10% since late May, has set up a great buying opportunity.

Some investors are concerned about the high price being paid for DJ and the strategic implications of the deal. However, I think they are overlooking NWS's recent announcements of asset sales (TV stations and Eastern European billboards) that will sell at similar premiums to DJ and finance half of the DJ deal. Additionally, the DJ deal represents just 10% of NWS market cap so I don’t view it as unusually risky even if it fails to offer the synergies that Rupert Murdoch must be expecting....

....Here is an overview of News Corporation's businesses based on 2008 estimates I compiled from a few of my favorite analysts:

Key assets include 20th Century Fox, the FOX TV Network and owned and operated TV stations, cable networks including Fox News and FX, Sky Italia, newspapers in the UK and Australia, and Fox Interactive Media which includes MySpace and is included in Other.

The bull case for NWS is pretty simple. As can be seen in the following table, NWS will have by far the fastest earnings growth among the megacap diversified entertainment conglomerates but the stock trades at the same multiple as the rest of the group:

Earnings growth began to accelerate last quarter with EPS gain 24%. June quarter earnings are expected to show again of at least 26%. The earnings growth is a combination of double digit top line gains, expanding margins, and the benefits of share buybacks. Key drivers of the earnings acceleration are Sky Italia, the cable networks, and MySpace. SkyItalia is the largest satellite TV provider in Italy. Multichannel penetration in Italy is low so there is plenty of room to grow. As subscriber growth continues margins are beginning to expand sharply. NWS has seen this movie before via its investments in satellite TV in Asia, England, and Latin America. The cable networks growth is being driven mostly by sharp increases in affiliate fees at Fox News. Recent deals reached with major cable operators like Time Warner (TWX) and Comcast (CMCSA) have tripled the monthly fee they pay NWS for each subscriber and bring the fee to levels long enjoyed by CNN. MySpace is benefiting from its multi-year deal with Google (GOOG) and additional monetization efforts on the heavily trafficked site.

NWS has the same combination of revenue growth, margin expansion, and share repurchase that investors have been rewarding at DIS which has risen 130% from the fall 2002 lows. NWS shares have enjoyed similar performance although the company has not had three years of consistent double digit operating income growth like DIS. Instead, I think that NWS share gains have been driven by the re-orienting of the asset portfolio toward higher long-term growth. Therefore, I think that as NWS replaces DIS as the fastest growing entertainment conglomerate the P-E multiple should expand driving significant further gains in the stock price.

One other factor supporting higher share prices is that the private market value of the company is well above current trading values if recent deal multiples are applied to the company's operations. NWS has a balanced mix of content and distribution assets that don’t seem likely to change much regardless of the outcome of the DJ takeover attempt. In fact, I think it is more likely that the asset base is rationalized via more divestitures like the TV stations, Eastern European billboards, and the DirecTV (DTV) divestiture in the deal with Liberty Capital (LCAPA). Next up could be a deal to merge MySpace into Yahoo! (YHOO) or something similar. Each of these deals simplifies NWS's capital structure and reaffirms underlying asset value making it easier for investors to reward the industry leading earnings growth.